SEC 332/BEC 432

LECTURER: M.C. MULENGA

COURSE OUTLINE
 Pre-requisites: Introduction to Micro Economics and
Macro Economics
 Course description
◦ There are fundamentally two mechanisms for the
coordination of human interaction: government or
market. When markets fail due to externalities,
monopoly, incomplete information – then enters
government. Government has two main functions:
Allocation and Distribution. The government allocates
resources either by providing goods and services itself
or by regulation of markets. The redistributive branch
of government focuses on the distribution of income
and wealth with the aim of achieving social justice.
The basic problem of the government is to devise
allocative/regulative and distributive institutions that
result in efficient outcomes.
Objectives
◦ At the end of the course, the students should be able
to:
 Understand the role of government in the economy
 Identify and analyse public sector problems
 Understand the various revenue sources of the
government.
 Know the meaning, nature, effects and theories of
public expenditure.
 Understand government budget and why the need
for budgeting.
 Know the concept of fiscal federalism and why
individual opt for a federal state.
Contents
1. The study and methodology of public finance.
1.1. The meaning and scope of public finance.
1.2. Methodology of public finance
2. Overview of Welfare Economics
2.1 The meaning of welfare economics
2.2 Criteria for optimality
2.2.1 Efficiency
2.2.2 Equity (Social justice)
3. Market failure and the rationale for Government Intervention
3.1 Market failure
3.2 Sources of Market failure: Public goods, Externalities,
Natural Monopolies, Information Asymmetry.
3.3 Functions of the public sector
3.4 Government failure.
4. Public Revenue and the Theory of Taxation
4.1 Sources of government revenue: Tax and Non-tax
4.2 Canons of taxation
4.3 Basic concepts of taxation: tax base, tax
incidence, tax burden, marginal tax rate, tax evasion
and tax avoidance, tax buoyancy and tax
elasticity, Income taxes i.e. PAYE and taxes on goods
i.e. Specific tax, Ad-valorem tax, VAT and Sales
Tax.
4.4 Classification of taxes
4.4.1. Single versus Multiple tax system
4.4.2. Direct versus Indirect taxes
4.4.3. Proportional versus progressive taxes
4.5 Principles of taxation
4.5.1. Benefit principle
4.5.2. Ability to pay principle
4.6 Zambia’s tax system
5. Public Expenditure theory
5.1 Meaning and nature of public expenditure
5.2 Theories of Public Expenditure growth
5.3 Classifications of Government Expenditures
5.4 Public Expenditure policy in Zambia
6. Public Debt
6.1 Concepts of Public debt
6.2 Need for public debt
6.3 Effects of public debt
6.4 Debt burden and debt financing
6.5 The problem of debt servicing and debt management
7. Government Budgeting
7.1 Definition of Budget
7.2 Type of budgeting; Line item Budgeting, Activity based
budgeting, Performance based Budgeting.
7.3 Budgeting process in Zambia
8. Fiscal Federalism
8.1 Definition of a federation
8.2 Federalism and basic public finance objectives
8.3 Advantages and disadvantages of decentralization
8.4 Intergovernmental grants
Course Assessment:
 Continuous assessment 40%.
 1 Tests: 10 Marks each
 2 Assignments: 15 Marks each
 Final examination 60%.
Required Readings
 Bhatia, H.L (1996): Public Finance, Vikas Publishing

House, New Delhi.

 Musgrave, R.A. and Musgrave P.B (1989): Public Finance

in Theory and Practice, Mc graw-Hill company, New York

 Hilman, A.L. (2003): Public Finance and Public policy:

Responsibilities and Limitations of Government,

Cambridge University Press, U.K.
 Human, D.N. (1996): Public Finance: A contemporary

Application of Theory to Policy, The Bryden Press,

Harcourt Brace College Publishers, New York.
 UNIT ONE:

 The Study and Methodology of Public

Finance
Why Study Public Finance?
Public Finance Defined
 Also known as “public sector economics” or “public
economics.”

 Public finance is a science that deals with the funds

raised by governments to meet the costs of
governments. It involves the raising and disbursement
of government funds.

 Public finance is about the taxing and spending

activities of the government.

 Scope of public finance unclear – government has role

in many activities, but focus will be on taxes and
spending.
Nature and Scope of Public Finance
 The study of public finance relates to financial
activities of the government including the
financial activities of the central govt. and local
govt.

 Public and Private Finance

 Public finance is concerned with the economic
activities of the govt.
 Private finance is related to finance of a person
Subject Matter of Public Finance

 The subject matter of public finance can be

divided into the following parts:

 Theory of public Revenue – This branch of public

finance is related to the study of all those sources
through which a govt. earns revenue. In it ,various
sources of govt. income, such as taxes, public debt and
deficit financing are studied.

 Theory of Public Expenditure – Problems related to

the govt. expenditure are studied in this branch of
public finance.
 Financial Administration – This branch of public
finance studies the income and expenditure of the
govt. (Budget).

Stability and Growth - In the present times, public

finance is mainly concerned with the economic
stability and other related problems of a country.

Federal Finance – Distribution of the sources of

income and expenditure between the central and the
state govt. in the federal system of the govt.
.
 Why Study Public Finance?

 The goal of public finance is to understand the proper

role of the government in the economy.

 Controversies about the proper role of the

government raise the fundamental questions
addressed by the branch of economics known as
public finance.

 There are fundamentally four questions public

finance tries to answer
The Four Questions of Public Finance

 1. When should the government intervene

in the economy?

 2. How might the government intervene?

 3. What is the effect of those interventions

on economic outcomes?

 4. Why do governments choose to intervene

in the way that they do?
1. When Should the Government Intervene in the
Economy?

 Market Failures - Problem that causes the market

economy to deliver an outcome that does not
maximize efficiency.

 Redistribution - The shifting of resources from some

groups in society to others.
2. How Might the Government Intervene?

 One way that the government can try to address

failures in the private market is to use the price
mechanism, whereby government policy is used to
change the price of a good in one of two ways:
◦ 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.
 Regulation - The government can directly restrict
the 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 can 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.
3. What Are the Effects of Alternative Interventions on economic outcomes?

 Direct effects - The effects of government

interventions that would be predicted if individuals
did not change their behavior in response to the
interventions. e.g Free health insurance increases
the number of people accessing health care.

 Indirect effects - The effects of government

interventions that arise only because individuals
change their behavior in response to the
interventions. Those who pay for private insurance
may abandon payment for the public alternative.
4. Why Do Governments Do What They Do?

 Political economy - The theory of how the

political process produces decisions that
affect individuals and the economy.

 Market Failure

 Redistribution
Significance of public finance to modern economy is evident from the following:

 1)To Achieve Adjustment in allocation of resource –

study of public finance tells how coordination
among the allocation of resources should be
effected. Income and expenditure process of the
govt. serves to allocate the resources of the
country between private goods and social goods.

 2)To Achieve Adjustment in the Distribution of

Income and Wealth – Study of Public finance gives
us knowledge of those methods which help us to
address inequalities of wealth and income
3) To Achieve Economic Stability
i) In order to remove involuntary unemployment,
effective demand can be stimulated by reducing the
taxes.
ii) To check inflation, public expenditure can be
curtailed.
iii) If there is full employment and price stability
in the economy, then existing level of taxes can be
maintained.
4)To Achieve Economic Development – To increase the
rate economic growth, it is essential to accelerate the
rate of capital formation. Hence, fiscal policy should be
so framed as to increase the rate of saving and
investment and reduce consumption.
Thank you