Indispensable Government Economics Notes | EduRev

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Economics : Indispensable Government Economics Notes | EduRev

 Page 1


Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 1 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subject: Public Economics 
Lesson: Indispensable Government 
Name: Vaishali Kapoor 
College/ Department: DDU, Rajdhani College, Delhi 
University 
 
  
Page 2


Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 1 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subject: Public Economics 
Lesson: Indispensable Government 
Name: Vaishali Kapoor 
College/ Department: DDU, Rajdhani College, Delhi 
University 
 
  
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 2 
 
Table of Contents 
Lesson: Crises in Capitalism 
• Learning outcomes 
• Introduction 
• Relevance of government in contemporary world 
• Major objectives 
• Allocation of social goods 
• Distribution  
• Stabilization 
• Paternalism 
• Need for government and market failures 
• Lack of competition 
• Public goods 
• Externalities 
• Incomplete markets 
• Information failures 
• Less than socially desirable outcome 
• Analyzing role of government 
• Summary 
• Exercises 
• Glossary 
• References 
 
 
  
Page 3


Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 1 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subject: Public Economics 
Lesson: Indispensable Government 
Name: Vaishali Kapoor 
College/ Department: DDU, Rajdhani College, Delhi 
University 
 
  
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 2 
 
Table of Contents 
Lesson: Crises in Capitalism 
• Learning outcomes 
• Introduction 
• Relevance of government in contemporary world 
• Major objectives 
• Allocation of social goods 
• Distribution  
• Stabilization 
• Paternalism 
• Need for government and market failures 
• Lack of competition 
• Public goods 
• Externalities 
• Incomplete markets 
• Information failures 
• Less than socially desirable outcome 
• Analyzing role of government 
• Summary 
• Exercises 
• Glossary 
• References 
 
 
  
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 3 
 
Learning outcomes: 
After you have read this chapter, you should be able to:- 
a) Describe the relevance of government actions. 
b) Explain role of government in correcting market failures. 
c) List all the market failures. 
d) State major objectives of government in an economy. 
e) Analyze the role of government. 
 
I. Introduction 
The term ‘Government’ brings to our mind, ‘group of people who govern us and work for our 
benefit’. The taxes that government levies generate revenues which are then used for 
welfare of the people, creating infrastructure, defense of the nation etc. Government 
performs functions that are indispensable for the poor, marginalized and weaker sections of 
the society. It also maintains law and order in the nation. 
 
In this chapter we will discuss role of government in an economy. This chapter is divided 
into four sections. First section explains role of government. In the second section, major 
objectives of government are discussed. Third section describes need of government in 
case market does not function properly. In the last section, tools for analysis of government 
actions are explained. 
 
II. Relevance of Government in contemporary world 
Dating back to Industrial revolution, capitalism has been predominant form of society and 
Adam Smith’s free hand of market was popularized then. The important feature of 
capitalism is private property rights i.e. the right of entrepreneur over production produced 
by workers. The enforcement of property rights rests on the government. Government 
ensures that private property is protected and property belongs to the person on whose 
name land is registered in the government records. In this case, when individual feels 
secure for the property he owns, he has incentive to work harder since rewards of such hard 
work belongs to him. Similarly, enforcement of contracts is assured and in case contracts 
are breached by either of the private party, penalty is imposed.  
 
Also, in current era of increasing financial deployment in the economies, the role of 
government is seen as inevitable. The economies have been vulnerable to crisis due to this. 
Government intervention, in case of poor functioning of markets and/or worsening macro 
stability, becomes mandatory. Government come to rescue enterprises, provide employment 
to unemployed, and reverse the falling trend of economic growth. Keynes propounded that 
government plays a vital role in fighting crisis away from the economy.  In the phase 
other than of crisis, government works for improving education and health facilities, 
reducing poverty, creating research and development etc.  
 
III. Major objectives 
The chief goal of any country’s government is the welfare of the people. This ‘welfare’ 
can be in form of supporting private agents and entities or it can be government 
Page 4


Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 1 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subject: Public Economics 
Lesson: Indispensable Government 
Name: Vaishali Kapoor 
College/ Department: DDU, Rajdhani College, Delhi 
University 
 
  
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 2 
 
Table of Contents 
Lesson: Crises in Capitalism 
• Learning outcomes 
• Introduction 
• Relevance of government in contemporary world 
• Major objectives 
• Allocation of social goods 
• Distribution  
• Stabilization 
• Paternalism 
• Need for government and market failures 
• Lack of competition 
• Public goods 
• Externalities 
• Incomplete markets 
• Information failures 
• Less than socially desirable outcome 
• Analyzing role of government 
• Summary 
• Exercises 
• Glossary 
• References 
 
 
  
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 3 
 
Learning outcomes: 
After you have read this chapter, you should be able to:- 
a) Describe the relevance of government actions. 
b) Explain role of government in correcting market failures. 
c) List all the market failures. 
d) State major objectives of government in an economy. 
e) Analyze the role of government. 
 
I. Introduction 
The term ‘Government’ brings to our mind, ‘group of people who govern us and work for our 
benefit’. The taxes that government levies generate revenues which are then used for 
welfare of the people, creating infrastructure, defense of the nation etc. Government 
performs functions that are indispensable for the poor, marginalized and weaker sections of 
the society. It also maintains law and order in the nation. 
 
In this chapter we will discuss role of government in an economy. This chapter is divided 
into four sections. First section explains role of government. In the second section, major 
objectives of government are discussed. Third section describes need of government in 
case market does not function properly. In the last section, tools for analysis of government 
actions are explained. 
 
II. Relevance of Government in contemporary world 
Dating back to Industrial revolution, capitalism has been predominant form of society and 
Adam Smith’s free hand of market was popularized then. The important feature of 
capitalism is private property rights i.e. the right of entrepreneur over production produced 
by workers. The enforcement of property rights rests on the government. Government 
ensures that private property is protected and property belongs to the person on whose 
name land is registered in the government records. In this case, when individual feels 
secure for the property he owns, he has incentive to work harder since rewards of such hard 
work belongs to him. Similarly, enforcement of contracts is assured and in case contracts 
are breached by either of the private party, penalty is imposed.  
 
Also, in current era of increasing financial deployment in the economies, the role of 
government is seen as inevitable. The economies have been vulnerable to crisis due to this. 
Government intervention, in case of poor functioning of markets and/or worsening macro 
stability, becomes mandatory. Government come to rescue enterprises, provide employment 
to unemployed, and reverse the falling trend of economic growth. Keynes propounded that 
government plays a vital role in fighting crisis away from the economy.  In the phase 
other than of crisis, government works for improving education and health facilities, 
reducing poverty, creating research and development etc.  
 
III. Major objectives 
The chief goal of any country’s government is the welfare of the people. This ‘welfare’ 
can be in form of supporting private agents and entities or it can be government 
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 4 
 
expanding its activities; but with the motto that lives of the people will be made better. 
Government set objectives for the economy, design policies, levy tax, make 
expenditures, and allocate budget to achieve aforesaid objectives. Following are the 
objectives that a government tries to achieve: 
 
III.1 Allocation of social goods 
Government’s first objective is allocating goods; wherein ‘allocation’ refers to 
provisioning of the goods. But the question arises: can’t private entities produce 
and provide goods in the economy. The answer is partly yes; private entities do 
produce and sell it in the market to the consumers. The problem lies in the 
provisioning of social goods. Before we proceed on, we need to understand the 
characteristics of social goods. 
 
The characteristics of the social goods are: 
a) Non – rivalry: if individual ‘A’ watches Zee News channel it doesn’t obstruct 
any other consumer from watching it. Hence ‘A’ wouldn’t face any rivalry from 
any other individual. Instead, assume T.V. sets’ consumption. If ‘A’ buys T.V. 
set, it will not be available to somebody say ‘B’. Here, consumption of T.V. set 
by ‘A’ stands in rival consumption to that of ‘B’. 
 
b) Non- excludability: if ‘A’ drives car on a particular road or sits in the park, 
‘A’ can’t exclude everyone /anyone from doing the same. If ‘A’ enjoys ride in 
his car, ‘A’ can exclude all other from this ride. 
 
From the benefit point of view, one can review non-rivalry and excludability. 
Non-rivalry means one’s consumption doesn’t reduce benefit of others and 
non-excludability means one can’t exclude anyone from partaking in the 
benefits. 
 
Given these characteristics, private players either don’t provide social goods 
or if they do, they do under-provide. The intuition behind this is: say if a 
street light is to be provided then seller should sell it to whom? Many people 
residing in that street will be benefitted. How will benefiters pay price? How 
can this benefit be measured? Wouldn’t everyone be revealing their 
preferences in a way that they pay less than the benefit they benefit from 
street light? No single individual will pay the price for it. The reason is that 
benefits are shared with others, all others can’t be excluded from the benefit 
and price paid by him would be higher than the benefit he receives.  
 
If it is announced that everyone who benefits from the provisioning of social 
good would pay their contribution, then everyone would tend to pay less and 
free ride i.e. enjoy good for which others have paid.  
 
 
 
 
 
 
 
 
Milk pond 
It is one of the Akbar Birbal story. 
Once, Akbar, the king, wished to see a pond full of milk. Akbar 
instructed his people that a person from each household should pour a 
glass of milk in the midnight; so that Akbar can see pond full of milk in 
the morning. But in the morning, everyone discovered that pond was 
filled only of water. Everyone actually poured water thinking that 
‘everyone else will do it’. This can be seen as free rider problem as 
everyone else tried to free ride on the cost of others. 
Page 5


Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 1 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subject: Public Economics 
Lesson: Indispensable Government 
Name: Vaishali Kapoor 
College/ Department: DDU, Rajdhani College, Delhi 
University 
 
  
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 2 
 
Table of Contents 
Lesson: Crises in Capitalism 
• Learning outcomes 
• Introduction 
• Relevance of government in contemporary world 
• Major objectives 
• Allocation of social goods 
• Distribution  
• Stabilization 
• Paternalism 
• Need for government and market failures 
• Lack of competition 
• Public goods 
• Externalities 
• Incomplete markets 
• Information failures 
• Less than socially desirable outcome 
• Analyzing role of government 
• Summary 
• Exercises 
• Glossary 
• References 
 
 
  
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 3 
 
Learning outcomes: 
After you have read this chapter, you should be able to:- 
a) Describe the relevance of government actions. 
b) Explain role of government in correcting market failures. 
c) List all the market failures. 
d) State major objectives of government in an economy. 
e) Analyze the role of government. 
 
I. Introduction 
The term ‘Government’ brings to our mind, ‘group of people who govern us and work for our 
benefit’. The taxes that government levies generate revenues which are then used for 
welfare of the people, creating infrastructure, defense of the nation etc. Government 
performs functions that are indispensable for the poor, marginalized and weaker sections of 
the society. It also maintains law and order in the nation. 
 
In this chapter we will discuss role of government in an economy. This chapter is divided 
into four sections. First section explains role of government. In the second section, major 
objectives of government are discussed. Third section describes need of government in 
case market does not function properly. In the last section, tools for analysis of government 
actions are explained. 
 
II. Relevance of Government in contemporary world 
Dating back to Industrial revolution, capitalism has been predominant form of society and 
Adam Smith’s free hand of market was popularized then. The important feature of 
capitalism is private property rights i.e. the right of entrepreneur over production produced 
by workers. The enforcement of property rights rests on the government. Government 
ensures that private property is protected and property belongs to the person on whose 
name land is registered in the government records. In this case, when individual feels 
secure for the property he owns, he has incentive to work harder since rewards of such hard 
work belongs to him. Similarly, enforcement of contracts is assured and in case contracts 
are breached by either of the private party, penalty is imposed.  
 
Also, in current era of increasing financial deployment in the economies, the role of 
government is seen as inevitable. The economies have been vulnerable to crisis due to this. 
Government intervention, in case of poor functioning of markets and/or worsening macro 
stability, becomes mandatory. Government come to rescue enterprises, provide employment 
to unemployed, and reverse the falling trend of economic growth. Keynes propounded that 
government plays a vital role in fighting crisis away from the economy.  In the phase 
other than of crisis, government works for improving education and health facilities, 
reducing poverty, creating research and development etc.  
 
III. Major objectives 
The chief goal of any country’s government is the welfare of the people. This ‘welfare’ 
can be in form of supporting private agents and entities or it can be government 
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 4 
 
expanding its activities; but with the motto that lives of the people will be made better. 
Government set objectives for the economy, design policies, levy tax, make 
expenditures, and allocate budget to achieve aforesaid objectives. Following are the 
objectives that a government tries to achieve: 
 
III.1 Allocation of social goods 
Government’s first objective is allocating goods; wherein ‘allocation’ refers to 
provisioning of the goods. But the question arises: can’t private entities produce 
and provide goods in the economy. The answer is partly yes; private entities do 
produce and sell it in the market to the consumers. The problem lies in the 
provisioning of social goods. Before we proceed on, we need to understand the 
characteristics of social goods. 
 
The characteristics of the social goods are: 
a) Non – rivalry: if individual ‘A’ watches Zee News channel it doesn’t obstruct 
any other consumer from watching it. Hence ‘A’ wouldn’t face any rivalry from 
any other individual. Instead, assume T.V. sets’ consumption. If ‘A’ buys T.V. 
set, it will not be available to somebody say ‘B’. Here, consumption of T.V. set 
by ‘A’ stands in rival consumption to that of ‘B’. 
 
b) Non- excludability: if ‘A’ drives car on a particular road or sits in the park, 
‘A’ can’t exclude everyone /anyone from doing the same. If ‘A’ enjoys ride in 
his car, ‘A’ can exclude all other from this ride. 
 
From the benefit point of view, one can review non-rivalry and excludability. 
Non-rivalry means one’s consumption doesn’t reduce benefit of others and 
non-excludability means one can’t exclude anyone from partaking in the 
benefits. 
 
Given these characteristics, private players either don’t provide social goods 
or if they do, they do under-provide. The intuition behind this is: say if a 
street light is to be provided then seller should sell it to whom? Many people 
residing in that street will be benefitted. How will benefiters pay price? How 
can this benefit be measured? Wouldn’t everyone be revealing their 
preferences in a way that they pay less than the benefit they benefit from 
street light? No single individual will pay the price for it. The reason is that 
benefits are shared with others, all others can’t be excluded from the benefit 
and price paid by him would be higher than the benefit he receives.  
 
If it is announced that everyone who benefits from the provisioning of social 
good would pay their contribution, then everyone would tend to pay less and 
free ride i.e. enjoy good for which others have paid.  
 
 
 
 
 
 
 
 
Milk pond 
It is one of the Akbar Birbal story. 
Once, Akbar, the king, wished to see a pond full of milk. Akbar 
instructed his people that a person from each household should pour a 
glass of milk in the midnight; so that Akbar can see pond full of milk in 
the morning. But in the morning, everyone discovered that pond was 
filled only of water. Everyone actually poured water thinking that 
‘everyone else will do it’. This can be seen as free rider problem as 
everyone else tried to free ride on the cost of others. 
Indispensable Government 
 
                                Institute of Lifelong Learning, University of Delhi  Page 5 
 
 
 
 
 
 
 
 
Government can collect taxes and provide such goods. Tax collection can be 
based on income and wealth. The provision of social goods then, hinges on 
government. In what mix of social good and private will be provided is decided by 
government. The point to note is that government may or may not produce such 
goods but only provide. In case of street lights, street lights can be produced by 
any private player and sold to government or else can be produced in PSUs but 
only government installs it.  
 
III.2 Distribution of income 
The just or fair distribution of income within the society is imperative. In the face 
of increasing inequality, redistribution becomes an important task. Let us 
consider an example. India is a labor abundant country. If one applies market 
rule for the wage determination, it seems that unskilled and semi-skilled labour 
should be paid less and capital which is scarce should be paid high returns. Now, 
question arises, who, in India, owns capital? Capital owners have to be ‘have-
class’ and sellers of labor power are poor man. This irony of market mechanism 
itself implies that ‘rich would go richer and poor becomes poorer’. Market, though 
provides efficient outcome, outcome is less than fair and not desirable by all. 
 
The question remains: is redistribution a better outcome? Before we answer this 
question we need to understand terms like Pareto efficient and Pareto 
improvement. An outcome is Pareto efficient, if when it is achieved no Pareto 
improvement is possible. A move is Pareto improvement if it makes someone 
better off and no one is made worse off. A policy though should bring Pareto 
improvement in the economy, but redistribution decisions can’t rest on this sort 
of efficiency measurement apparatus. The fair distribution is desirable involves 
considerations of social philosophy and value judgment.  
 
Redistribution policy should be undertaken if it maximizes total happiness or 
satisfaction. For this, consider an economy where in market provides income of 
Rs. 2,00,000 to individual ‘A’ and Rs. 5,000 to ‘B’. Government has tax as a tool 
that would bring redistribution. Equal distribution would mean that ‘A’ gives 
Rs.97,500 To ‘B’ so that then each individual enjoys income of Rs. 1,02,500. A 
fair or just distribution mean a part of income is taken away from ‘A’ and given to 
‘B’. Say, Rs. 10,000 is taken away from ‘A’ and given to ‘B’. There are two points 
to note: 
a) It is fair as long as ‘B’ doesn’t envy ‘A’ and is happy with Rs.15,000 and same 
is with ‘A’. 
b) The total happiness does increase. Though ‘A’ is made worse off but his 
satisfaction lost would be greater than increase in satisfaction of ‘B’. The 
reason for the same is that at higher levels of income Rs.10,000 have lower 
levels of utility and at lower levels high utility. So there is a net gain of utility. 
 
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