Public Finance for CA Foundation
Public finance: why markets fail, public and merit goods, the functions of government, taxes, deficits and fiscal policy.
Business EconomicsPaper 411 MCQs2 lessons2 flashcards3 memory tricks
What you'll learn
- Market failure and the role of government
Explain why markets fail and how governments respond. - Budget, taxes and fiscal policy
Calculate deficits and choose fiscal policy measures.
Key formulas
| Revenue deficit | Revenue expenditure − revenue receipts |
|---|---|
| Fiscal deficit | Total expenditure − (revenue receipts + non-debt capital receipts) |
| Primary deficit | Fiscal deficit − interest payments |
Concepts explained
Market failure and externalities
Markets fail when they don't produce the socially best outcome: public goods, externalities, information gaps and market power.
What it means
- Negative externality: cost on others (pollution): over-production.
- Positive externality: benefit to others (vaccination): under-production.
- Information asymmetry: one side knows more (used cars, insurance).
- Market power: monopolies restrict output and raise prices.
- Factory smoke harms residents
Answer: Negative externality: tax or regulate
- Protects others too
Answer: Positive externality: subsidise
Related terms
- Pigouvian tax: tax equal to external cost
- Adverse selection: bad risks crowd out good ones
Exam tip: Ask who bears a cost or gets a benefit without paying: that's the externality.
Public, merit and demerit goods; functions of government
Public goods are non-rival and non-excludable; merit goods are under-consumed; demerit goods over-consumed. Musgrave's functions: allocation, distribution, stabilisation.
What it means
- Pure public goods: defence, street lights, lighthouses.
- Merit goods: education, health; demerit goods: tobacco, alcohol.
- Allocation: provide what markets under-supply.
- Distribution: progressive taxes and transfers; stabilisation: control inflation and unemployment.
- National defence
Answer: Pure public good
- Cigarettes
Answer: Demerit good: taxed heavily
Related terms
- Quasi-public goods: parks, roads: partly excludable
- Common resources: rival but non-excludable (fish stocks)
Exam tip: Non-rival + non-excludable together make a pure public good.
Deficits, taxes and fiscal policy
Budget deficits measure the government's gap between spending and income; fiscal policy changes spending and taxes to steer the economy.
What it means
- Revenue deficit = revenue expenditure − revenue receipts.
- Fiscal deficit = total expenditure − (revenue receipts + non-debt capital receipts).
- Primary deficit = fiscal deficit − interest payments.
- Direct vs indirect taxes; progressive, proportional, regressive.
- TE 50; RR 30; non-debt CR 2; interest 10
Answer: FD 18; PD 8
- Demand falling
Answer: Raise spending, cut taxes
Related terms
- FRBM Act: law setting fiscal deficit targets
- Crowding out: government borrowing pushing up interest rates
Exam tip: Fiscal deficit = total borrowing; take out interest to get the primary deficit.
Memory tricks
Public goods are non-excludable and non-rival.
FD = TE − (RR + non-debt CR); PD = FD − interest; RD = RE − RR.
Allocation, distribution and stabilisation functions.
Try 3 CA Foundation-style questions
Q1. The free-rider problem arises because
- goods are too expensive
- people can enjoy a public good without paying for it
- governments don't collect taxes
- firms produce too much
Show answer
Answer: (2) people can enjoy a public good without paying for it
Since non-payers can't be excluded, people wait for others to pay, so markets under-provide public goods.
Q2. Education and health care are examples of
- demerit goods
- pure public goods
- inferior goods
- merit goods
Show answer
Answer: (4) merit goods
Merit goods are socially desirable but under-consumed if left to the market, so governments encourage them.
Q3. Primary deficit is
- fiscal deficit minus interest payments
- fiscal deficit plus interest payments
- revenue deficit minus interest
- capital expenditure minus capital receipts
Show answer
Answer: (1) fiscal deficit minus interest payments
Primary deficit removes interest on past debt, showing current borrowing for present needs.
Practise all 11 questions Free · explanations for every option · see where you go wrong