Answer to Question #169964 in Macroeconomics for joseph

Question

How does government finance affect both political and market equilibrium?

Answer 1

Solution:

Government finance also known as public finance is the deliberate alteration of revenues and expenditures of the government. It is the government financial plan, where it uses different types of revenues and expenditures as fiscal tools to accomplish various objectives. This includes high economic growth, equitable distribution of income and wealth, price stability, a favorable balance of trade and payment, proper distribution of resources, and a balanced and stable economic growth. Government finance has two sides, that is government revenue and government expenditure. Sources of government revenue include taxes, fines, charges, fees, and various earnings. Government expenditure includes development, administrative, diplomatic, payment of the public debt, and miscellaneous expenditure. The government expenditure is financed through taxes, donations, loans, and the profit of public corporations.

The government finance can affect political equilibrium in that, different parties compete with each other over policies that voters care about. That competition is strategic in that, an equilibrium in the inter-party game should comprise of a pair of policies that are mutual best responses. The preference and interests of their contributors according to their financial contribution to the party. The two parties will compete on who will contribute more to finance government expenditure so that they can get positive reviews on which policies to be adopted by the government, and this push and pull by political parties will impact political equilibrium.

Government finance affects market equilibrium in so many ways. One of those ways is taxation, when the government introduces higher taxes the market equilibrium price will increase and quantity will reduce, while lower taxes will reduce the market equilibrium price and increase the equilibrium quantity. The government can also introduce subsidies in production, which causes the supply curve to shift right decreasing equilibrium price and increasing equilibrium quantity. The government can also introduce price ceilings in the market, which can reduce the market equilibrium price and increase the quantity. The government can also introduce price floors, which will increase the equilibrium price and reduce the quantity.