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Government Aims and Fiscal Policy: Question 8

Syllabus 4.2

Structured 9 marks

The government of Farrow's budget for one year allocates:

  • $3.5 billion to building two new hospitals and upgrading regional rail lines.
  • $10.5 billion to paying the salaries of public sector doctors, nurses and teachers already in post.

(a) Calculate Farrow's total spending on these two items, and calculate the hospital-and-rail item as a percentage of this total. [3]

(b) State which of the two items is capital spending and which is current spending, and explain the key difference between capital spending and current spending. [3]

(c) Explain one reason why a government might choose to fund healthcare and education directly through spending like this, rather than leaving their provision entirely to the private market. [3]

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Worked solution

Part (a): Total spending and the capital-spending share

Total spending on the two items: 3.5+10.5=143.5 + 10.5 = 14

So Farrow spends $14 billion in total on these two items.

The hospital-and-rail item as a percentage of this total: 3.514×100=25%\frac{3.5}{14}\times100 = 25\%

So the hospital-and-rail spending makes up 25% of the $14 billion total.

Part (b): Capital spending vs current spending

The $3.5 billion spent building two new hospitals and upgrading rail lines is capital spending: it creates long-lasting physical assets (buildings and infrastructure) that will keep providing a service for many years into the future.

The $10.5 billion spent on the salaries of doctors, nurses and teachers already in post is current spending (sometimes called recurrent spending): it pays for the ongoing, day-to-day running costs of public services. Unlike capital spending, it does not create a lasting physical asset, and it has to be paid again in full the following year to keep the same staff employed.

Part (c): Why fund healthcare and education directly?

Healthcare and education are examples of merit goods: goods that provide benefits to society beyond just the individual who consumes them. A well-educated, healthy workforce is more productive, and the whole economy gains from lower rates of illness and higher skill levels, not just the individual patient or student. If provision were left entirely to the private market, price would ration access, and people on low incomes could be priced out of healthcare and education they still genuinely need. By funding hospitals and schools directly through government spending, Farrow’s government can ensure a more widespread level of provision than an unregulated private market would deliver on its own.

Final answers

  • (a) Total spending = $14 billion; hospital-and-rail spending = 25% of the total.
  • (b) $3.5 billion (hospitals/rail) = capital spending; $10.5 billion (salaries) = current spending. Capital spending creates lasting assets; current spending covers repeated, day-to-day running costs.
  • (c) Healthcare and education are merit goods with wider benefits to society, so direct government funding avoids under-consumption by those who cannot afford market prices.