Public Fiannce

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Public Finance Exam, May 2014

1. Government economic functions are promotion of: Efficiency; Equity and Stability; Please explain shortly the government’s role in each of the three fields.

1 Efficiency: A correction of market failure for defects of the guiding role of the invisible hand.

2 Equity: An equity aspect emerges when society shows its concerns for distribution of income

3 Stability: Stabilization policy attempts to smooth a growth curve.

2. One of reasons of the necessity of the government involvement in economy is market inefficiency; please explain the sources of market inefficiency.

1 Imperfect competition: An agent in a market can gain market power, allowing them to block other mutually beneficial gains from trade from occurring. This can lead to inefficiency due to imperfect competition, which can take many different forms, such as monopolies, monophonies, cartels, or monopolistic competition if the agent does not implement perfect price discrimination. 

2 Externalities: The actions of an agent can have "side effects" known as externalities, which are innate to the methods of production, or other conditions important to the market. 

3 Lack of public goods: If left to the free market mechanism, no public goods would be provided and, as a result, there would be a clear market failure. No individual consumer would pay for a product that could be consumed for free if another household decided to purchase it. 

3. There are at least two sources of market inability of efficient allocation of resources: imperfect competition and externalities; please explain using a few sentences.

1 Imperfect competition occurs because an economic reality is a blend of competitive and monopolistic elements. Imperfect competition prevails whenever the individual sellers have some measure of control over the price of the good in that industry. There are 3 levels of imperfection...