PUBLIC FINANCE

What are the three branches in Richard Musgrave's taxonomy of fiscal functions?

• Allocation Function – Corrects market failure and provides public goods.
• Redistribution Function – Reduces income and wealth inequality.
• Stabilization Function – Maintains high employment and price stability.
• Mnemonic: ARS (Allocation, Redistribution, Stabilization)

What are Adam Smith's three primary duties of the State?

• National Defence
• Administration of Justice
• Public Works and Public Institutions

Which Constitutional Articles govern the Union Budget, Finance Commission, GST Council, and GST legislation?

• Article 112 – Annual Financial Statement (Union Budget)
• Article 280 – Finance Commission
• Article 279A – GST Council
• Article 246A – GST legislation

What is the difference between Complete Market Failure and Partial Market Failure?

• Complete Market Failure – Market does not produce the good at all.
• Partial Market Failure – Market exists but produces the wrong quantity or price.
• Both reduce economic welfare.

What are the two characteristics of Pure Public Goods?

• Non-rivalry – One person's use does not reduce another's use.
• Non-excludability – People cannot be prevented from consuming the good.
• Examples: National defence, street lighting.

What is the Free Rider Problem?

• Occurs because public goods are non-excludable.
• People enjoy benefits without paying.
• Private firms cannot recover costs.
• Therefore, government provides public goods.

Classify goods based on Rivalry and Excludability.

• Pure Private Goods – Rival and Excludable
• Pure Public Goods – Non-rival and Non-excludable
• Club Goods – Non-rival and Excludable
• Common Pool Resources – Rival and Non-excludable

What are Merit Goods?

• Goods with positive externalities.
• Society benefits more than the individual.
• Under-produced by the market.
• Examples: Education, Healthcare.

What are Demerit Goods?

• Goods with negative externalities.
• Over-consumed in the market.
• Government discourages consumption through taxes or bans.
• Examples: Tobacco, Alcohol.

What is the relationship between Private Cost and Social Cost?

• Social Cost = Private Cost + External Cost.
• External costs are borne by society.
• Negative externalities increase social cost.

What is a Pigouvian Tax?

• Tax imposed on activities creating negative externalities.
• Makes producers bear social costs.
• Reduces harmful production.
• Helps achieve socially optimal output.

Differentiate between Adverse Selection and Moral Hazard.

• Adverse Selection – Hidden information before a contract.
• Moral Hazard – Hidden actions after a contract.
• Both arise because of asymmetric information.

Differentiate between Revenue Receipts and Capital Receipts.

• Revenue Receipts do not create liabilities or reduce assets.
• Capital Receipts create liabilities or reduce assets.
• Examples: Taxes are Revenue Receipts.
• Borrowings are Capital Receipts.

Differentiate between Revenue Expenditure and Capital Expenditure.

• Revenue Expenditure does not create assets.
• Capital Expenditure creates assets or reduces liabilities.
• Examples: Salaries are Revenue Expenditure.
• Road construction is Capital Expenditure.

What is Revenue Deficit?

• Revenue Deficit = Revenue Expenditure – Revenue Receipts.
• Indicates borrowing for current consumption.
• Does not create productive assets.

What is Fiscal Deficit?

• Fiscal Deficit = Total Expenditure – Revenue Receipts – Non-debt Capital Receipts.
• Represents total borrowing requirement of the government.

What is Primary Deficit?

• Primary Deficit = Fiscal Deficit – Interest Payments.
• Shows current year's borrowing excluding interest on past debt.

What is Effective Revenue Deficit?

• Effective Revenue Deficit = Revenue Deficit – Grants for creation of capital assets.
• Gives a better picture of actual consumption expenditure

What are Ways and Means Advances (WMA)?

• Short-term loans provided by RBI.
• Help governments manage temporary cash shortages.
• Not a source of long-term finance.

What are the objectives of the FRBM Act, 2003?

• Fiscal discipline.
• Debt sustainability.
• Transparency in fiscal operations.
• Reduce revenue and fiscal deficits.

What is Expansionary Fiscal Policy?

• Used during recession.
• Increase government expenditure.
• Reduce taxes.
• Increases aggregate demand and employment.

What is Contractionary Fiscal Policy?

• Used during inflation.
• Reduce government expenditure.
• Increase taxes.
• Decreases aggregate demand.

What is the Crowding-Out Effect?

• Government borrowing raises interest rates.
• Higher interest rates reduce private investment.
• Weakens the impact of expansionary fiscal policy.

What are Automatic Stabilizers?

• Work automatically without government action.
• Progressive taxes.
• Unemployment benefits.
• Reduce economic fluctuations.

True or False: The Balanced Budget Multiplier is zero.

• False.
• Under the simple Keynesian model, the Balanced Budget Multiplier equals 1.
• Equal increases in government spending and taxes increase national income by the same amount

What are the three policy lags in Fiscal Policy?

• Recognition Lag
• Decision (Action) Lag
• Implementation (Impact) Lag
• Mnemonic: RDI

Match the following fiscal tools with their effects.

• Progressive Taxation → Automatic Stabilizer
• Infrastructure Spending → Increases Aggregate Demand
• Deficit Financing → Borrowing or Money Creation

Why are Pure Public Goods not supplied by private firms?

• They are non-excludable.
• Free rider problem prevents charging users.
• Private firms cannot earn profits.
• Government supplies them through taxation.

True or False: Grants given by the Central Government to States are Capital Expenditure.

• False.
• They are classified as Revenue Expenditure in the Union Budget.
• They are considered while calculating Effective Revenue Deficit.

How does Fiscal Policy reduce income inequality?

• Progressive taxation.
• Direct Benefit Transfers (DBT).
• Free or subsidized merit goods like education and healthcare.
• Higher taxes on luxury goods and lower taxes on essential goods.