CA Foundation · Business Economics

Public Finance: formula sheet

Full chapter guide

Key formulas

Private good: Rival + Excludable; Example: food, clothes, a mobile phone. Markets supply these efficiently.
Public good (pure): Non-rival + Non-excludable; Example: national defence, street lights, public park with open access. Prone to free riding.
Club good: Non-rival + Excludable; Example: cable TV, a private club, toll road when uncongested. Access can be charged for.
Common resource: Rival + Non-excludable; Example: ocean fish, open grazing land. Prone to overuse.
Free rider problem: Benefit received without paying, because exclusion is not possible; Leads to under-provision of public goods by the market.
Social cost: Social cost = Private cost + External cost; Negative externality: social cost is greater than private cost, so the market overproduces.
Social benefit: Social benefit = Private benefit + External benefit; Positive externality: social benefit is greater than private benefit, so the market underproduces.
Public good test: Public good = Non-rival + Non-excludable; Both features must be present. A good with only one feature is not a pure public good.
Remedy matching: Negative externality → tax/regulation; Positive externality → subsidy; Public good → government provision; Information gap → disclosure rules; Use this as a quick mapping in MCQs.
Social cost: Social cost = Private cost + External cost; Used for negative externalities. External cost is borne by third parties.
Social benefit: Social benefit = Private benefit + External benefit; Used for positive externalities. External benefit goes to third parties.
Negative externality outcome: Social cost > Private cost → market output is higher than the socially optimal output; Overproduction or overconsumption. Correct with a tax or regulation.
Positive externality outcome: Social benefit > Private benefit → market output is lower than the socially optimal output; Underproduction or underconsumption. Correct with a subsidy or public provision.
Efficient output condition: Social marginal benefit = Social marginal cost; The target of any correction. A corrective tax is set near the marginal external cost.
Three functions (Musgrave): Allocation + Distribution + Stabilisation; Memory aid: A-D-S. Each is a role of the budget, not a separate budget.
Allocation tools: Provide public goods; tax or subsidise externalities; regulate; Aim is efficient use of resources where the market fails.
Distribution tools: Progressive taxes + transfers + subsidies; Aim is equity: a fairer sharing of income and wealth.
Stabilisation: slump (recession): Expansionary fiscal policy: higher spending and/or lower taxes; Raises aggregate demand to cut unemployment.
Stabilisation: boom (inflation): Contractionary fiscal policy: lower spending and/or higher taxes; Reduces aggregate demand to cool prices.
Direct tax: Impact usually = Incidence (burden generally not shifted); Levied on income or wealth. Examples: income tax, corporate tax, wealth-based taxes. In practice, some direct taxes can be partly shifted.
Indirect tax: Impact ≠ Incidence (burden can be shifted); Levied on goods and services. Examples: GST, customs duty, excise-type duties.
Average tax rate: Tax rate = (Tax paid ÷ Income) × 100; Progressive: rate rises with income. Proportional: rate constant. Regressive: rate falls with income.
Adam Smith's four canons: Equity, Certainty, Convenience, Economy; Equity means ability to pay. Economy means low cost of collection. To remember the order, use the first letters E, C, C, E. This is just a memory aid made for this guide, not a standard term.
Impact vs incidence: Impact = first payer; Incidence = final bearer; Shifting connects the two.
Revenue expenditure: Recurring spending that creates no asset and reduces no liability; Examples: salaries, interest, pensions, subsidies. Interest on debt is revenue expenditure.
Capital expenditure: Spending that creates an asset or reduces a liability; Examples: roads, dams, machinery, loan repayment.
Wagner's law: Public expenditure tends to rise as a share of national income as an economy develops; This means expenditure tends to grow faster than national income. It is a tendency stated for growing economies, not a fixed rule.
Internal vs external debt: Internal = borrowed within the country; External = borrowed from outside; External debt is repaid in foreign exchange and carries a real burden.
Transfer payment: Payment made with no good or service received in return; Examples: pensions, unemployment benefits, subsidies.
Budget deficit: Budget deficit = Total expenditure − Total receipts; Older, broader idea. Modern questions focus on the three deficits below.
Revenue deficit: Revenue deficit = Revenue expenditure − Revenue receipts; Only revenue account items. Capital items are ignored.
Fiscal deficit: Fiscal deficit = Total expenditure − (Revenue receipts + Recovery of loans + Other non-debt capital receipts); Equals the government's net borrowing requirement. Total expenditure = revenue + capital expenditure. Non-debt capital receipts include recovery of loans and disinvestment proceeds.
Fiscal deficit (borrowing view): Fiscal deficit = Borrowings and other liabilities; Use when the question gives the amount borrowed.
Primary deficit: Primary deficit = Fiscal deficit − Interest payments; Zero primary deficit means borrowing is only to pay interest. If interest payments exceed the fiscal deficit, the result is negative, which is a primary surplus.
Effective revenue deficit: Effective revenue deficit = Revenue deficit − Grants for creation of capital assets; Introduced in the Union Budget 2011-12. It is a secondary concept and not core to the CA Foundation syllabus, so do not spend much time on it.
Fiscal deficit in terms of revenue deficit: Fiscal deficit = Revenue deficit + Capital expenditure − Non-debt capital receipts; Useful when revenue deficit is given directly.

Quick revision

Public good: non-rival and non-excludable, so free-riding occurs and the market under-supplies it.
Private good: rival and excludable.
Market failure: the market fails to allocate resources efficiently, for example due to public goods, externalities or market power.
Negative externality: the social cost is higher than the private cost. Positive externality: the social benefit is higher than the private benefit.
Corrections for externalities: taxes, subsidies, regulation and tradable permits.
Musgrave's functions: allocation, distribution and stabilisation.
Direct tax: the burden falls on the person who pays it. Indirect tax: the burden can be shifted to others.
Progressive tax: the rate rises as income rises. Regressive tax: the rate falls as income rises.
Revenue deficit = revenue expenditure − revenue receipts.
Fiscal deficit = total expenditure − total receipts excluding borrowings.
Primary deficit = fiscal deficit − interest payments.
Public debt is the government's borrowing; it funds deficits and must be repaid with interest.

Common mistakes

Calling any government-provided good a public good. Fix: Classify by rivalry and excludability, not by who supplies it.
Mixing up club goods and common resources. Fix: Remember: club goods let you exclude (club has a gate); common resources are rival (fish run out).
Calling any good provided by government a public good. Fix: Test for non-rivalry and non-excludability. Government-run schools or hospitals can still be rival and excludable.
Saying negative externalities cause underproduction. Fix: Negative externality: social cost is higher than private cost, so the market overproduces. Positive externality leads to underproduction.
Treating a cost to the producer as a negative externality. Fix: An externality must fall on a third party. A cost the producer pays itself is a private cost.
Saying positive externalities cause overproduction. Fix: Positive externality means social benefit exceeds private benefit, so the market produces too little.
Calling every tax or subsidy a distribution measure. Fix: Check the purpose. A subsidy to correct a positive externality is allocation; a subsidy to raise poor households' consumption is distribution.
Placing public goods provision under distribution. Fix: Public goods exist because markets fail to supply them. That is allocation.
Calling a tax direct because the shopkeeper pays it to the government. Fix: Ask where the tax is levied. If it is on goods or services and can be shifted, it is indirect.
Treating a tax as progressive because the rupee amount rises. Fix: Always compute tax ÷ income. A progressive tax needs a rising percentage.

Exam tips

Most questions are one-line classifications. Learn the 2×2 grid and you can answer in seconds.
Watch the words 'pure' and 'mixed'. Pure public goods need both non-rivalry and non-excludability.
Link the free rider problem to market failure and government provision through taxes; options often test this link.
Examples are tested often: lighthouse, defence, street lights as public; food and clothes as private.
Do not guess between two close options; with 0.25 negative marking, skip and return if unsure.
Questions are usually direct: identify the type of failure from a short example, so practise spotting keywords.
Always check the direction: negative externality means overproduction, positive means underproduction.
For public goods, both features (non-rival and non-excludable) must hold. Watch for options that give only one.