Some Concepts in Economics-1

Taken from Book "Day to Day Economics" by Prof. Satish Y. Deodhar

Why government decides to undertake some economic activities in her own hand and not leave it to private sector.

There are two features in these activities that prompt government to undertake these activities in her own hand. One is called Public Goods and the other are called Natural Monopolies.

There are certain services which are called as the “pure public goods”. For example National defence is a pure public good. Also it is non-rival in consumption, as if one is enjoying the benefit of the defence, he cannot prevent other to enjoy it. It is also nonexclusive, as every individual is enjoying the benefits of the defence of the nation. A private firm cannot provide national defence. It is so because they cannot express how much they value their security, and why would anyone pay for it.

Apart from that there are services where the set up costs are so high that only one single firm can provide the service at an affordable cost. For example supply of potable water is such services. However, if a single private firm is allowed to offer this service, then in absence of competition, it would turn into an monopolist. Thus government will undertake such services. The goods and services that fall under this category are called “Natural Monopolies”. Similarly running of postal service, generation and supply of electricity and the provision of landline telephone services.

Why Government applies taxes on some activities and give subsidies on some other activities

There are certain economic activities that affect a bystander that are not party to that activities. For example late night playing of loud music disturbs the peace of neighbourhood. This creates what is called as negative externality. Government wants to discourage this activity.

Similarly government gives subsidy on the electric cars. Why , as it doesn’t pollute atmosphere and doesn’t use fossil fuel. Government wants to encourage this activity.  This creates what is called as a positive externality.

Similarly subsidy on primary education, taxing on the chemical factory are such examples.

·         Size of the budget expenditure in 2011-12 is 11 Trillion Rs. which is 14% of Indian GDP. The receipts are 6.8 trillion Rs. which is 9.5 % of India’s GDP. This is very small if we compare the receipts for other countries ( France-39%, UK-34%, Brazil-20% and Russia- 17%)

·         There are three types revenue receipts. First is the Revenue Deficit, this is the difference between revenue expenditure and revenue receipts. A deficit of this kind shown that the government has to borrow money to finance administrative activities which do not lead to the creation of any assets.

·         The second type of deficit is Fiscal deficit, which refers to the difference between the government’s total expenditure and the total non-debt receipts. This indicates that the government has exhausted all its options for financing its expenditure and the only recourse left for it is to borrow.

·         Also there is Primary Deficit. This deficit is defined as the difference between Fiscal Deficit and the interest payment on debts incurred in earlier years. If one removes the interest payments from the Fiscal deficit, the primary deficit becomes a smaller number.

·         Looking at the numbers in 2011, Fiscal deficit was 4.8% of the GDP, Revenue was 3.5% and Primary was 1.7% of the GDP. Also ((Revenue/Fiscal)x100) is 72.5%.  

How high fiscal deficit “Crowd Out” private investments 

This linkage is explained in two ways:

1.       High Fiscal deficità Government will borrow heavilyà demand for loans will rise in the marketà Interest rates go upà Cost of borrowing for Private firms go up à Investments projects become economically unviableà Fall in private investmentsà Adverse impact on employment generation and income

2.       High Fiscal deficità Government will borrow heavilyà Also borrow from International marketà Foreign fund starts flowingà Demand for Rupee goes up to exchangeà Indian exports become expensiveà Higher imports and Lower Exportsà Higher trade deficit

·         Direct Taxes in India in 2011 was 56.5% of total tax revenue and Indirect taxes are 42.2 %