Introduction to Public Finance and reasons for Government interventions in the free market

1. PUBLIC FINANCIAL MANAGEMENT
 WHAT IS PUBLIC FINANCIAL MANAGEMENT?
Public financial management (PFM) is a central element of a functioning
administration, underlying all government activities. It encompasses the
mechanisms through which public resources are collected, allocated, spent,
and accounted for. As such, PFM processes comprise the whole budget
cycle, public procurement, audit practices, and revenue collection. Sound,
transparent and accountable public financial management is a key pillar of
governance reform and of vital importance to provide public services of
good quality to citizens, as well as to create and maintain fair and
sustainable economic and social conditions in a country.

2. The Four Questions of Public Finance
When should the government intervene in the
economy?
How might the government intervene?
What is the effect of those interventions on
economic outcomes?
Why do governments choose to intervene in the
way that they do?

3. When should the government intervene in the
economy?
 Reason for government intervention:
 In an economy a series of trades between producers (firms) and consumers
take place. A trade is efficient if it makes at least one party better off without
making the other party worse off. The total efficiency of the economy is
maximized when as many efficient trades as possible are made.
 Resulting in Competitive market equilibrium which is the most efficient
outcome for society—that is, it is the outcome that maximizes the gains
from efficient trades.
 There is a free adjustment of prices that guarantees, in competitive market
equilibrium, that supply equals demand. When supply equals demand, all
trades that are valued by both producers and consumers are being made.
 Market Failures: Problems that cause a market economy to deliver an
outcome that does not maximize efficiency.
 Redistribution: The shifting of resources from some groups in society to
others.

4. How might the government intervene?
 Tax or Subsidize Private Sale or Purchase:
 1. Through taxes, which raise the price for private sales or purchases of
goods that are overproduced, or
 2. Through subsidies, which lower the price for private sales or purchases of
goods that are underproduced.
 Restrict or Mandate Private Sale or Purchase: Alternatively, the
government can directly restrict private sale or purchase of goods that are
overproduced, or mandate the private purchase of goods that are
underproduced and force individuals to buy that good.
 Public Provision: The government provide the good directly, in order to
potentially attain the level of consumption that maximizes social welfare
 Public Financing of Private Provision: Governments may want to
influence the level of consumption but may not want to directly involve
themselves in the provision of a good. In such cases, the government can
finance private entities to provide the desired level of provision.

5. What is the effect of those interventions on
economic outcomes?
 This evaluation is the focus of empirical public finance, which
involves gathering data and developing statistical models to
assess how people and firms might respond to policy
interventions.
Direct Effects: Those effects that would be predicted if
individuals did not change their behavior in response to the
interventions.
Indirect Effects: Those effects that arise only because
individuals change their behavior in response to the
interventions.

6. Why do governments choose to intervene in the
way that they do?
 Governments face enormous challenges in figuring out what the public
wants and how to choose policies that match those wants.
 In addition, governments may be motivated by much more than simply
correcting market failures or redistributing income.
 Just as there are a host of market failures that can interfere with the
welfare-maximizing outcome from the private market, there are a host
of government failures that can lead to inappropriate government
interventions.
 Politicians must consider a wide variety of viewpoints and pressures,
only two of which are the desire to design policies that maximize
economic efficiency and redistribute resources in a socially preferred
manner
 Political Economy: (How governments make public policy decisions).
The theory of how the political process produces decisions that affect
individuals and the economy.