Question

a) What are the justification for public intervention when one of the hypothesis of the first theorem of welfare is violated?

b) Outline the major limits and shortcomings of economic policy coordination.

c) Write short notes on each of the following.

i) Actual (financial) or cyclically adjusted (structural) deficit.

ii) Budgetary balance

Answer 1

A) According to the first theorem of welfare, the market will more towards the point of weakly Pareto optimal competitive equilibrium when two of the conditions are met. The two conditions are:  

1. There should not be any transaction cost in the market and all the individuals have perfect information.  

2. Everyone should be free to enter and exit the market and all the firms in the market should be price taker.  

If the first hypothesis of the welfare theorem is not met that is every individual does not have perfect information in the market then the government intervention can be a justification for the problem. The government intervention can help the economy by providing the required information to the market.  

B) The economic policy coordination is one of the major issues that the government face. Economic policy coordination is not a easy task for the government to implement. The economic policies are coordinated such that the decisions of one policy does not have negative consequences on the decisions of other policy. This is very challenging for the government and may take too much efforts and time. Implementing economic policy coordination may lead to political conflicts in the economy as policies may be interpreted differently by every political party. It can create pressure on the government to achieve policy coordination and also to avoid conflicts caused because of policy coordination

C) i) Actual (financial) or cyclically adjusted (structural) deficit: It is a type of budget deficit that takes place for a short period of time. Financial crisis and recession in the economy leads to cyclically adjusted deficit.

ii) Budgetary balance: It can be described as a situation when the revenue of the government is equal to the expenditures incurred by the government.