CA Foundation · Business Economics · Public Finance
Which statement best explains why the allocation function is needed in a mixed economy, according to Musgrave's framework?
The allocation function is needed because markets may fail to provide public goods and may ignore externalities, leading to inefficient use of resources. The government corrects this by providing such goods, taxing or subsidising activities with spillovers, or regulating, so that resource allocation moves closer to social optimum.
- APrivate markets always produce an equal distribution of income
- BMarkets may fail to provide public goods and may ignore externalities, so resources are not efficiently allocatedCorrect
- CMarkets cannot generate any employment without government spending
- DGovernment must produce all goods to prevent business cycles
Explanation
The allocation function exists because of market failure: public goods are under-supplied due to non-excludability and free riding, and externalities cause prices to misstate social costs and benefits. Markets do not ensure equal incomes, but that concerns distribution. Business cycles relate to stabilisation, and government need not produce all goods.
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