Public Sector

Economics

1
 PUBLIC SECTOR
The public sector is that portion of an economic system that is
controlled by national, state or provincial, and local
governments.

The P U B L I C S E C T O R is the part of the economy

concerned with providing various government services. The
composition of the public sector varies by country, but in most
countries the public sector includes such services as the
military, police, public transit and care of public roads, public
education, along with health care and those working for the
government itself, such as elected officials. The public sector
might provide services that a non-payer cannot be excluded
from (such as street lighting), services which benefit all of
society rather than just the individual who uses the service.
 PUBLICSECTORECONOMICS
Public sector economics is an area of study that is directly relevant to
our everyday lives. It affects the taxes we pay, the buses and trains
on which we travel, the workers who empty our bins, the gas and
electricity delivered to our homes, and even the water coming out of
our taps!
Public sector economics is concerned with justifying the existence of
governments and explaining how they can affect economic activity.
It explains how the ‘invisible hand' of the market is tempered by the
‘visible hand' of government in the mixed economy of both private
and public sectors adopted by the vast majority of nations.
Traditionally, public-sector economics has been concerned with the
study of how governments can deal with the failure of markets to
achieve efficient outcomes. Possible remedies which are
considered include using public expenditure and taxation, taking
some firms into state ownership and introducing regulation. These
are all areas of microeconomic theory, policy and practice.
 PUBLICSECTORECONOMICSWELFARE
Welfare (n): The health, happiness, and fortunes of a person or group
A branch of Economics that focuses on the optimal allocation of resources and
goods and how this affects social welfare. Welfare economics analyzes the
total good or welfare that is achieved at a current state as well as how it is
distributed. This relate to the activity of income distribution and how it affects
the common good.
Definition of economic welfare: The level of prosperity and quality of living
standards in an economy. Economic can be measured through a variety of
factors such as GDP and other indicators which reflect welfare of the
population (such as literacy, number of doctors, levels of pollution e.t.c)
Economic welfare is a general concept which doesn’t lend to easy definition.
Basically, it refers to how well people are doing. Economic welfare is usually
measured in terms of Real Income, real GDP. An increase in Real Output and
real incomes suggests people are better off and therefore there is an
increase in economic welfare.
However, economic welfare will be concerned with more than just levels of
income. For example, people’s living standards are also influenced by factors
such as levels of congestion and pollution. These quality of life factors are
important in determining economic welfare.
 EXTERNALITIES
Externalities are benefits (costs) received (borne) by neither the seller or the buyer
but by third parties.
Private benefits + external benefits = social benefits
Private costs + external costs = social costs
Since external benefits and costs are not perceived by buyersand sellers they
are not captured in markets.
In Economics, an externality is the cost or benefits that affects a party who did
not choose to incur that cost or benefits.
Externalities are a loss or gain in the welfare of one party resulting from
an activity of another party, without there being any compensation for the
losing party.
 POSITIVE EXTERNALITIES

A positive Externality arises say when any project or activity (say building a bridge) creates a positive benefit
for the immediate society. Thus a positive externality would increase the utility of third parties at no cost to
them. For example:

Govt Programmes : NREGA, Sarva Sikhshya Abhiyan, Bharat Nirman, Mid day meals schemes

Millennium Development Goals by the United Nations (started in 2000)

Infrastructure Initiatives : Building a bridge or road

A positive externality would increase the utility of third parties at no cost to them
 N E G AT I V E E X T E R N A L I T I E S

• Marginal social costs are greater than marginal private costs.

•
Pollution is a cost that may not be borne by sellers, but it is a cost
nonetheless to society.
•
Private markets will overproduce (devote too many resources)to
the production of goods with negative externalities.
• Damage to environment and Scarce resources etc
•
Water pollution by industries that adds effluent, which harms
plants, animals and humans.
•
Noise pollution which may be mentally and psychologically
disruptive.
ENCOURAGING POSITIVE EXTERNALITIES

•
Increasing supply: Govt grants and subsidies to producers of goods and
services that generate external benefits will reduce costs of production
and encourage more supply.
• Increasing Demand: Demand for goods, which generates positive
externalities, can be encouraged by reducing the price paid by
consumers. For example subsidizing the tuition fees of university students
will encourage more young people to go to university, which will
generate a positive externality for future generations.
 LABOUR MARKET

• The nominal market in which workers find paying work, employers find
willing workers, and wage rates are determined.

• Labor markets may be local or national (even international) in

their scope and are made up of smaller, interacting labor markets for
different qualifications, skills, and geographical locations. They depend on
exchange of information between employers and job seekers about wage
rates, conditions of employment, level of competition, and job location.
LABOR MARKET in India
LABOR MARKET in India
 MONETARY INSTITUTIONS

Definition: The monetary system represents the totality of laws and

decisions adopted by national authorities which aim to secure the
proper functioning of money by regulating the circulation of money.

Components of Financial System

A financial system refers to a system which enables the transfer of
money between investors and borrowers. A financial system could be
defined at an international, regional or organization level. The term
“system” in “Financial System” indicates a group of complex and
closely linked institutions, agents, procedures, markets, transactions,
claims and liabilities within a economy.
•

Five Basic Components of Financial System

• Financial Institutions
• Financial Markets
• Financial Instruments (Assets or Securities)
• Financial Services
• Money
 Financial Institutions
Financial institutions facilitate smooth working of the financial system by making
investors and borrowers meet. They mobilize the savings of investors either
directly or indirectly via financial markets, by making use of different financial
instruments as well as in the process using the services of numerous financial
services providers. They could be categorized into Regulatory, Intermediaries,
Non-intermediaries and Others. They offer services to organizations looking for
advises on different problems including restructuring to diversification strategies.
They offer complete array of services to the organizations who want to raise
funds from the markets and take care of financial assets for example deposits,
securities, loans, etc.
Financial Markets
A financial market is the place where financial assets are created or transferred.
It can be broadly categorized into money markets and capital markets. Money
market handles short-term financial assets (less than a year) whereas capital
markets take care of those financial assets that have maturity period of more
than a year. The key functions are:
1. Assist in creation and allocation of credit and liquidity.
2. Serve as intermediaries for mobilization of savings.
3. Help achieve balanced economic growth.
4. Offer financial convenience.
 Financial Instruments
This is an important component of financial system. The products which are
traded in a financial market are financial assets, securities or other type of
financial instruments. There is a wide range of securities in the markets
since the needs of investors and credit seekers are different. They indicate a
claim on the settlement of principal down the road or payment of a regular
amount by means of interest or dividend. Equity shares, debentures, bonds,
etc are some examples.
Financial Services
Financial services consist of services provided by Asset Management and
Liability Management Companies. They help to get the necessary funds and
also make sure that they are efficiently deployed. They assist to determine the
financing combination and extend their professional services upto the stage of
servicing of lenders. They help with borrowing, selling and purchasing securities,
lending and investing, making and allowing payments and settlements and
taking care of risk exposures in financial markets. These range from the leasing
companies, mutual fund houses, merchant bankers, portfolio managers, bill
discounting and acceptance houses. The financial services sector offers a
number of professional services like credit rating, venture capital financing,
mutual funds, merchant banking, depository services, book building, etc.
Financial institutions and financial markets help in the working of the financial
system by means of financial instruments. To be able to carry out the jobs given,
they need several services of financial nature. Therefore, Financial services are
considered as the 4th major component of the financial system.
 Money
Money is understood to be anything that is accepted for payment of
products and services or for the repayment of debt. It is a medium of
exchange and acts as a store of value.

DEFINITION OF'FINANCIAL SYSTEM

Afinancial system can be defined at the global, regional or firm specific level.
The firm's financial system is the set of implemented procedures that track
the financial activities of the company. On a regional scale, the financial
system is the system that enables lenders and borrowers to exchange funds. The
global financial system is basically a broader regional system that encompasses
all financial institutions, borrowers and lenders within the globaleconomy.
Important Functions Performed by Central Banks

1. It issues the currency notes of the country.

2. It is the custodian of the foreign exchange reserves of the country.
3. It serves as banker to the government.
4. It serves as banker to commercial banks.
5. Being a monetary authority, it regulates the banks’ credit creation
activity and performs the function of a controller of credit.
6. If promotes the economic development of the country.

A central bank, reserve bank, or monetary authority is an

institution that manages a state's currency, money supply, and
interest rates.
Functions of Commercial Banks
A commercial bank is authorized to serve the following functions:
•

•
• Receive deposits - take money in from individuals and businesses (called
•
depositors)
•• Disburse payments - make payments upon the direction of its depositors,
such as honoring a check Collections - a bank will act as your agent to
•

collect funds from another bank payable to you, such as when someone
pays you by check drawn on an account from a different bank
• Invest funds in securities for a return
• Safeguard money - banks are considered a safe place
to store your wealth Maintain and service savings
and
• Maintain custodial accounts - accounts controlled by one person but for
the benefit of another person, such as a trust account
A commercialbank is a financial institution that is authorized by law to
receive money from businesses and individuals and lend money to them.
Commercial banks are open to the public and serve individuals,
institutions, and businesses. A commercial bank is almost certainly the
type of bank you think of when you think about a bank because it is the
type of bank that most people regularly use.
 C A P I TA L M A R K E T

Capital markets are financial markets for the buying and selling of long-
term debt or equity-backed securities. These markets channel the wealth of
savers to those who can put it to long-term productive use, such as
companies or governments making long-term investments. Capital markets
are defined as markets in which money is provided for periods longer than a
year. It is the part of a financial system concerned with raising capital by
dealing in shares, bonds, and other long-term investments.
 DEBT MARKETS
What is the Debt Market?: :t is a market meant for trading (i.e. buying or
selling) fixed income instruments. Fixed income instruments could be securities
issued by Central and State Governments, Municipal Corporations, Govt. Bodies
or by private entities like financial institutions, banks, corporates, etc.

What is bonds/debt? :Simply put, a bond/debt can be defined as a loan for

which an investor is the lender. The issuer of the bond pays the investor interest
(at a predetermined rate and schedule) in return for the funding.

The maturity date refers to the date on which the issuer has to repay the principal
to the investor.

The bond market (also debt market or credit market) is a financial market
where participants can issue new debt, known as the primary market, or
buy and sell debt securities, known as the secondary market. This is
usually in the form of bonds, but it may include notes, bills, and so on.

The debt market is the market where debt instruments are traded. Debt
instruments are assets that require a fixed payment to the holder, usually with
interest. Examples of debt instruments include bonds (government or
corporate) and mortgages.
 SOMEBASICDEFINITION
In accounting and finance, equity is the difference between the value of the
assets/interest and the cost of the liabilities of something owned. For example,
if someone owns a car worth $15,000 but owes $5,000 on that car, the car
represents $10,000 equity. Equity can be negative if liability exceeds assets.

DEFINITION OF 'LIABILITY
(Responsibility, future sacrifices of economy)

A company's legal debts or obligations that arise during the course of

business operations. Liabilities are settled over time through the transfer of
economic benefits including money, goods or services.
DEFINITION OF 'LIQUIDITY'
Liquidity describes the degree to which an asset or security can be quickly
bought or sold in the market without affecting the asset's price.

Market liquidity refers to the extent to which a market, such as a country's stock
market or a city's real estate market, allows assets to be bought and sold at
stable prices. Cash is the most liquid asset, while real estate, fine art and
collectibles are all relatively illiquid.
 Monetary and Fiscal Policy Tools
Imagine that Sam is sick. He's at home right now, and the doctor's been called.
All of a sudden, the doorbell rings, and standing at the front door is a doctor
carrying a medical kit. Now, the doctor comes in the patient's bedroom, opens
up the kit and finds three tools inside. I'll bet you're curious about what's in the
kit, huh? The doctor chooses one or two of the tools in his toolkit and uses them
on the patient.
Now imagine the patient is the whole economy. The economy has entered a
slowdown that has now turned into a full-blown recession. Unemployment is
high, and people are fearful of their financial future.
The government uses its own fiscal policy toolkit, like a doctor, to administer
fiscal policy tools - like government spending, taxes and transfer payments -
to help strengthen aggregate demand when it's
weak. On the other hand, when the economy is overheating by growing beyond
its capacity, fiscal policy does the opposite and slows down economic growth to
address the problem of inflation.
Now, the word 'fiscal' means 'budget' and refers to the government's budget.
Fiscalpolicy, therefore, is the use of government spending, taxation and
transfer payments to influence aggregate demand and, therefore, real GDP. If
you imagine the government as the doctor carrying the medical kit, these three
things are in the toolkit: government spending, taxes and transfer payments.
Let's briefly look at some examples of each one of these fiscal policy tools.
 Fiscal Policy tool Impact on Economy

GOVERNMENTSPENDING
Government spending includes the purchase of goods and services - for
example, a fleet of new cars for government employees or missiles for national
defense. Government spending is a fiscal policy tool because it has the power
to raise or lower real GDP. By adjusting government spending, the government
can influence economic output.
In addition to the primary effect of government spending on the economy, this
spending multiplies through the economy as it affects businesses who sell the
goods and services bought by the government. Consumers then go on to
spend the paychecks they earn from those businesses, stimulating real GDP
even more.
For example, when Larry's Limos receives a large order for more government
vehicles, his sales increase, and he hires more employees who earn a
paycheck from the company. Once they cash their paycheck, they spend this
money on goods and services, and the effect of a single increase in
government spending now leads to a much greater result - an effect that
economists call the multiplier effect.
 T A X ES
Alright, let's talk about taxes. Taxes are a fiscal policy tool because changes in
taxes affect the average consumer's income, and changes in consumption lead
to changes in real GDP. So, by adjusting taxes, the government can influence
economic output. Taxes can be changed in several ways. Firstly, marginal tax
rates can be raised or lowered. Secondly, they can be eliminated entirely, or the
tax rules can be modified.
TRANSFER PAYMENTS
Alright. We've talked about government spending, then we talked about taxes -
now let's talk about transfer payments. Transfer payments include things like
Social Security, welfare or unemployment checks. These checks go out all over
the country on a monthly basis and serve as the income for tens of millions of
consumers. Transfer payments are fiscal policy tools in the same way that taxes
are because changes in transfer payments lead to changes in consumer income,
and when consumers spend more of their income, this influences economic
output.
So, these are the three main tools that the government administers to the
economy to help it in the short-term.
 PHILLIPS CURVE

An economic concept developed by A. W. Phillips stating that inflation and

unemployment have a stable and inverse relationship. According to the Phillips
curve, the lower an economy's rate of unemployment, the more rapidly wages
paid to labor increase in that economy.
Explaining the Phillips curve
The curve suggested that changes in the level of unemployment have a
direct and predictable effect on the level of price inflation. The accepted
explanation during the 1960’s was that a fiscal stimulus, and increase in AD,
would trigger the following sequence of responses:

I) An increase in the demand for labour as government spending generates

growth.

ii) The pool of unemployed will fall.

iii) Firms must compete for fewer workers by raising nominal wages.

iv) Workers have greater bargaining power to seek out increases in nominal
wages.

v) Wage costs will rise.

vi) Faced with rising wage costs, firms pass on these cost increases in
higher prices.