Bangladesh University of Professionals (BUP)

Assignment On Role of Government in Market Economy”

Course Name: Business Economics

Course No: BUS 8403

Submitted To Submitted By

Prof. Dr. Md. Moniruzzaman Taniya Arefin

Faculty of Business Studies (FBS) Roll No.: 19020015
Bangladesh University of Session: 2019-2020
Professionals (BUP)

Date of Submission : 02.04.2020

Introduction
Growing populism, market scepticism and euroscepticism are, above all, a reflection of a lack of
trust. Governments create expectations and build or destroy trust depending on whether they deliver.
This has an important link to economics. First, governments are tempted to promise too much to
everybody. This is bound to create frustrations instead of building trust because people’s desires are
unlimited while financing is not. Moreover, the ability of governments is limited by the "laws" of
the market against which adverse policy measures can only temporarily prevail (Böhm-Bawerk
1914, Issing 2009). Moreover, there is the risk of contradictions between extensive promises to
different groups (high social welfare versus low taxes; security versus open borders). Governments
may find it hard to resist this temptation which would require dealing with the scarcity of their
means and prioritising their tasks.

Market Economy
A market economy is an economy where most resources are owned and controlled by individuals
and are allocated through voluntary market transactions governed by the interaction of supply and
demand.
People exchange resources, such as money, for other resources, such as goods or services, on a
voluntary basis in the market. The value of the resources exchanged is based upon how scarce each
resource is and how many people want the resource. If the supply of a resource is low, but the
demand is high, the price will tend to be high. If the demand is low and the supply high, the price
will tend to be low.
Economic growth and development in a market economy is determined by the relative risks and
rewards (or profits) that particular economic activity presents to individuals. If risks are too high and
rewards are too low, then certain activities probably will not be pursued.
Government involvement in regulating market transactions in a market economy is limited to pretty
much ensuring that the rules of the market are enforced and applied fairly to all participants.
Additionally, government involvement in planning or directing economic development and growth
is very limited. In practice, there is no such thing as a pure market economy because that would
mean there would be no taxes on economic activities or government regulation of economic
activities at all.
Advantages of Market Economy
Market economy has several advantages. Having a healthy competition and a system that
encourages entrepreneurship is important in any market. Below are some of the major pros of
market economy.

1. Harder working employees due to the threat of losing their job or being laid off because the
product or service is not selling.
2. Friendly competition between companies will encourage efficiency among employees to lower
costs for success.
3. Companies become creative in finding new products to sell or manufacture and less expensive
ways to accomplish their goals.
 4. As companies grow because of the market economy, foreign investors will begin to take an
interest and help expand.
5. Private companies take over activities and venues that were in the past public sector. This
reduces the size, power and cost of state bureaucracies.
6. Production increases for the frivolities that will cost more money but people want. This is a
classic example of supply and demand.
7. Social and technical skills needed to function within a market economy system are quickly
learned as is the knowledge to succeed.
8. There is a larger variety of consumer goods available for a wide range of people ranging from
middle-class to the very affluent.
9. Encourages people to step up and try their hand in the market economy. Encourages
entrepreneurs to start up a business and sell merchandise or offer services at competitive rates.

Disadvantages of Market Economy

Although the market economy system sounds ideal, there are always problems with any type of
economic system. Here are some of the disadvantages of the market economy system.

1. The exploitation of workers has a big disadvantage because of the working conditions, long
hours for less pay for a very few benefit. The large corporations have moved their production
to countries where they can get cheap labor with few safety regulations for the workers.
2. Investment priorities and wealth becomes distorted. The wealthy keep getting wealthier and
the public sector such as public education, transportation routes and public health does not get
the needed funds to keep evolving and providing for the public’s needs.
3. Goods will be mass produced and therefore the cost will be driven lower. As a product
becomes popular and overproduced, the manufacturers must unload the goods, even if that
means lowering prices to where the general public can afford them.
4. Due to overproduction, industrial machinery will lay idle and there will be no production or
profit for the manufacturer. Until the prices drop, the goods will remain unsold and people who
cannot afford them have their needs unmet.
5. Unemployment rates go up due to the overproduction of goods. Workers are not needed to
keep producing goods and therefore companies cannot afford to keep workers employed.
6. Having the market economy system will lead to periods of economic crisis. The economy
will stop growing when goods are overproduced and workers are then unemployed. The
economic crisis will not end until the next item is found that the wealthy just have to have.
Then the cycle starts again.

Role of Government in Market Economy

what do we want from our government? One answer is that we want a great deal more than we did
several decades ago. The role of government has expanded dramatically in the last 75+ years. In
1929 (the year the Commerce Department began keeping annual data on macroeconomic
performance in the United States), government expenditures at all levels (state, local, and federal)
were less than 10% of the nation’s total output, which is called gross domestic product (GDP). In
the current century, that share has more than tripled. Total government spending per capita,
adjusted for inflation, has increased more than six fold since 1929.
Figure 15.1 “Government Expenditures and Revenues as a Percentage of GDP” shows total
government expenditures and revenues as a percentage of GDP from 1929 to 2007. All levels of
government are included. Government expenditures include all spending by government
agencies. Government revenues include all funds received by government agencies. The primary
component of government revenues is taxes; revenue also includes miscellaneous receipts from fees,
fines, and other sources. We will look at types of government revenues and expenditures later in this
chapter

Figure 15.1 “Government Expenditures and Revenues as a Percentage of GDP” also shows

government purchases as a percentage of GDP. Government purchases happen when a government
agency purchases or produces a good or a service. We measure government purchases to suggest the
opportunity cost of government. Whether a government agency purchases a good or service or
produces it, factors of production are being used for public sector, rather than private sector,
activities. A city police department’s purchase of new cars is an example of a government purchase.
Spending for public education is another example

Government expenditures and purchases are not equal because much government spending is not for
the purchase of goods and services. The primary source of the gap is transfer payments, payments
made by government agencies to individuals in the form of grants rather than in return for labor or
other services. Transfer payments represent government expenditures but not government purchases.
Governments engage in transfer payments in order to redistribute income from one group to another.
The various welfare programs for low-income people are examples of transfer payments. Social
Security is the largest transfer payment program in the United States. This program transfers income
from people who are working (by taxing their pay) to people who have retired. Interest payments on
government debt, which are also a form of expenditure, are another example of an expenditure that
is not counted as a government purchase.

Several points about Figure 15.1 “Government Expenditures and Revenues as a Percentage of

GDP” bear special attention. Note first the path of government purchases. Government purchases
relative to GDP rose dramatically during World War II, then dropped back to about their prewar
level almost immediately afterward. Government purchases rose again, though less sharply, during
the Korean War. This time, however, they did not drop back very far after the war. It was during this
period that military spending rose to meet the challenge posed by the former Soviet Union and other
communist states—the “Cold War.” Government purchases have ranged between 15 and 20% of
GDP ever since. The Vietnam War, the Persian Gulf War, and the wars in Afghanistan and Iraq did
not have the impact on purchases that characterized World War II or even the Korean War. A
second development, the widening gap between expenditures and purchases, has occurred since the
1960s. This reflects the growth of federal transfer programs, principally Social Security, programs to
help people pay for health-care costs, and aid to low-income people. We will discuss these programs
later in this chapter.

Finally, note the relationship between expenditures and receipts. When a government’s revenues
equal its expenditures for a particular period, it has a balanced budget. A budget surplus occurs if a
government’s revenues exceed its expenditures, while a budget deficitexists if government
expenditures exceed revenues.

Prior to 1980, revenues roughly matched expenditures for the public sector as a whole, except during
World War II. But expenditures remained consistently higher than revenues between 1980 and 1996.
The federal government generated very large deficits during this period, deficits that exceeded
surpluses that typically occur at the state and local levels of government. The largest increases in
spending came from Social Security and increased health-care spending at the federal level. Efforts
by the federal government to reduce and ultimately eliminate its deficit, together with surpluses
among state and local governments, put the combined budget for the public sector in surplus
beginning in 1997. As of 1999, the Congressional Budget Office was predicting that increased
federal revenues produced by a growing economy would continue to produce budget surpluses well
into the twenty-first century.

That rather rosy forecast was set aside after September 11, 2001. Terrorist attacks on the United
States and later on several other countries led to sharp and sustained increases in federal spending
for wars in Afghanistan and Iraq, as well as expenditures for Homeland Security. The administration
of George W. Bush proposed, and Congress approved, a tax cut. The combination of increased
spending on the abovementioned items and others, as well as tax cuts, produced substantial deficits.

The evidence presented in Figure 15.1 “Government Expenditures and Revenues as a Percentage of
GDP” does not fully capture the rise in demand for public sector services. In addition to
governments that spend more, people in the United States have clearly chosen governments that do
more. The scope of regulatory activity conducted by governments at all levels, for example, has
risen sharply in the last several decades. Regulations designed to prevent discrimination, to protect
consumers, and to protect the environment are all part of the response to a rising demand for public
services, as are federal programs in health care and education.

Figure 15.2 “Government Revenue Sources and Expenditures: 2007” summarizes the main
revenue sources and types of expenditures for the U.S. federal government and for the European
Union. In the United States, most revenues came from personal income taxes and from payroll taxes.
Most expenditures were for transfer payments to individuals. Federal purchases were primarily for
national defense; the “other purchases” category includes things such as spending for transportation
projects and for the space program. Interest payments on the national debt and grants by the federal
government to state and local governments were the other major expenditures. The situation in the
European Union differs primarily by the fact that a greater share of revenue comes from taxes on
production and imports and substantially less is spent on defense.

Figure 15.2 Government Revenue Sources and Expenditures: 2007

The four panels show the sources of government revenues and the shares of expenditures on various
activities for all levels of government in the United States and the European Union in 2007

To understand the role of government, it will be useful to distinguish four broad types of
government involvement in the economy. First, the government attempts to respond to market
failures to allocate resources efficiently. In a particular market, efficiency means that the quantity
produced is determined by the intersection of a demand curve that reflects all the benefits of
consuming a particular good or service and a supply curve that reflects the opportunity costs of
producing it. Second, government agencies act to encourage or discourage the consumption of
certain goods and services. The prohibition of drugs such as heroin and cocaine is an example of
government seeking to discourage consumption of these drugs. Third, the government redistributes
income through programs such as welfare and Social Security. Fourth, the government can use its
spending and tax policies to influence the level of economic activity and the price level.

We will examine the first three of these aspects of government involvement in the economy in this
chapter. The fourth, efforts to influence the level of economic activity and the price level, fall within
the province of macroeconomics.

Core tasks of government: some conceptual issues

The link from the role of government to trust in government and the market economy is indirect
(Figure 1). If governments perform well on their core tasks, we are likely to witness more growth
and prosperity, better opportunities and more satisfaction by people in the ability of governments to
deliver on their expectations.
 Figure The link from government performance

However, if this is not the case, we are also likely to see poor performance of the economy, parts of
society without opportunities and a general sense of frustration with the economic and political
system. Worse, the poor performance of the market economy may induce governments to blame the
market instead of themselves. This risks discrediting the economic system and may create a spiral of
new intervention, worsening performance and further undermining trust.

Responding to Market Failure

In an earlier chapter on markets and efficiency, we learned that a market maximizes net benefit by
achieving a level of output at which marginal benefit equals marginal cost. That is the efficient
solution. In most cases, we expect that markets will come close to achieving this result—that is the
important lesson of Adam Smith’s idea of the market as an invisible hand, guiding the economy’s
scarce factors of production to their best uses. That is not always the case, however.

We have studied several situations in which markets are unlikely to achieve efficient solutions. In an
earlier chapter, we saw that private markets are likely to produce less than the efficient quantities of
public goods such as national defense. They may produce too much of goods that generate external
costs and too little of goods that generate external benefits. In cases of imperfect competition, we
have seen that the market’s output of goods and services is likely to fall short of the efficient level.
In all these cases, it is possible that government intervention will move production levels closer to
their efficient quantities. In the next three sections, we shall review how a government could
improve efficiency in the cases of public goods, external costs and benefits, and imperfect
competition.

Public Goods

A public good is a good or service for which exclusion is prohibitively costly and for which the
marginal cost of adding another consumer is zero. National defense, law enforcement, and generally
available knowledge are examples of public goods.
The difficulty posed by a public good is that, once it is produced, it is freely available to everyone.
No consumer can be excluded from consumption of the good on grounds that he or she has not paid
for it. Consequently, each consumer has an incentive to be a free rider in consuming the good, and
the firms providing a public good do not get a signal from consumers that reflects their benefit of
consuming the good.

Certainly we can expect some benefits of a public good to be revealed in the market. If the
government did not provide national defense, for example, we would expect some defense to be
produced, and some people would contribute to its production. But because free-riding behavior will
be common, the market’s production of public goods will fall short of the efficient level.

The theory of public goods is an important argument for government involvement in the economy.
Government agencies may either produce public goods themselves, as do local police departments,
or pay private firms to produce them, as is the case with many government-sponsored research
efforts. An important debate in the provision of public education revolves around the question of
whether education should be produced by the government, as is the case with traditional public
schools, or purchased by the government, as is done in charter schools.

External Costs and Benefits

External costs are imposed when an action by one person or firm harms another, outside of any
market exchange. The social cost of producing a good or service equals the private cost plus the
external cost of producing it. In the case of external costs, private costs are less than social costs.

Similarly, external benefits are created when an action by one person or firm benefits another,
outside of any market exchange. The social benefit of an activity equals the private benefit revealed
in the market plus external benefits. When an activity creates external benefits, its social benefit will
be greater than its private benefit.

The lack of a market transaction means that the person or firm responsible for the external cost or
benefit does not face the full cost or benefit of the choice involved. We expect markets to produce
more than the efficient quantity of goods or services that generate external costs and less than the
efficient quantity of goods or services that generate external benefits.

Consider the case of firms that produce memory chips for computers. The production of these chips
generates water pollution. The cost of this pollution is an external cost; the firms that generate it do
not face it. These firms thus face some, but not all, of the costs of their production choices. We can
expect the market price of chips to be lower, and the quantity produced greater, than the efficient
level.

Inoculations against infectious diseases create external benefits. A person getting a flu shot, for
example, receives private benefits; he or she is less likely to get the flu. But there will be external
benefits as well: Other people will also be less likely to get the flu because the person getting the
shot is less likely to have the flu. Because this latter benefit is external, the social benefit of flu shots
exceeds the private benefit, and the market is likely to produce less than the efficient quantity of flu
shots. Public, private, and charter schools often require such inoculations in an effort to get around
the problem of external benefits.
Imperfect Competition

In a perfectly competitive market, price equals marginal cost. If competition is imperfect, however,
individual firms face downward-sloping demand curves and will charge prices greater than marginal
cost. Consumers in such markets will be faced by prices that exceed marginal cost, and the
allocation of resources will be inefficient.

An imperfectly competitive private market will produce less of a good than is efficient. As we saw
in the chapter on monopoly, government agencies seek to prohibit monopoly in most markets and to
regulate the prices charged by those monopolies that are permitted. Government policy toward
monopoly is discussed more fully in a later chapter.

Assessing Government Responses to Market Failure

In each of the models of market failure we have reviewed here—public goods, external costs and
benefits, and imperfect competition—the market may fail to achieve the efficient result. There is a
potential for government intervention to move inefficient markets closer to the efficient solution.

Figure 15.3 “Correcting Market Failure” reviews the potential gain from government intervention
in cases of market failure. In each case, the potential gain is the deadweight loss resulting from
market failure; government intervention may prevent or limit this deadweight loss. In each panel, the
deadweight loss resulting from market failure is shown as a shaded triangle.
Figure 15.3 Correcting Market Failure

In each panel, the potential gain from government intervention to correct market failure is shown by the
deadweight loss avoided, as given by the shaded triangle. In Panel (a), we assume that a private market
produces Qm units of a public good. The efficient level, Qe, is defined by the intersection of the demand curve D1 for the
public good and the supply curve S1. Panel (b) shows that if the production of a good generates an external cost, the
supply curve S1 reflects only the private cost of the good. The market will produce Qm units of the good at price P1. If the
public sector finds a way to confront producers with the social cost of their production, then the supply curve shifts to S2,
and production falls to the efficient level Qe. Notice that this intervention results in a higher price, P2, which confronts
consumers with the real cost of producing the good. Panel (c) shows the case of a good that generates external benefits.
Purchasers of the good base their choices on the private benefit, and the market demand curve is D1. The market quantity
is Qm. This is less than the efficient quantity, Qe, which can be achieved if the activity that generates external benefits is
subsidized. That would shift the market demand curve to D2, which intersects the market supply curve at the efficient
quantity. Finally, Panel (d) shows the case of a monopoly firm that produces Qm units and charges a price P1. The
efficient level of output, Qe, could be achieved by imposing a price ceiling at P2. As is the case in each of the other
panels, the potential gain from such a policy is the elimination of the deadweight loss shown as the shaded area in the
exhibit.

Panel (a) of Figure 15.3 “Correcting Market Failure” illustrates the case of a public good. The
market will produce some of the public good; suppose it produces the quantity Qm. But the demand
curve that reflects the social benefits of the public good, D1, intersects the supply curve at Qe; that is
the efficient quantity of the good. Public sector provision of a public good may move the quantity
closer to the efficient level.

Panel (b) shows a good that generates external costs. Absent government intervention, these costs
will not be reflected in the market solution. The supply curve, S1, will be based only on the private
costs associated with the good. The market will produce Qm units of the good at a price P1. If the
government were to confront producers with the external cost of the good, perhaps with a tax on the
activity that creates the cost, the supply curve would shift to S2 and reflect the social cost of the
good. The quantity would fall to the efficient level, Qe, and the price would rise to P2.

Panel (c) gives the case of a good that generates external benefits. The demand curve revealed in the
market, D1, reflects only the private benefits of the good. Incorporating the external benefits of the
good gives us the demand curve D2 that reflects the social benefit of the good. The market’s output
of Qm units of the good falls short of the efficient level Qe. The government may seek to move the
market solution toward the efficient level through subsidies or other measures to encourage the
activity that creates the external benefit.

Finally, Panel (d) shows the case of imperfect competition. A firm facing a downward-sloping
demand curve such as D1 will select the output Qm at which the marginal cost curve MC1intersects
the marginal revenue curve MR1. The government may seek to move the solution closer to the
efficient level, defined by the intersection of the marginal cost and demand curves.

While it is important to recognize the potential gains from government intervention to correct
market failure, we must recognize the difficulties inherent in such efforts. Government officials may
lack the information they need to select the efficient solution. Even if they have the information,
they may have goals other than the efficient allocation of resources. Each instance of government
intervention involves an interaction with utility-maximizing consumers and profit-maximizing firms,
none of whom can be assumed to be passive participants in the process. So, while the potential exists
for improved resource allocation in cases of market failure, government intervention may not always
achieve it.

The late George Stigler, winner of the Nobel Prize for economics in 1982, once remarked that
people who advocate government intervention to correct every case of market failure reminded him
of the judge at an amateur singing contest who, upon hearing the first contestant, awarded first prize
to the second. Stigler’s point was that even though the market is often an inefficient allocator of
resources, so is the government likely to be. Government may improve on what the market does; it
can also make it worse. The choice between the market’s allocation and an allocation with
government intervention is always a choice between imperfect alternatives. We will examine the
nature of public sector choices later in this chapter and explore an economic explanation of why
government intervention may fail to move market solutions closer to their efficient levels.

Merit and Demerit Goods

In some cases, the public sector makes a determination that people should consume more of some
goods and services and less of others, even in the absence of market failure. This is a normative
judgment, one that presumes that consumers are not always the best judges of what is good, or bad,
for them.

Merit goods are goods whose consumption the public sector promotes, based on a presumption that
many individuals do not adequately weigh the benefits of the good and should thus be induced to
consume more than they otherwise would. Many local governments support symphony concerts, for
example, on grounds that the private market would not provide an adequate level of these cultural
activities.

Indeed, government provision of some merit goods is difficult to explain. Why, for example, do
many local governments provide tennis courts but not bowling alleys, golf courses but not auto
racetracks, or symphony halls but not movie theaters? One possible explanation is that some
consumers—those with a fondness for tennis, golf, and classical music—have been more successful
than others in persuading their fellow citizens to assist in funding their preferred activities.

Demerit goods are goods whose consumption the public sector discourages, based on a presumption
that individuals do not adequately weigh all the costs of these goods and thus should be induced to
consume less than they otherwise would. The consumption of such goods may be prohibited, as in
the case of illegal drugs, or taxed heavily, as in the case of cigarettes and alcohol.

Income Redistribution

The proposition that a private market will allocate resources efficiently if the efficiency condition is
met always comes with a qualification: the allocation of resources will be efficient given the initial
distribution of income. If 5% of the people receive 95% of the income, it might be efficient to
allocate roughly 95% of the goods and services produced to them. But many people (at least 95% of
them!) might argue that such a distribution of income is undesirable and that the allocation of
resources that emerges from it is undesirable as well.

There are several reasons to believe that the distribution of income generated by a private economy
might not be satisfactory. For example, the incomes people earn are in part due to luck. Much
income results from inherited wealth and thus depends on the family into which one happens to have
been born. Likewise, talent is distributed in unequal measure. Many people suffer handicaps that
limit their earning potential. Changes in demand and supply can produce huge changes in the values
—and the incomes—the market assigns to particular skills. Given all this, many people argue that
incomes should not be determined solely by the marketplace.

A more fundamental reason for concern about income distribution is that people care about the
welfare of others. People with higher incomes often have a desire to help people with lower
incomes. This preference is demonstrated in voluntary contributions to charity and in support of
government programs to redistribute income.
A public goods argument can be made for government programs that redistribute income. Suppose
that people of all income levels feel better off knowing that financial assistance is being provided to
the poor and that they experience this sense of well-being whether or not they are the ones who
provide the assistance. In this case, helping the poor is a public good. When the poor are better off,
other people feel better off; this benefit is nonexclusive. One could thus argue that leaving private
charity to the marketplace is inefficient and that the government should participate in income
redistribution. Whatever the underlying basis for redistribution, it certainly occurs. The governments
of every country in the world make some effort to redistribute income.

Programs to redistribute income can be divided into two categories. One transfers income to poor
people; the other transfers income based on some other criterion. A means-tested transfer payment is
one for which the recipient qualifies on the basis of income; means-tested programs transfer income
from people who have more to people who have less. The largest means-tested program in the
United States is Medicaid, which provides health care to the poor. Other means-tested programs
include Temporary Assistance to Needy Families (TANF) and food stamps. A non-means-tested
transfer payment is one for which income is not a qualifying factor. Social Security, a program that
taxes workers and their employers and transfers this money to retired workers, is the largest non-
means-tested transfer program. Indeed, it is the largest transfer program in the United States. It
transfers income from working families to retired families. Given that retired families are, on
average, wealthier than working families, Social Security is a somewhat regressive program. Other
non-means tested transfer programs include Medicare, unemployment compensation, and programs
that aid farmers

Figure 15.4 “Federal Transfer Payment Spending” shows federal spending on means-tested and
non-means-tested programs as a percentage of GDP, the total value of output, since 1962. As the
chart suggests, the bulk of income redistribution efforts in the United States are non-means-tested
programs.
Figure 15.4 Federal Transfer Payment Spending

The chart shows federal means-tested and non-means-tested transfer payment spending as a percentage of GDP from
1962–2007.

The fact that most transfer payments in the United States are not means-tested leads to something of
a paradox: some transfer payments involve taxing people whose incomes are relatively low to give
to people whose incomes are relatively high. Social Security, for example, transfers income from
people who are working to people who have retired. But many retired people enjoy higher incomes
than working people in the United States. Aid to farmers, another form of non-means-tested
payments, transfers income to farmers, who on average are wealthier than the rest of the population.
These situations have come about because of policy decisions.
 Bangladesh University of Professionals (BUP)
“Assignment On Fiscal Policy of Bangladesh”
Course Name: Business Economics

Course No: BUS 8403

Submitted To Submitted By

Prof. Dr. Md. Moniruzzaman Taniya Arefin

Faculty of Business Studies (FBS) Roll No.: 19020015
Bangladesh University of Session: 2019-2020
Professionals (BUP)

Date of Submission

02.04.2020
Fiscal policy
Fiscal policy of Bangladesh basically comprises activities to ensure macroeconomic stability of the
country. Fiscal policy of Bangladesh is expansionary that causes large budget deficit. As a result,
government of Bangladesh follows reflationary fiscal stance- borrows money to overcome the
budget deficit. In the fiscal year 2009-2010, Bangladesh government estimated the budget deficit of
Tk. 343.58 billion of which Tk. 137.14 will come from domestic sources and Tk.
173.25 will come from foreign sources. The main reasons of budget deficit are tax avoidance of public
and corruption in government sector. However, present government is trying to increase both the
government and public investment. As a result, government should improve the environment of
investment by ensuring available supply of energy, gas, transportation and implementing law and
order system. Another negative side of Bangladesh economy is high inflation rate. So, government
should take all the necessary steps to reduce the inflation. Otherwise, people have to suffer a lot.
So, the overall circumstance of Bangladesh economy is not so good.

Fiscal Policy: Fiscal Policy generally refers to the use of taxation and government expenditure to
regulate the aggregate level of economic activity in a country. Fiscal policy is taken by the
government of a country.

Classification of fiscal policy: Fiscal policy has got three forms and by the help of those forms
the government regulates the fiscal activity in an economy.
.
Expansionary fiscal policy: A form of fiscal policy in which an increase in government purchases,
a decrease in taxes, and an increase in transfer payments are used to correct the problems of a
business cycle contraction. The goal of expansionary fiscal policy is to close a recessionary gap,
stimulate the economy, and decrease the unemployment rate. Expansionary fiscal policy is
designed to stimulate the economy during or anticipation of a business-cycle contraction. This is
accomplished by increasing aggregate expenditures and aggregate demand through an increase in
government spending or a decrease in taxes. Expansionary fiscal policy leads to a larger
government budget deficit or a smaller budget surplus. Expansionary fiscal policy is usually
associated with a budget deficit.
 Contradictory fiscal policy: A form of fiscal policy in which a decrease in government purchases,
an increase in taxes, and a decrease in transfer payments are used to correct the inflationary
problems of a business-cycle expansion. The goal of contradictory fiscal policy is to close an
inflationary gap, restrain the economy, and decrease the inflation rate. Contradictory fiscal policy
is designed to restrain the economy during or anticipation of an inflation-inducing business-cycle
expansion. This is accomplished by decreasing aggregate expenditures and aggregate demand
through a decrease in government spending or an increase in taxes. Contradictory fiscal policy
leads to a smaller government budget deficit or a larger budget surplus.

Self-Financing Fiscal Policy: Assume an economy in which output is well below its potential,
cyclical unemployment is elevated, supply constraints on short-run demand are absent, conventional
monetary policy is constrained by the zero lower bound, and the central bank is either unable or
unwilling to, but in any case does not, provide additional stimulus through quantitative easing or
other means. A simple calculation then conveys the main message of this paper: under these
circumstances, a combination of real government borrowing rates in the historical range, modestly
positive fiscal multiplier effects, and small hysteresis effects are together sufficient to render fiscal
expansion self-financing.

Fiscal policy in Bangladesh

Fiscal policy in Bangladesh basically comprises activities, which the country carries out to obtain and
use resources to provide services while ensuring optimum efficiency of the economic units. The
policy influences the behavior of economic forces through public finance. Major objectives of the
fiscal policy of Bangladesh are to ensure macroeconomic stability of the country, promote economic
growth, and develop a mechanism for equitable distribution of income. The main tools to achieve
these objectives are variation in public revenue, variation in public expenditure, and management of
public debt. These are reflected in the budgetary operations of the government, prepared and
implemented on year-on-year basis.
History of Bangladesh fiscal policy
In the initial years of independence, the government of Bangladesh had to spend a large amount of
its resources in reconstruction and rehabilitation work. It had negative public savings and limited
private investment. Despite large inflows of FOREIGN AID, the increasingly large financing gap
became the main concern of the government. The situation was further aggravated by frequent
internal and external shocks. Under the circumstances, government fiscal policies during 1970s and
1980s were largely oriented at rehabilitating the war-torn economy as well as stabilizing it from various
shocks. This had gradually leaded to weak fiscal structure and poor fiscal management. The tax
structure was such that any increases in taxes due to built-in consequences of economic growth were
virtually not possible. This was because of the fact that despite a moderate growth of the economy,
INCOME DISTRIBUTION was skewed, and had been pushing more and more people below the
POVERTY line each year. As such, the proportion of POPULATION with taxable surplus went
down overtime. More than 80% of the total tax revenue came from indirect taxes, amongst which
taxes on imports contributed about 60%. Since most imports were in the government sector and basic
need-oriented, it was hardly possible to increase import duty. Despite higher production costs, prices
of most public goods could not be rationalized due to socio - economic reasons. As such, these were kept
lower, which resulted in inadequate cost recovery.
Taxation Policy of Bangladesh Government:
Taxation one of the major sources of public revenue to meet a country's revenue and development
expenditures with a view to accomplishing some economic and social objectives, such as
redistribution of income, price stabilization and discouraging harmful consumption. It supplements other
sources of public finance such as issuance of currency notes and coins, charging for public goods
and services and borrowings. Bangladesh inherited a system of taxation from its past British and
Pakistani rulers. According to Article 152(1) of the Constitution of Bangladesh, taxation includes the
imposition of any tax, rate, duty or impost, whether general, local or special, and tax shall be
construed accordingly. To develop manpower for efficient tax administration, the government runs
two training academies - BCS (Tax) Academy at DHAKA for direct tax training and Customs,
Excise and Value Added Tax Training Academy at Chittagong for indirect tax training. The NATIONAL
BOARD OF REVENUE (NBR) is the apex tax authority of Bangladesh and it collects around 93% of
total taxes or 76% of total public revenues. The NBR portion of total taxes includes CUSTOMS
DUTY, VALUE ADDED TAX (VAT), supplementary duty (SD), EXCISE DUTY, income tax,
foreign travel tax, electricity duty, wealth tax , turnover tax (TT), air ticket tax, advertisement tax,
gift tax and miscellaneous insignificant taxes. Public revenue also comes from non-tax receipts such as
surplus of sector corporations, financial institutions, railways, postal department, telegraph and
telephone, judicial stamp, etc, and these non-tax revenues represent around 19% of total revenues.
 Tax structure of our country:
Direct Tax: Direct tax includes income tax, gift tax, land development tax, non-judicial stamp,
registration, immovable property tax, etc. Since direct taxes represent only about 19% of total
taxes. Of the direct taxes, around 69% come from income tax, 19% from non-judicial stamp,
5.7% from land revenue, 5.6% from registration and balance from gift tax and other direct taxes.

Indirect Tax: Indirect tax includes customs duty, excise duty, motor vehicle tax, VAT, SD,
foreign travel tax, TT, electricity duty, advertisement tax, etc. Tax-structure is heavily dependent
on indirect taxes. . Indirect taxes (representing 81% of total taxes), on the other hand, are mainly
import-dependent. Around 67% of indirect taxes are collected at import stage by customs
authorities as customs duty (38.0% of indirect tax or 30.7% of total tax), VAT (24.3% of
indirect tax or 19.6% of total tax), and SD (4.7% of indirect tax or 3.8% of total tax). Balance of
indirect taxes (representing around 26.64% of total taxes) include taxes collected on domestic
production, consumption or transactions such as VAT (11.4%), SD (11.6%), excise duty (1.5%),
foreign travel tax (0.7%), electricity duty (0.6%), motor vehicle tax (0.7%), TT (0.03%), air
ticket tax (0.01%) and advertisement tax (0.001%).

Bangladesh Government Expenditure: Bangladesh government expenditure includes both the

purchase of final goods and services, or gross domestic product, and transfer payments. Bangladesh
government expenditures are used by the government sector to undertake key functions, such as
national defense and education etc. These expenditures are financed with a combination of taxes and
borrowing.

List of some major expenditure of our country: According to the total allocation of expenditure
of national budget of Bangladesh under the fiscal policy are listed below.

 ducation and IT 12 percent.

 Interest payment 14 percent.
 Social security and welfare 7 percent.
 Defense 5 percent.
 Health 6 percent.
 Agriculture 5 percent.
 Public administration 14 percent.
  Local government and rural development 5 percent.
 Transportation and communication 6 percent.
 Public and security 7 percent.
 Housing 1 percent.
 Industrial and Economic state 1 percent.
 Energy and power 4 percent.
 Culture and religious affairs 1 percent.
Pension 3 percent
Slow Pace of the Economy during Election Years

Deficit
Fiscal GDP Growth Revenue Expenditure Development Expenditure
(Billion
Year (%) (Billion Taka) (Billion Taka)
Taka)
1 2 3 4 5

1989-90 5.9 67.4 57.17 56.79

1990-91 3.3 73.10 52.69 47.57

1994-95 4.9 103.00 103.03 63.93

1995-96 4.6 118.14 100.16 63.18

2000-01 5.3 206.62 161.51 126.40

2001-02 4.4 226.92 140.90 91.12

2007-08 6.2 579.22 184.55 158.38

2008-09 5.7 676.03 196.68 180.91

2011-12 6.23 1021.30 380.00 252.45

2012-13 6.03 1369.60 523.70 496.60

Source: iBAS, Bangladesh Economic Review 2012 and different issues of Budget in Brief.
Parameter Values for the Base Case

Parameter Interpretation Assumed value

μ Present-period government spending multiplier 0–2.5

Real government borrowing rate and social rate of time
r 0.025–?
discount, per year
g Trend growth rate of potential GDP, per year 0.025

 Marginal tax-and-transfer rate 0.333

Disincentive effect: reduction in potential output from
 0.25–0.5
raising additional tax revenue
Hysteresis effect: proportional reduction in potential
 0–0.2
output from a temporary downturn

List of Successfully Implemented Policies/Programmes/Activities

Included in Last Four Budgets (Financial Sector)

1. Money Laundering Prevention Act, 2012 enacted

2. Anti-Terrorism (Amendment) Act, 2012 enacted
3. Insurance Act, 2009 enacted
4. The Securities and Exchange Commission (Public Issue) Rules, 2006 amended
5. The Securities and Exchange Commission (Mutual Fund) Rules, 2001 amended
6. The Securities and Exchange Commission (Merchant Banker and Portfolio Manager) Rules
7. The Exchanges (Demutualization) Act, 2012 passed in the parliament
8. The Securities and Exchange Commission Act, 1990 amended
9. The Securities and Exchange Ordinance, 1969 amended
10. The Securities and Exchange Commission (Private Placement of Debt Securities) Rules
11. Insurance Development and Regulatory Authority Act, 2009 enacted
12. Insurance Development and Regulatory Authority (IDRA) established and process started to
formulate Insurance Corporation Act, 2013
13. Bangladesh Development Bank Ltd. established by merging Bangladesh Shilpa Bank and
Bangladesh Shilpa Rin Shangstha
14. The face value of all shares and mutual funds listed with the stock exchanges reset to Tk 10
15. The mandatory provision for sponsor–directors of listed limited companies to hold
 individually minimum 2.0 per cent and collectively 30 per cent share made
16. The Corporate Governance Guidelines modernized
17. A network connecting all departments of the head office with branches of Bangladesh Bank
18. The total accounting and human resource management systems of Bangladesh Bank brought
under Enterprise Resource Planning (ERP) software

Inflation in Bangladesh:
In economics, inflation is a rise in the general level of prices of goods and services in an
economy over a period of time. When the price level rises, each unit of currency buys fewer goods
and services; consequently, annual inflation is also erosion in the purchasing power of money – a
loss of real value in the internal medium of exchange and unit of account in the economy. A chief
measure of price inflation is the inflation rate, the annualized percentage change in a general price
index (normally the Consumer Price Index) over time. Although the present situation of inflation in
Bangladesh is not very good, it is better than the previous year. The present scenario of inflation in
Bangladesh is given below:

Year Inflation rate (consumer prices) Rank Percent Change Date of Information

2003 3.10 % 117 2002 est.

2004 5.60 % 67 80.65 % 2003 est.

2005 6.00 % 160 7.14 % 2004 est.

2006 7.00 % 160 16.67 % 2005 est.

2007 7.20 % 163 2.86 % 2006 est.

2008 9.10 % 184 26.39 % 2007 est.

2009 8.90 % 137 -2.20 % 2008 est.

2010 5.10 % 142 -42.70 % 2009 est.

Stance of Bangladesh fiscal policy

The fiscal stance is a term that is used to describe whether fiscal policy is being used to actively
expand demand and output in the economy (a reflationary or expansionary fiscal stance) or conversely
to take demand out of the circular flow (a deflationary fiscal stance).
A neutral fiscal stance might be shown if the government runs with a balanced budget where government
spending is equal to tax revenues. Adjusting for where the economy is in the economic cycle, a
neutral fiscal stance means that policy has no impact on the level of economic activity.
A reflationary fiscal stance happens when the government is running a large deficit budget (i.e. G>T).
Loosening the fiscal stance means the government borrows money to inject funds into the economy so as
to increase the level of aggregate demand and economic activity.
A deflationary fiscal stance happens when the government runs a budget surplus (i.e. G
From budget scenario it is seen that government of Bangladesh is running a large budget deficit (i.e.
G>T). As a result, the government borrows money to inject funds into the economy so as to increase the
level of aggregate demand and economic activity. So it can be said that the stance of Bangladesh fiscal
policy is reflationary.

Fiscal Policy Affect the Macro Economy

Fiscal policy affects aggregate demand, the distribution of wealth, and the economy’s capacity to produce
goods and services. In the short run, changes in spending or taxing can alter both the magnitude and the
pattern of demand for goods and services. With time, this aggregate demand affects the allocation of
resources and the productive capacity of an economy through its influence on the returns to
factors of production, the development of human capital, the allocation of capital spending, and
investment in technological innovations. Tax rates, through their effects on the net returns to
labor, saving, and investment, also influences both the magnitude and the allocation of productive
capacity. Macroeconomics has long featured two general views of the economy and the ability of
fiscal policy to stabilize or even affect economic activity. The equilibrium view sees the economy quickly
returning to full capacity whenever disturbances displace it from full employment. Accordingly, changes
in fiscal policy, or even in monetary policy for that matter, have little potential for stabilizing the
economy. Instead,

inevitable delays in recognizing economic disturbances, in enacting a fiscal response, and in the economy’s
reacting to the change in policy can aggravate, rather than diminish, business-cycle fluctuations. An
alternative view sees critical market failures causing the economy to adjust with more difficulty to
these disturbances. If, for example, consumers were to reduce their current spending in order to
consume more in the future, producers, who would not know the consumers’ future plans for
want of the appropriate futures markets for goods and services, would see only an indefinite drop
in demand, and this might encourage them, in turn, to reduce their hiring and capital spending. In
this world, changes in fiscal and monetary policy have greater potential for stabilizing aggregate
demand and economic activity. How the economy reacts to fiscal policy depends on whether it is at
full employment or operating below its full capacity.

Effects of a Tax Cut on Consumer Spending

To illustrate the importance of the difference in these two views for fiscal policy stabilization, consider
the effects of a cut in personal taxes—a classic countercyclical fiscal-policy action. Lower taxes,
everything else being constant, increase households’ disposable income, al owing consumers to increase
their spending. The consequences of the cut—how much is spent or saved, and the response of
economic activity—depend on the way households make their decisions and on prevailing
macroeconomic conditions.
For example, whether the tax cut is perceived to be temporary or permanent will influence how much
consumers save. A temporary cut when the economy is at full employment will alter households’
lifetime disposable income relatively little, and so might have little effect on consumption. If the cut is,
instead, perceived to be permanent, then households will perceive a larger increase in their lifetime
disposable income and so will likely increase their desired consumption by much more than they
would if they thought the cut were temporary.
So far, we have been considering the effect of a tax cut on households’ consumption expenditures
with everything else held constant. However, lower taxes will increase the government’s fiscal deficit.
Suppose that the economy tends to remain near ful employment and that households do not expect
their disposable income to rise any higher than it would have risen without the change in fiscal policy.
Even if the tax cut is long-lasting, many will conclude that future taxes will need to be higher than
they otherwise would have been in order to retire the

extra public debt resulting from the tax cut. In the extreme case, households will not feel that their
disposable income has risen, because they have completely internalized the increase in the public debt
arising from the tax cut, treating it as though it were equivalent to personal debt.
Yet even in the full-employment view, consumption might increase as a result of the tax cut if capital
markets are imperfect. Consumers who are liquidity constrained, living from paycheck to paycheck, will
likely increase their spending even if they internalize the public debt. So the effect of the tax cut
will depend on its incidence over different types of Tax payers. Consumption will also increase if the
government can borrow at a lower rate of interest than the consumer.
However, consumption can increase more significantly when the economy is not at full employment
and if the tax cut is seen as an instance of a continuing fiscal policy that stabilizes economic activity, or
if the tax cut otherwise raises households’ expected income by increasing the economy’s future
productive capacity. Although the tax cut entails an increase in public debt, higher current and future
income diminishes the burden of servicing or repaying this debt. In this case, the tax cut is essentially
an investment in a public good that redounds to the benefit of households.

Effects on Interest Rates, Capital Formation, and

International
Capital Flows
Over time, an increase in the budget deficit resulting from a tax cut will increase the public debt.
That increase raises important issues concerning the long-run effects of the tax cut on interest rates,
capital investment, and future economic welfare. The rich range of possible consequences makes this a
very controversial and interesting topic.

Fiscal policies that increase the deficit will result in future taxes being higher than they otherwise would
have been, but, depending on the policies’ effects on incentives for investing in human or physical
capital, they might also raise future living standards. Policies that absorb slack resources or foster
investment might reduce government saving, as reflected in the greater budget deficit, while they
increase total saving, as reflected in the greater rate of capital formation. This additional saving
might be supplied by the increase in national income, or it might come from foreign sources. Policies
that fail to raise income and investment not only reduce government saving, but also reduce total
saving . When the economy is at full employment and a tax cut today is expected to be offset by a tax
increase in the future, as discussed above, lower taxes do not necessarily increase consumption spending.
In this extreme case, the increase in the government’s deficit wil be matched by an increase in
private saving. As a result, national saving, interest rates, and investment spending will be much
the same as if there had been no change in fiscal policy. If, instead, consumers spend much of
their additional disposable income while the economy is already at full employment, personal saving
will not rise sufficiently to offset the drop in public saving, interest rates will rise, and investment
spending will decline, unless business saving (resulting from the additional consumption spending) or
capital inflows from abroad increase sufficiently to make up the difference. If the economy is not
at full employment, national income might expand as a result of the cut, providing additional
income-tax receipts and saving, and thereby preventing a drop in national saving. In either case, a tax
cut that increases the return on capital can increase business saving and attract, for a time, an inflow
of foreign saving sufficient to maintain total saving and investment. If, however, fiscal policy
depresses investment, then both the capital stock and economic output will be lower in the future
than they otherwise would have been. The lower capital stock will tend to be accompanied by real
interest rates that are higher than they otherwise would have been.
If capital inflows from abroad increase sufficiently to offset any drop in national saving resulting
from a change in fiscal policy, then investment need not fall. In this case, the current account deficit,
which is equal to the quantity of capital inflows from abroad, will increase at least enough to
offset the increase in the budget deficit less the induced increase in private saving. The future levels of
the capital stock and real output will not fall, but future domestic consumption will be reduced
because an increased share of the return to capital will accrue to foreign nationals— unless the fiscal
policy fosters a greater utilization of the stock of capital, greater capital formation, or greater net
returns on capital to compensate for the outflow. The concurrent large budget and current account
deficits that occurred in the early 1980s and again in the last few years have led many to believe
that increases in the current account deficit would generally accompany large increases in the budget
deficit, and gave rise to the term “twin deficits.”

Tension between Short-Term Stabilization and Long-Term

Goals
In the discussion so far, it is apparent that there is a potential conflict between the use of fiscal policy
to stimulate aggregate demand when the economy is operating below potential in the short run and
the use of policy to promote longer-run goals for national saving and capital formation to improve future
living standards. When there are underutilized economic resources, fiscal stimulus can increase
investment. But when the economy is operating near potential, an increase in the public debt
might eventually depress private investment, unless the fiscal stimulus is reversed as the economy
approaches full employment or the policy fosters capital formation and increases the supply of labor.
This tension between short-run stabilization and longer-run growth is prominent in the rest of this
volume. The volume begins with a reconsideration of the role of fiscal policy in macroeconomic
stabilization before turning to an analysis of longer-term concerns.
 The national income multiplier effect
The multiplier effect or spending multiplier is the idea that an initial amount of spending (usually
by the government) leads to increased consumption spending and so results in an increase in
national income greater than the initial amount of spending. In other words, an initial change in
aggregate demand causes a change in aggregate output for the economy that is a multiple of the
initial change.
The change in government expenditure of Bangladesh 2010 is influenced by a national income
multiplier. If multiplier is 5 then income will be 5 times of government expenditure. If income
rises, then interest rate or opportunity cost of holding money will fall. As a result, investment on business
and residence will increase. Because of increase in investment aggregate demand will increase and be 5
times of government expenditure. Because of unavailable information, national income multiplier is
assumed 5.

Fiscal Policy Improves Macro Stabilization

Countercyclical Fiscal Policy in Theory
Through the 1980s and 1990s, the predominant answer in the profession was a resounding “no.” Alan
Blinder takes issue with that conclusion in “The Case against the Case against Discretionary Fiscal
Policy.” Blinder reminds the reader that views on the use of discretionary fiscal policy as a tool for
macroeconomic stabilization have undergone a sea change since the early 1960s, when the prevailing
wisdom was that discretionary stabilization policy was effective and desirable for taming the business
cycle, and that fiscal policy was the most important tool with which to conduct stabilization policy.
Then, beginning in the late 1960s, theoretical and empirical work raised serious doubts about fiscal
policy’s ability to accomplish countercyclical stabilization; while large deficits in the 1980s made it
unlikely any would be attempted.
Blinder begins by reviewing the intellectual and policy developments that led to the diminished
role of fiscal policy, and then turns his attention to a critical analysis of the arguments against the use
of discretionary fiscal policy as a stabilization tool. After discussing the theoretical assumptions
underlying, Blinder evaluates the empirical research on this topic. He concludes that the weight of
the evidence supports the view that both temporary and permanent tax changes do affect consumption
spending. Overall, Blinder finds the practical arguments against the use of discretionary fiscal policy to be
more compelling than the theoretical arguments.
Long lags in the formulation and implementation of appropriate stabilization policies are likely to
be especially severe when the policy instrument is government purchases, leading Blinder to conclude
that changes in taxes and transfers are more effective fiscal instruments for stabilization. Blinder
suggests that institutional changes, such as placing short-run tax policy in the hands of a board of
technical experts modeled after the Federal Reserve Board, might alleviate some of the practical
aspects of using tax policy for stabilization. Another suggestion Blinder makes is to improve the
targeting of changes in taxes and transfers. If tax and transfer changes were better targeted at those
households that are most likely to change their consumption spending in response to temporary
changes in their disposable income, then fiscal policy would be more effective at influencing aggregate
demand. Blinder cites the expansion of unemployment insurance benefits as an example of a fiscal
policy that is well targeted for increasing consumption. Blinder also suggests that future fiscal
stabilization make greater use of opportunities to exploit intertemporal substitution. Examples of
policies that exploit intertemporal substitution to temporarily stimulate aggregate demand are a
temporary cut in sales-tax rates, which creates an incentive for consumers to purchase durable goods
earlier than they otherwise would in order to avoid paying the tax, and a temporary investment tax
credit, which provides an incentive for firms to accelerate the timing of new investment projects.

Conclusion
Bangladesh fiscal policy is expansionary which causes large budget deficit. For that, government takes
reflationary stance of fiscal policy. The reasons behind this budget deficit are tax avoidance of
citizens, corruption in government sector, high inflation rate and global recession. As a result, government
should take all the necessary steps to remove these negative aspects. Otherwise, Bangladesh economy
will fall into great danger.