- Resource allocation refers to the way in which the available factors of production are allocated among the various uses to which they might be put. It determines how much of the various kinds of goods and services will actually be produced in an economy. One of the most important functions of an economic system is the optimal or efficient allocation of scarce resources so that the available resources are put to their best use and no wastages are there.
- As we know, the private sector resource allocation is characterized by market supply and demand and price mechanism as determined by consumer sovereignty and producer profit motives. The state’s allocation, on the other hand, is accomplished through the revenue and expenditure activities of governmental budgeting. In the real world, resource allocation is both market determined and government determined.
- A market economy is subject to serious malfunctioning in several basic respects. There is also the problem of nonexistence of markets in a variety of situations. While private goods will be sufficiently provided by the market, public goods will not be produced in sufficient quantities by the market. Why do markets fail to give right answers to the question as to what goods should be produced and in what quantities? In other words, why do markets generate misallocation of resources?
- Imperfect competition and presence of monopoly power in different degrees leading to under-production and higher prices than would exist under conditions of competition. These distort the choices available to consumers and reduce their welfare.
- Markets typically fail to provide collective goods which are, by their very nature, consumed in common by all the people.
- Externalities which arise when the production and consumption of a good or service affects people and they cannot influence through markets the decision about how much of the good or service should be produced e.g. pollution.
- Factor immobility which causes unemployment and inefficiency
- Imperfect information, and
- Inequalities in the distribution of income and wealth.
According to Musgrave, the state is the instrument by which the needs and concerns of the citizens are fulfilled and therefore, public finance is connected with economic mechanisms that should ideally lead to the effective and optimal allocation of limited resources. This logic, in effect, makes it necessary for the government to intervene in the market to bring about improvement in social welfare. In the absence of appropriate government intervention, market failures may occur and the resources are likely to be misallocated by too much production of certain goods or too little production of certain other goods. The allocation responsibility of the governments involves suitable corrective action when private markets fail to provide the right and desirable combination of goods and services. Briefly put, market failures provide the rationale for government’s allocative function.
You might have noticed that in many cases, the government can provide us with goods and services that we cannot produce on our own or buy at a price from the market. For example, the government establishes property rights and makes the necessary arrangements for enforcing contracts through provision of law enforcement and courts. Goods which involve externalities that are not met by the market require intervention by the government for corrective measures. Merit goods which are greatly beneficial to the society also fall under the purview ofprovision by the government. These interventions do not imply that markets are replaced by government action. In its allocation role, the government acts as a complement rather than as a substitute to the market system in an economy.
The resource allocation role of government’s fiscal policy focuses on the potential for the government to improve economic performance through its expenditure and tax policies. The allocative function in budgeting determines who and what will be taxed as well as how and on what the government revenue will be spent. It is concerned with the provision of public goods and the process by which the total resources of the economy are divided among various uses and an optimum mix of various social goods (both public goods and merit goods). The allocation function also involves the reallocation of society’s resources from private use to public use.
A variety of allocation instruments are available by which governments can influence resource allocation in the economy. For example,
- government may directly produce the economic good(for example, electricity and public transportation services)
- government may influence private allocation through incentives and disincentives (for example, tax concessions and subsidies may be given for the production of goods that promote social welfare and higher taxes may be imposed on goods such as cigarettes and alcohol)
- government may influence allocation through its competition policies, merger policies etc which will affect the structure of industry and commerce ( for example, the Competition Act in India promotes competition and prevents anti-competitive activities)
- governments’ regulatory activities such as licensing, controls, minimum wages, and directives on location of industry influence resource allocation
- government sets legal and administrative frameworks, and
- any of a mixture of intermediate techniques may be adopted by governments
Maximizing social welfare is one of the primary and most commonly manifest reasons for government intervention in the market. However, it is also possible that instead of eliminating market distortions, sometimes governments may contribute to generate them. The possible sources of this type of government failures are inadequate information, conflicting objectives and administrative costs involved in government intervention.
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