What is Public Finance and Difference it from the Private Finance

 

Public Finance :-
Public finance deal with the income and expenditure of the state. The study of public finance can be divided into four parts.
1. Public Revenue.
2. Public Expenditure.
3. Public Debt.
4. Budgeting.
Today modern states have to perform various types of function. It has also to promote the welfare of the people and to provide the full employment in the country. There are large number of problems, which the states are facing inflation over population, defense, economic crises and poverty are the most important issues of the present age.
Public finance is used as a tool by the state to reduce and control all these problems.

Difference Between Private and Public Finance :-

There is a great difference in private and public finance when we talk about its revenue and expenditure. On other hand the management of personal and private income to make certain expenditure is called private finance.
We can distinguish between two by the following facts :

1. Private Expenditure :-
Private authority / person spends the money according to his income. He lives with in his own resources. So he first of all looks to his pocket and then spends accordingly.

2. Public Expenditure Adjustment :-
While public authority adjust its income according the expenditure. It looks forward to expenditure and then increase or decrease the income accordingly.

3. State can Issue the Currency :-
A private person can not issue the currency while a state has authority to issue the currency to meet its expenditure.

4. Record Keeping :-
The state keeps the proper record of income and expenditure every year. While a private person continue earning and spending without keeping any record.

5. Budget Period :-
Government balances its budget during a one year while individuals do not have any specific period.

6. Deficit Financing Facility :-
Through the process of deficit financing Govt. can increase the supply of money to meet its expenditure while an individual can not avail this facility.

7. Difference in Objectives :-
The main objective of the public finance is increase the welfare of the people. While the individual have the objective of personal satisfaction.

8. Borrowing :-
The state can borrow the money from inside and outside the country while an individual can borrow from other persons.

9. Publishing of Budget :-
Budget is not secret document, it is published by the government. While an individual keeps secrecy about his income and expenditure.

10. Surplus Budget :-
If government prepares surplus budget, it is considered inefficient. On other hand if a man saves the money he is appreciated.

11. Changes in Public Finance :-
The government can bring a big changes in the income and expenditure of the state according the prevailing situation. But an individual can not bring a big change at the time of crises.

Discuss the trend of foreign trade (Export) in Pakistan

Export Performance :-
After partition the foreign trade of Pakistan was also affected like other sectors of the economy. But after the establishment of some industries exports were increased. We can study the export performance under three different periods :

1. Performance From 1948 to 1971 :-
Before the partition internal and external trade was controlled by the English Rulers so foreign trade was affected very badly after 1947. In 1948 the government of Pakistan increased the import of consumer goods t remove the shortage in the country. It expanded the volume of exports. About 60% of the total exports of Pakistan were purchased by the India in the early years.

2. Demand of Devaluations Refused :-
In 1949 Pakistan refused to devalue the currency and India refused to purchase the Jute and Cotton of Pakistan. So Pakistan decided to develop the trade relations with other countries like U.K, France, Germany and Italy.

3. Effects of Korean War :-
The exports of Pakistan's raw material increased due to Korean war. India government also decided to import the Jute of Pakistan. But the prices of Pakistan's exports increased. The exports value decreased due to fall in the prices of raw material in the world market.

4. Devaluation of Currency :-
The government of Pakistan reduced the value of Pakistani currency upto 30% in 1955 to encourage the exports. There was a continuously fall in exports except one year after devaluation.

5. Martial Law 1958 :-
In 1958 Martial Law was imposed and government introduced export Bonus Scheme. It increased our exports but due to heavy imports our balance of trade remained unfavorable.

6. Second Five Year Plan Period (1960-65) :-
In the second five year plan due to liberal import policy our balance of trade remained unfavorable.

7. Third Five Year Plan Period (1965-70) :-
In this period also export performance remained very poor due to many reasons like political disturbance and increase in imports. Later on the war of 1965 created more problems for exports.

8. Separation of East Pakistan :-
After the separation of East Pakistan export policy was revised by the government.
Following measures were taken to increase the exports of the country.
1. Export Bonus Scheme was abolished.
2. Currency was devalued upto 131%.
3. Multiple exchange rate system was finished.
4. Trade agreements were made with Muslim Countries.
The above measures increased the exports in 1971-72 to Rs. 10161.2 million. There was a marginal increase in the value of exports upto 1976-77.

Following were the main causes of low exports :
1. Nationalization of industries.
2. Frequent changes in fiscal and monetary policies.
3. Floods.

During the 1977-81 there was an increase in the exports. However in 1981-82 the increase in as fallen upto 17%. It has the following reasons :
1. The consumption of goods increased at home and exports reduced.
2. The demand of our exports reduced in the world market.
3. Fall in the terms of trade.
4. Unfavorable Global conditions.
5. Afghan Refugees Problem.

Relinking of Dollar in 1982 :-
The government of Pakistan adopted various measures like relinking of dollar to improve the exports. In the year 1987-88, Pakistan earned 4.4 billion dollar from exports. Cotton and cotton product is the major source of foreign exchange. The present government is also stressing more on the export of manufactured goods and value added goods. The total value of export during 1993-94 was 6.75 billion dollars. The trade deficit during 1995-96 was 3.75 billion dollars. During the year 1998-99 the trade deficit was 1.65 billion dollar and 1.60 in 2000-2001.
After studying the exports performance we can say that now the share of manufactured goods is increasing in the exports and it is good sign for Pakistani economy.

What is Gresham's law ? explain this statement Bad money drives good money out of circulation and Point out the different forms of its application and the conditions essential to its operations and also criticise on it

GRESHAM'S LAW :-
Definition of Gresham's Law : " When bad money and good money both are circulating side by side as a media of exchange bad money drives good money out of circulation other things remaining the same."

Bad money we mean underweight or clipped due to circulation. Good money is that money which contains full value which is stated on the face of the coin. This law applies to the coinage system. But this law have been reformed and now its application is extended to both metallic and nonmetallic currency.
This law is associated with the name of Mr. Thomsan Gresham who was the famous merchant and financial advisor of Queen Elizbeth. During her father reign a large number of underweight coins were in circulation. People were loosing faith in the currency. Queen tried to declare the debased coins from circulation by issuing the new coins. But people hold the new coins and passed on the old coins. In this way former disappeared from circulation. So Mr. Gresham formulated the law that bad money drives good money from circulation when both are in circulation side by side.


OPERATION OF THE GRESHAM LAW :
1. Good Money Is Hoarded :-
When the new (good money) coins and old coins (bad money) or underweight or clipped coins are circulating together, people will prefer the new coins for the purpose of hoarding. In this way new coins will disappear and old coins (bad money)  will remain in circulation.

2. Good Money Is Melted :-
If any person wants to melt the coins for ornaments he will prefer to melt the full weight coins (good money). So bad money will remain in circulation.

3. Good Money Is Exported :-
Gold generally acceptable by all the world. If any importer of goods wants to make the payment in gold the exporter, he will melt new coins having full weight. It will create shortage of money in the country.


APPLICATION OF THE GRESHAM'S LAW :
This law is applicable in the following monetary standards.

1. Mono-Metallism :-
When the worn out coins (bad money) and new full weight coins (good money) are made by the same material and they have the same face value, circulate together. In case of hoarding, melting or exporting good money will be used and bad money will remain in circulation.

2. Bi-metallism :-
When two mettles say gold and silver are used as a materials for the standard money and a ratio of exchange is fixed by law between their values, this system is called Bi-Metallism. When the mint ratio of exchange of mettles differ from the market ratio, one mettle would be over valued and the other would be under valued. So over valued (good money) metal coin will disappear from circulation. It may be hoarded, exported or melted.

3. Paper Money :-
When coins and paper money circulate side by side as a standard money, then metallic money will be considered good money. If at any time money is to be hoarded, exported or melted coins will be preferred over paper money.

4. Credit Money :-
If secured and unsecured credit money is circulating as a media of exchange, the unsecured credit (bad money) will drive the good money (secured credit) out of circulation.


LIMITATIONS OF THE GRESHAM'S LAW :
This law is not applicable under the following circumstances :

1. Bad Money Disliked :-
If the bad money is disliked by the people and they hesitate to accept it then bad money can not serve and remain in circulation.

2. Govt. Prohibition :-
If Govt. takes severe action against those persons who hoard, melt or export the under valued (good money) money, then bad money can not serve.

3. Small Quantity :-
If the quantity of bad money is very small and it can not meet the requirements of the people in that case good and bad money both will remain in circulation.

Define devaluation, objects of devaluation, merits and demerits of devaluation, effects of devaluation or depreciation

MEANING OF DEVALUATION :

It means to depreciate the value of domestic currency interms of foreign currencies. For example the rate of exchange between India U.S.A. is 35 Rs. = 1 Dollar. If India readjusts the exchange rate and offers Rs. 45 = 1 Dollar. The Indian currency will be said to have been devalued or depreciated.


OBJECTIVES OF DEVALUATION :
Almost all the countries of the world have devalued their currencies time to time to achieve certain economic objectives. During great depression of 1930 most of the countries devalued their currencies.

Following are the main objectives of devaluation :
1. To Encourage Exports :-
Devaluation policy is adopted to increase the exports of the country. As the currency of any country is devalued, the commodities of that country becomes cheap for the other countries and they increase their demand.

2. To Discourage The Imports :-
As the currency of any country is devalued the other countries goods becomes costly to import from that country. So the people reduce their demands for foreign goods.

3. To Correct The Balance Of Payment :-
When the balance of payment of any country is unfavorable the devaluation policy is adopted. When the currency is devalued, the value of imports increases but the value of exports will be greater then the value of imports, we will say that balance of payment is favourable.


MERITS OR POSITIVE EFFECTS OF DEVALUATION : 

1. Correction Of Deficit :-
Devaluation makes home goods cheaper to foreign countries and foreign goods expensive to home country. In this way deficit in the balance of payment is corrected.

2. Adjustment Of Currency Value :-
When the currency is over valued, devaluation brings equilibrium in the external and internal value of the currency. So various imbalances in the economy removes.

3. Increase In Foreign Aid :-
The international lending agencies like IMF, IBRD insists upon devaluation, specially to under developed countries like India, Pakistan etc. Foreign investor also feels pleasure to do the investment in those countries where currency is devalued.

4. End Of Uncertainty :-
Devaluation removes the uncertainty in the business circles. Rate of investment alsi increases.

5. Inflow Of Remittances :-
The workers who are working abroad they would prefer to send capital in side the country. Because they will get more currency in terms of foreign currency.


DEMERITS OR NEGATIVE EFFECTS OF DEVALUATION :
1. Temporary Curve :-
History shows that devaluation is a temporary curve for the unfavorable balance of payment. Its effects are for the short period. Some under developed countries were adopted this police but its effects were only for few month.

2. Increase In Prices :-
Costly imports brings inflation inside the country. So price level inside the country also rises, due to devaluation. So it creates problem for the consumer.

3. Increase In Debt Burden :-
Devaluation increases the foreign debt burden in terms of home currency. This is big loss for the poor country like India, Pakistan.

4. Competition In Devaluation :-
There is a chance that if one country devalues other countries also follow this policy then this policy will become useless.

5. Terms Of Trade Problem :-
On one hand country has to pay greater amount of money for imports, on the other hand she gets less money for her exports. So devaluation causes deterioration in terms of trade.

What is an index number ? How you will construct index number or How the changes in the value of money can be measured

MEASUREMENT OF THE CHANGING VALUE OF MONEY :-
The value of money has opposite relation with the price level in the country. When the value of money falls the level of prices rises. As the prices falls value of money increases. The statistical method of computing changes in the value of money is called index number.

DEFINITION OF INDEX NUMBER :-
Index number is an instrument which measures the average price movements of a number of selected commodities.
Index number of prices measures the changes in the value of money.

THE CONSTRUCTION OF INDEX NUMBER :-
Construction of index number is a complicated process. The main steps for the construction of index number are following :

1. Purpose Of Index Number :-
If we do not have any purpose in mind, the selection of commodities, selection of markets and relation of base period is useless. So first of all we will have to fix the object of index number.

2. Selection Of Commodities :-
For the construction of index number it is necessary to include only these commodities which are most commonly used by that class of people for whom, the index number are constructed. For example poor class uses vegetables, so we will have to select this at the time of construction.

3. Selection Of Markets :-
If we want to construct the cost of living index number of rich class, then we will have to choose those markets where this class goes for shopping.

4. Price Quotations :-
The prices of commodities vary from place to place and from shop to shop in the same locality. It is not possible to collect prices from cash and every shop in the selected market but we should take into account the whole sale prices and not the retail prices.

5. Choice Of Base Period :-
There are two methods for selecting the base period. One method is the selection of certain year as a base year. While the other is chain base method. Some times a normal year prices are neither too high nor too low as compared to the previous years.

Fixed Base Method Formula =   Price for the current year/ Price for the base year x 100

Chain Base Method =   Price in the current year/ Price of the previous year x 100

6. Choice Of The Average :-
After computing the link relative, their average is taken to get the required index number. The average in the base year will be always 100. If average in the subsequent year is high indicates the rise in the general price level otherwise it will show fall in the price level.

7. Choice Of Weight :-
While constructing index number proper weights are given according the importance of different commodities. More important commodity will get more weight. Because of a rise in the prices of essential commodities the poor consumer is more affected then others.
Following are the methods which are generally :

1. Weighted aggregate method.
2. Weighted average of relatives.

8. Average Of Price Ratio :-
An average of the prices of the commodities can be calculated in many ways. Usually Arithmetic mean and Geometric mean is used.

The following table shows that how an index number is constructed.

Formula P/PO x 100 = PO = Price of Current Year = Price of the base year

   
Average = 500/5 = 100
Average = 620/5 = 124

The above index number shows that the prices of 2000 as compared to the price of 2003. One person can purchase as many goods in 2003 with Rs. 124 as one could purchase with Rs. 100 in 2000. The above noted index number is called UN-weighted index number. While constructing such index number every commodity is given the same importance. But the people do not give same importance to the commodities. The each commodity must be given a weight according to its own importance. Now we construct the weighted index number, according the
Weighted              Aggregate             Method

               Formula :  P1q0/ P0q0 x 100

P1 = Price for the current year.
P0 = Price for the base year.
q0 = Quantity of the base year.

EXAMPLE : COMPUTE WEIGHTED INDEX NUMBER :-
By using weighted aggregate method from the following data taking base year 2000.



Weighted Index Number = P1q0/ P0q0 x 100

Weighted Index Number = 10750/ 7750 x 100

Weighted Index Number = 138.83


EXAMPLE :-
Calculates the weighted index number by using weighted average relatives.

Formula :

                 1V/ V
               V = P0q0
           I = P1/ PO x 100
           I = P1/ P0 x 100 = P0Q0




Weighted average index number for the current year 2000 = 1074890/ 7750 = 138.83

According to the weighted index number there was a rise of 138.83% rise in the general price level in 2003 as compared to 2002.

DIFFICULTIES IN CONSTRUCTION

1. Assignment Of Weight :-
It is very difficult to assign weight to each commodity according to its importance in national consumption. For example wheat is more important for poor and also important to rich people.

2. Changes In Taste and Traditions :-
From year to year taste and traditions changes. So the measurement of the value of money may not give accurate results.

3.  Choice Of Base Year :-
It is also very difficult to choose a normal year as a base year.

4. Difficulty In The Preparation Of Cost Of Living Index :-
It is very difficult to construct the cost of living index number for every person and every class because their consumption taste is different.

5. Retail Prices Problem :-
We take retail prices because these are more representative but it is very difficult to obtain the retail prices because these are not uniform.
No doubt there are so many difficulties in the construction of index number but it is fact that these are very helpful in measuring the value in the short run.

Critically examine the quantity theory of money

QUANTITY THEORY OF MONEY :-
Professor Taussing has defined it in the following words :

"Double the quantity of money and other things remaining the same prices will be twice and the value of money one half. Half the quantity of money prices will be one half and the value of money double."

The theory also assumes that the quantity of money is directly related to goods and services offered for sale over a given period of time and the supply of goods and services remains fixed.
Now we can explain this theory by the following example :
Example : Let us suppose that there is only one hundred (100) rupees in circulation and there are only ten commodities for sale and purchase. All the goods have the same value. So the price of each commodity will be 100/10 = 10 Rs. Further suppose that the quantity of money in circulation double (200). Now the price of each will be Rs. 20. It means the price has doubled but the value of money has reduced to 1/2.

Now further we assume that we reduce the quantity of money from 100 to Rupee 50. Now each commodity price will be 50/10 = 5 Rs. So in this way, the price is reduced to 1/2 but the value of money is doubled.

Professor Fisher has introduced the quantity theory in the mathematical equation and he has also discussed the velocity of circulation of money.

Formula :   P = MV + M'V' / T

P = General price level.
M = Amount of money in circulation.
V = Velocity of circulation.
M' = Credit money issued by bank
V' = The velocity of credit circulation.
T = Total amount of goods and services bought and sold.

Let us suppose the supply of currency in circulation ( M ) is Rs. 100 and the velocity is 3 ( V ). The bank credit ( M' ) in circulation. We assume is also 100 Rs. and its velocity is 2 ( V' ). The total volume of transaction is 100.

The equation is =  P = MV + M'V' / T

P = 100 x 3 + 100 x 2/100  = Rs. 500/100 = 5 Rs.

Now we double the money and credit amount and then check the price level.

P = 200 x 3 + 200 x 2/100 = Rs. 1000/100 = 10 Rs.

According to it prices has doubled by doubling the M. So further if we one half the M, the prices will ab also 1/2.

According to Prof. Fisher, there are three important factors which influence the value of money.
1. Quantity of money.
2. Transaction velocity of money.
3. Volume of transaction.


ASSUMPTIONS :-
Following are the important assumptions :

1. Constant Velocity Of Circulation Of Money :-
Velocity of circulation means that one unit of money how many times passes in different hands. For example if 5 Rs. note passes through five persons, it means the quantity of money will be twenty five. According to this theory it has been assumed that velocity of circulation of money remains constant. There is no change in it.

2. No Change In Credit Money :-
It has been also assumed that credit money ( M' ) in circulation will remain constant.

3. No Changes In The Volume Of Transaction :-
It has been assumed that total goods and services quantity remains constant.

4. No Change In Direct Exchange :-
There should be no change in the volume of direct exchange.

5. No Change In The Hidden Money :-
There should be no change in the quantity of hidden money otherwise this theory will be not be applicable.


CRITICISM ON QUANTITY THEORY OF MONEY :-
1. Useless Assumptions :-
This theory has been assumes that velocity V,V,T remains constant in the short run while the fact is that in real life they change in the long run as well as in the short run.

2. Independent Variables :-
In this equation it has been assumed that M,V and T are independent variables while it is not true. When money changes it brings changes in velocity and in the amount of goods and services.

3. Proportionate Change :-
According to Fisher the increase or decrease in the quantity of money brings proportionate change in the price level. While the history shows that it is not true.

4. Unemployed Resources Case :-
The amount fundamental objection on this theory is that if the we are unemployed resources in a country then an increase in the supply of money will be absorbed in the unemployment resources and production will increase. There will be no rise in the prices level.

5. Trade Cycle :-
According to this theory Govt. can increase  the quantity of money to remove the deflation and decrease the supply of money to control inflation. But in 1930 when great depression took place every country tried her best to increase the quantity of money but the prices did not rise and depression could not be removed.

6. Ignores The Rate Of Interest :-
Another serious defect is that this theory does not take into consideration the influences of the rate of interest on cash balances.

7. Dynamic Treatment :-
Another objection is that it does not treat the problem dynamically. It has failed to explain the processes through which the changes in the quantity of money affect the price level.
After long discussion it seems that this theory is not acceptable but it is fact that it enables us in understanding the fluctuations in the value of money.