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Chapter 1
The Public Sector and the
Economy and
Chapter 2
Sections 2.4 2.7 only

Lecturer: Lyndal Keeton


NCB 200
Lyndal.Keeton@wits.ac.za
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1.1 Introduction
Economics: How to use resources to satisfy
needs/wants

WHAT IMPACT DOES THE GOVERNMENT


HAVE ON RESOURCE ALLOCATION?
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Mixed Economy
Political System Market System
Needs not satisfied by mkt Prices
system alone Supply and Demand
Mechanism between Supply Consumer preferences,
and Demand is ballot box incomes, costs of production,
Price = tax paid by citizens technology
Resource use different to that
of private sector
NB issues: efficiency and
equity of resources
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Key Features of SA Democracy


Constitutional change requires two thirds
parliamentary majority
Constitutional court (JHB)
Bill of Human Rights
Human Rights Commission (HRC)
Independent Judiciary
Auditor General
Independent Central Bank (SARB)
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3 Tiers of Government

1. Executive (PTA)
2. 9 Provincial Governments
3. 278 Municipalities (changed since textbook
was published)
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1.1.1 Legacy of the Past


On 27th April 1994 SA became a
democracy under a new constitution
PERSISTENT PROBLEMS
We have one of most uneven distribution
of incomes in the world
About 1/3 of labour force is unemployed
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1.1.2 Fiscal Challenges facing


Democratic Government
Smaller deficit
Lower public debt
Restructure public sector without jeopardising
macro stability
Opportunity to revamp all institutions and
policies
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1.1.3 Field of Public Economics (1)


Public Economics
Studies the role of the government in the economy, i.e.
the nature, principles and economic consequences of
expenditure, tax, finance & regulation in the non-profit
making government sector of the economy

Instruments of public policy


Include decision-making, expenditure, tax, financing and
regulation
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1.1.3 Field of Public Economics (2)


Regulation
Enacting a law or administratively proclaiming
an enforceable instruction that leads to a
different allocation of private resources that
would apply in the absence of government.

Non-profit making
In the absence of profit maximisation we need
other criteria for public institutions and NGOs
1.2.1 Composition of public sector

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1.2.1 Composition of public sector


M easure 1960 1960-69 1970-79 1980-89 1990-99 2000-04
Taxes (indirect & direct) 14.2 15.5 18.8 22.2 24.6 25.5
Resource use (1) 17.8 20.5 27.3 27.3 24.5 23.1
of which
G eneral govt consum ption 9.5 11.1 14.2 17.4 19.4 18.7
Investm ent Total 8.3 9.4 13.1 9.9 5.1 4.4
O f which
G eneral govt 7.0 7.5 8.8 5.7 2.8 2.8
Public corps 1.3 1.9 4.3 4.2 2.3 1.6
Transfer paym ents (2) 3.9 4.1 5.5 8.4 11.2 9.6
O f which
Interest on public debt 0.7 0.9 1.7 3.7 5.6 4.7
Subsidies and current transfers 3.2 3.2 3.8 4.7 5.6 4.9
Total public sector resource 21.7 24.6 32.9 35.7 35.6 32.7
m obilisation (1) + (2)
O f which
G eneral G ovt 20.5 22.7 28.6 31.5 33.4 31.1
Public C orporations 1.3 1.9 4.3 4.2 2.3 1.6
NOTE: Current prices as % of GDP
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1.2.3 The Relationship between


Public and Private Sectors
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Impact of a budget imbalance on the


financial sector (1)
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Impact of a budget imbalance on the


financial sector (2)
In national accounting terms, a budget
imbalance (GT) implies either SI (internal
imbalance) or MX (external or balance of
payments disequilibrium)
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Impact of a budget imbalance on the


financial sector (3)
If T<G (budget deficit) then the govt has to
borrow.
The size and nature of the deficit and how it is
financed has implications for macro stability.
If T>G (surplus) then the government
supplements the savings of the economy.
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2.4 Overview of Market Failure


Lack of Information

Consumers and producers do not always have


information necessary to make rational decisions
Information could be too costly to obtain
Government can provide this function (eg SABS) and
it can be very important for trade (EU)
Private institutions can be better at acquiring and
disseminating info than the government (profit
driven)
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Market Failure
Adjustment lags
Markets dont always adjust quickly to changes in
Supply and Demand
Due to lack of information and immobility of factors
(takes time to retrain people etc)

Incomplete Market
Markets dont always meet demand eg street lighting,
defense etc
Markets dont always account for external costs and
benefits (pollution, vaccines etc)
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Market Failure
Non competitive markets
Rule not exception
Commodity markets monopoly or oligopoly
Labour markets bargaining councils, minimum
wages and trade unions

Macro Instability
Markets take too long to adjust to exogenous shocks
Government uses monetary and fiscal policy to end
speculative attacks
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Market Failure
Distribution of Income
Neoclassical model is neutral on issue of
distribution
Distribution determined by initial endowments
of K and L for two individuals
If initial distribution unequal, so to will final
distribution.
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IMPLICATIONS
Real world economies are not economically efficient
They will never be pareto optimal
They will never on their own produce equitable
income distribution
Does not mean that central planning is better (USSR)
Instead look at market based economy with role for
public sector.
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2.5 Public Sector Functions


Allocative Function
Market forces distort allocation of resources in economy
(especially incomplete & non-competitive markets)

Externalities
Failure to account for external effects creates a greater
divergence between actual prices and quantities and the
socially optimal levels
Pollution (-ve)
Education (+ve)
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Allocative Function
Pure public goods Mixed goods
Defense, street lighting Can be supplied by markets
Users dont reveal demand so but neither price nor quantity
can not determine the price or supplied will be optimal
force users to pay for benefits Education, health care
derived from using the service
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Allocative Function
NON COMPETITIVE MARKETS

Artificial Monopoly Natural Monopolies


Perfect competition is feasible Economies of Scale
but prevented by legal Water, electricity etc
restrictions from government
or by professional bodies
Doctors, car servicing etc
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Distributive Function
Market outcomes exhibit inequality in
distribution of income
All governments use taxes, transfer payments
and subsidies to alter these outcomes
Disagreement still exists about criteria for
evaluating distributive function of government.
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Stabilisation Function
Macro objective (includes economic growth, full
employment, price stability, sound bop etc)
Keynesian approach based on three premises:
market economy inherently unstable
macro instability is form of market failure and is costly to
economy
can use policies to stabilise economy
Therefore Keynes advocated policies to stimulate AD
But can lead to damagingly high levels of public debt if
not managed properly
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2.6 Direct vs Indirect Government


intervention
DIRECT INDIRECT
actual participation of regulatory function of
government in economy government
taxes, borrowing in financial Regulation: enacting a law that
markets, budgeted spending gives rise to market outcomes
programmes etc that are different from those
ie supply national defence, obtained in the absence of
finance production through intervention
private sector etc Labour laws, anti tobacco laws,
can be measured tax burden, competition policy etc
government expenditure Can not measure total effect
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2.7 Government Failure


Governments, like markets, can fail
Politicians, bureaucrats & public employees are
also self-interested Utility maximisers
Mistakes and corruption happens as a result
Therefore it is important to understand how
efficient the government is.
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Next Lecture:
Chapter 3
Public Goods and Externalities