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The essential question of public economics and the main stress of our course is the question of whether the government should intervene in the market and if so, how? To have an answer to this question, we need some benchmark measures against which we can critically compare the outcome with and without the government interference
The appropriate role of government provides a preliminary point for the analysis of public finance. In theory, under some circumstances, private markets will assign goods and services among individuals resourcefully (in the sense that no wastage occurs and that the individual tastes are correctly matching with the economy's productive abilities). If the private markets were able to provide effective outcomes and if such distribution of the income were socially acceptable, then there would have been little or no scope for government at all. In several cases, however, conditions for the private market efficiency are often violated. For example, if several people can enjoy the same good at the same time, then the private markets may tend to supply too little of that good. National defense is one of the examples of non-rival consumption, or moreover of a public good.
"Market failure" generally occurs when the private markets do not efficiently allocate goods or services. The existence of such market failure provides a rationale based on efficiency for collective or for governmental provisions of goods and services. Externalities, informational advantages, public goods, strong economies of scale, as well as network effects can often cause market failures. Public provisions through a government or a voluntary association are subject to other kinds of inefficiencies, which are termed as "government failures."
Under large assumptions, government decisions about the effective scope and level of activities can be proficiently alienated from decisions about the design of taxation systems (termed as Diamond-Mirlees separation). In this outlook, public sector programs should be designed in such a way that it can maximize social benefits minus costs (known as cost-benefit analysis), and then revenues needed to pay for those spending should be raised through a proper taxation system which creates the fewest efficiency losses normally caused by a distortion of economic activity. In general practice, government budgeting or such kinds of public budgeting is substantially more complex and often results in ineffective practices.
Government can then pay for spending by borrowing (for example, by distributing government bonds), although borrowing is a way of distributing tax burdens through time rather than a simple replacement for taxes. A deficit is termed as the difference between the total government spending and its revenues. The accumulation of deficits over time is called the total public debt. Deficit finance allows governments to smoothen out tax burdens over time, and generally it gives governments a decisive fiscal policy tool. Deficits can also narrow down the options of successor governments as such.
Public finance is very much connected to the issues of income distribution as well as social equity. Governments can reallocate their income through the transfer payments or by designing effective tax systems which treats high-income and low-income households in a different way.
The Public Choice approach to the public finance attempts to explain how the self-interested voters, politicians, as well as the bureaucrats actually operate, rather than how should they operate.
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