ABSTRACT
This chapter examines the role of public expenditures in an efficiency-oriented economic theory of the state. It begins with a brief overview of the historical development and refinement of the notion of economic efficiency, or social economy, and of the economic role of the state as inferred from discrepancies between the actual situation and the ideal. During the long prehistory of economic thought from Aristotle to Adam Smith, there was little recognition of the self-regulating features of markets. The theory of market failure deals with the fundamental factors which account for the inability of decentralized private markets to attain economic efficiency. Development of an economic theory of the state based on conceptualization of sources of market failure requires identification of the various sources with alternative public policies. Most of the literature on public policies toward externalities, increasing returns, and public goods accepts the convention in value theory of treating transactions as costless.
