LEARNING UNIT 3

THE PUBLIC SECTOR

1. COMPONENT OF PUBLIC SECTOR

• Central Govt
- Focuses on national issues eg ____________________________ and relationships with the rest of the world eg
________________________________
• Regional / Provincial Govt
- Focuses on regional issues eg ___________________________________________________________________
• Local Govt
- Focuses on local issues eg ______________________________________________________________________
• Public corporations and business enterprises
- eg _________________________________________________________________________________________
• General Govt
- Consists of general departments of the 3 levels of government
• Public Sector
- Consists of general govt + govt enterprises

2. GOVT INTERACTION WITH HOUSEHOLDS AND FIRMS

- Provides __________ g and s eg ____________________________________________________________________
- Collects taxes
- Makes transfer payments to households eg ___________________________________ and firms eg ______________
__________________________
- Influences economic activity through regulation

3. ROLE OF GOVT IN THE ECONOMY

- Private initiative and market forces tend to be more efficient so govt _________________ be involved in production of g
and s that can be produced more efficiently by the private sector
- Govt ___________ maintain law and order, recognise property rights and enforce contracts
- Govt ___________ intervene to correct market failure
- Govt ___________ intervene if market outcomes are not equitable by implementing measures to redistribute income and
wealth

4. MARKET FAILURE
- Occurs when market system is unable to achieve an efficient allocation of resources, ie. does not achieve the best
available outcome
- 5 main types:
• Monopoly and Imperfect Competition
- Unlike perfect competition, monopoly and oligopoly are not allocatively efficient as firms have market power,
charge higher prices, produce less output, have higher costs and profits
➢ List 5 ways in which govt can intervene.
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________

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• Public goods
- Public goods are ____________________________________________ (consumption by one does not reduce
consumption by others) and _________________________ (is no way to stop anyone from consuming)
- Examples include defence, public information, streetlights, broadcast signals, basic research
- Free market system does not provide public goods at all so they should be provided by govt
- May be produced by private firms but must be paid for from tax revenue and provided free to all users
- Private goods are ____________________________________ and _____________________ and should be
produced by the _________________________________
- Examples include computers, clothes, cellphones, chocolates
- Mixed goods are _________________ but __________________________________________ and are often
provided by govt
- Examples include non-congested roads, cinemas, satellite TV, rugby stadiums
- User charges such as toll fees, entrance fees to parks, museums and public swimming pools are levied
➢ Explain what is meant by free riding.
________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________

• Externalities
- Occur if costs or benefits of a transaction or activity are borne or enjoyed by parties not directly involved
- Negative externalities exist when there are ______________________ eg when a firm that produces chemicals
pollutes a river it imposes costs on others
- Allocation of resources is not socially efficient as markets tend to produce ___________________ of the product
➢ Draw a diagram to illustrate a negative externality in a perfectly competitive market.

o Equilibrium with no govt intervention (E 1)

DD represents the market demand for the product and SS represents the supply or marginal private cost of
the industry.
Market price is P1 and quantity produced is Q1.
o Socially efficient equilibrium (E 2)
Pollution caused by the industry represents an additional cost to society
Marginal social cost is _________________ than the marginal private cost
Equilibrium is where MSC = price of product
Price is P2 and quantity produced is Q2
o Welfare loss to society
Is represented by the shaded triangle

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 ➢ What can govt do to improve efficiency?
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________
- Positive externalities exist when there are external benefits eg inoculation against diseases, opening a factory in
a remote area as facilities and services are made available to others
- Allocation of resources is socially inefficient as markets produce ________________
➢ What can govt do to improve efficiency?
_______________________________________________________________________________________

• Asymmetric information
- Consumers and firms can only make informed choices when they have full info on quality, availability and prices
of g and s and inputs
- In the absence of perfect info, there is an inefficient allocation of resources
- Some examples of asymmetric information are:
o Suppliers of cigarettes do not release info on health hazards of smoking to potential consumers
o Employers do not fully inform mineworkers and people living nearby about potential hazardous effects on
health
➢ Draw a diagram to illustrate asymmetric information in a goods market.

oEquilibrium with asymmetric information (E 0)

Price is P0 and quantity is Q0
o Equilibrium with symmetric information (E1)
Demand ________________ when potential buyers acquire info about health hazards of smoking.
Price is _____________ and quantity is _______________
Represents socially efficient equilibrium
➢ What can govt do to remedy the situation?
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________

• Common property resources

- Resources that are __________________________ but _________________________________________
- Belong to no one but are available free of charge to anyone who wants to use them

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 - Examples include fish in the ocean, wildlife, rivers and common grazing land
- Tend to be __________________ and no single individual has an incentive to consider the impact of their
activities on others
➢ What can govt do to protect or avoid overexploitation of common property resources?
_______________________________________ ______________________________________________
_____________________________________________________________________________________
_____________________________________________________________________________________
- Enforcement of restrictions is however a major problem

5. FURTHER REASONS FOR GOVT INTERVENTION

• Income distribution
- The free market produces the most _______________ allocation of resources but tends to generate an __________
distribution of income
➢ What steps can govt take to achieve a more equitable distribution of income?
_____________________________________________________________________________________________
_____________________________________________________________________________________________
_____________________________________________________________________________________________
_____________________________________________________________________________________________
_____________________________________________________________________________________________
- Measures to increase equity may however result in a decrease in efficiency

• Macroeconomic growth and stability

- Market systems experience business cycles therefore govt should apply ______________________________ to try to
achieve economic growth, full employment and price stability

• Merit goods
- Are ____________________ but have ______________________ (positive externalities)
- Are regarded as so beneficial to society that everyone should receive or consume them
- Govt often provides them in addition to the private sector
- Examples include education, health, shelter, sports facilities
- Demerit goods are socially _____________ so govt may discourage or prohibit certain activities or products
- Examples include tobacco, addictive drugs, gambling

6. THREE BROAD FUNCTIONS OF GOVT

- The _______________________ function refers to govt’s role in correcting market failure and achieving a more efficient
allocation of resources
- The ______________________ function refers to steps taken to achieve a more socially acceptable distribution of income
- The ______________________ function refers to measures taken to promote macroeconomic stability

7. HOW DOES GOVT INTERVENE?

- Govt can achieve its objectives by
• Public provision of g and s (via public ownership or public financing)
• Its role as a market participant (employs labour, buys g and s from private sector)
• Govt spending (to impact on the economy) and transfer payments (to change the distribution of income)
• Taxation (to redistribute income, promote desirable and penalise undesirable activities)
• Regulation (to affect private behaviour)

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8. GOVERNMENT FAILURE
- Govt intervention may be unsuccessful, ie. it may fail
- Rational behaviour by 3 groups leads to an __________________ of g and s by govt

• Politicians
- Are elected
- Aim to maximise ___________ and to be re-elected
- Vote maximising-strategies result in them supporting a variety of programmes that serve the interests of different
groups
- Do not properly consider benefits, costs or consistency of their policies
- Favour programmes that have immediate benefits and deferred costs

• Bureaucrats / civil servants

- Are appointed
- Agents for politicians and the public
- Aim to maximise _______________________________________________________ to maximise their salaries,
status, power or prestige
- Often know more about the functioning of govt than do politicians
- Formulate and implement spending plans and can manipulate the supply of g and s to their own advantage
- No market incentives and pressures to be efficient as there is no competition

• Interest groups
- Engage in _______________________ activities
- Attempt to influence govt behaviour and benefit at expense of society
- Spend large amounts of resources to secure special benefits
➢ Give some examples of interest groups and what rents they seek.
________________________________________________________________________________________
________________________________________________________________________________________
Activities distort allocation of resources and result in efficient use

9. NATIONALISATION AND PRIVATISATION

➢ Define nationalisation.
____________________________________________________________________________________________
____________________________________________________________________________________________
____________________________________________________________________________________________
- Attractive to politicians and groups of voters or workers but often results in large bureaucracies, inefficiency and political
interference
- Mining sector, banks, financial sector, insurance houses and property (commercial farmland) are targets for
nationalisation
➢ Define privatisation.
_____________________________________________________________________________________________
_____________________________________________________________________________________________
- 3 reasons in favour of privatisation are:
• Possible way to finance increased govt expenditure
• Private ownership is always more efficient
• Losses of inefficient state-owned enterprises contribute to increased budget deficits and fiscal problems

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 ➢ Give 3 arguments against privatisation.
____________________________________________________________________________________________
____________________________________________________________________________________________
_____________________________________________________________________________________________
_____________________________________________________________________________________________

10. FISCAL POLICY AND THE BUDGET

- Fiscal policy refers to govt’s policy in respect of the level and composition of govt spending, taxation and borrowing
- The ______________ is the main instrument of fiscal policy
- It outlines spending plans for the year and how it plans to finance it
- The main policy variables are ______________________ and ________________
- The budget is mainly a political decision but it has significant effects on macroeconomic variables
- Can be used to stimulate economic growth and employment, redistribute income, control inflation or address balance of
payments problems
- Classified as an instrument of ________________________________ as it influences total spending in the economy
- Monetary policy is also a demand management policy
- Fiscal policy refers to the use of ______________________________________________________, whereas monetary
policy involves the manipulation of ____________________________
- Fiscal policy is controlled by _____________, while monetary policy is conducted by the _____________________
➢ What is meant by expansionary fiscal policy and when is it applied?
______________________________________________________________________________________________
______________________________________________________________________________________________
______________________________________________________________________________________________
➢ What is meant by restrictive / contractionary fiscal policy and when is it applied?
______________________________________________________________________________________________
______________________________________________________________________________________________
______________________________________________________________________________________________

11. GOVERNMENT SPENDING

- Govt’s involvement in the economy is often measured by the ___________________________________ in total spending
- Govt spending has increased over the past 4 decades because of:
• changing consumer preferences
• political and other shocks
• redistribution of income
• misconceptions and entitlement
• population growth and urbanisation
- There has also been a change in the _____________________ of govt spending due to changes in govt’s priorities and
economic and social conditions
- There has been a ______________ in the share of__________________________________________________________
________________________ but an ______________ in the share of spending on _______________________

12. FINANCING OF GOVERNMENT EXPENDITURE

• Income from property
- Includes interest and dividend income from ownership of enterprises, profit earned from govt production and sale of
agric products, licence fees etc
• Taxes
- main source of revenue
• Borrowing
- the ______________ is financed by borrowing

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 ➢ Define the budget deficit.
__________________________________________________________________________________________
- Can borrow in capital markets (by __________________________) or from central bank (by ______________
__________________________________)
- Financing by the central bank is called inflationary financing as it increases the money stock
- Govt borrowing increases the public debt and the interest on the public debt
➢ How are the budget deficit, public debt and interest on public debt measured?
_________________________________________________________________________________________

13. TAXATION
- Compulsory payments to govt
• Criteria for a good tax
o Neutrality
- Taxes affect prices and decisions
- They distort allocation of resources which → a decrease in social welfare
- Also act as a _______________________ to owners of fop
- These costs are known as the excess burden / deadweight loss of a tax and must be kept as low as possible
- Taxes should minimise the effect on _______________________ so that taxpayers do not change their
behaviour, ie. they should be neutral
o Equity
- The tax burden should be spread as fairly as possible among various taxpayers
- The _______________________ principle means that people should pay according to their ability (usually
according to level of income)
➢ Distinguish between horizontal and vertical equity.
________________________________________________________________________________________
________________________________________________________________________________________
________________________________________________________________________________________
- The ____________ principle means that recipients of benefits generated by a particular govt expenditure
should pay for the g or s concerned, ie. the tax is a charge / levy that has to be paid for g or s provided by govt
- The __________ you receive, the __________ you have to pay
o Administrative Simplicity
- ________________ costs are costs incurred by ___________________ , such as keeping records, completing tax
returns or paying accountants to do so
- ___________________________ costs are costs incurred by _______ , such as employing people to write tax
laws, design tax forms, collect taxes and assess returns
- To keep these costs as low as possible taxes must be simple and certain
➢ Distinguish between tax avoidance and tax evasion.
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________
_______________________________________________________________________________________

• Different types of taxes

o Direct and Indirect Taxes
- Direct taxes are levied on income and wealth of ________________ (individuals and organisations)
- Also known as taxes on income and wealth
➢ Give some examples of direct taxes.
_______________________________________________________________________________________

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 - Indirect taxes are levied on _________________ and are usually paid by those who consume the g and s
- Also known as taxes on g and s or taxes on products
➢ Give some examples of indirect taxes.
_______________________________________________________________________________________
o General and Selective Taxes
- A general tax is levied on ____________ g and s, eg VAT
- Selective taxes are levied on ____________ goods only, eg excise duty on tobacco and alcohol (sin taxes), fuel
and some luxury goods
o Progressive, Proportional and Regressive Taxes
- Average tax rate = ratio of tax paid to taxable income
- If average tax rate ↑ as taxable income ↑ then the tax is ________________________
- People with higher incomes pay a _________________ of their income as tax than people with low incomes, eg
personal income tax
- If average tax rate is the same at all levels of income then the tax is __________________ , eg company tax
- If average tax rate ↓ as taxable income ↑ (or ↑ as taxable income ↓ ) then the tax is ___________________
- Takes a _______________ of income of __________________ individuals and groups than of those with higher
incomes, eg indirect taxes such as VAT
• Personal Income Tax
- Most important form of ______________ tax and largest single source of tax revenue
- Is a progressive tax
- Legal tax base is taxable income = total income – personal and other allowances
- There is a minimum amount of tax for each tax bracket
- The marginal tax rate is the rate at which each ___________________ rand of income is taxed
- The average tax rate is also called the ______________ tax rate
• Company Tax
- Levied on _____________________________
- Is a proportional tax as all profits are taxed at a uniform rate and the average tax rate is the same as the marginal tax
rate
• Value-added Tax
- The most important source of _____________ tax
- Is a regressive tax
- Most g and s are taxed at the same standard rate but the average tax rate is greater for low-income households than
for high-income households (spend a greater proportion of their income on goods that carry VAT than do high-
income consumers)
- Tax burden↑ as income ↓

14. TAX INCIDENCE: WHO REALLY PAYS THE TAXES?

- ________________ or legal incidence refers to who has to hand over the money to govt and can be determined by govt
- __________________ incidence refers to who ultimately bears the burden of the tax
- Taxes can be shifted to others so the burden may not be borne by the person who pays the tax
- Part or all of the burden can be shifted to others
➢ Who are the 3 groups who can bear the burden of a company tax?
__________________________________________________________________________________________________

Mohr, P & Associates. 2014. Economics for South African Students. 5th ed. Pretoria: Van Schaik Publishers, pp 275 – 297
Mohr, P & Associates. 2020. Economics for South African Students. 6th ed. Pretoria: Van Schaik Publishers, pp 309 - 330

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