Government Intervention and Microeconomics - Essay Example

Governmental Intervention Economics is making wise decisions to maximize returns under limited resources. Micro economics, a branch of economics, “analyzes the market behavior of individual consumers and firms in an attempt to understand the decision-making process of firms and households.” .Microeconomics examines the decision making process of individuals, firms, Governments and the impact of the decisions on demand and supply of goods and services and how it in turn affects the prices and the effect of relative prices on the market.. Microeconomics, a division of economics deals with the decisions taken by individuals, firms and governments under constraints in order to maximize their goal. The individual or common man’s decision may be controlled by his income which is a constraint. Within his income limit he has to make his buying decisions to increase his happiness. A firm’s decision on its sales and selling price, hiring charges and production costs may be controlled by technology it uses and by the competition prevailing in the market, demand of the product etc. The decision taken should improve the total revenue of the firm. The Government’s decision will be based on the well-being of its people but is controlled by limited technology and resources it possesses. The government might impose tax, laws and quantity of production to protect the people. Thus, we can say that microeconomics, deals with various economic decisions taken by individuals, firms, Government, which affects the demand and supply of goods and services, prices of commodities, quantity of output etc. Thus Microeconomics “looks at the smaller picture, and focuses more on basic theories of supply and demand and how individual businesses decide how much of some thing to produce and how much to charge for it” . Demand and Supply: Demand and Supply can be regarded as the basic principles of economics. Demand can be described as the want of people with the required ability to buy goods and services at a particular price. There prevails a variety of alternative prices for the goods at a particular time. Supply on the other hand is the amount of goods and services bid by sellers for sale at a particular time and at a particular price. The relationship between the demand and supply is the major force which controls the market economy. This force guides the market economy. In a free market or market economy, resources are allocated based on the demand of the product. The supply decisions are made in order to maintain equilibrium between the demand and the supply. The free market functions through price signals. Higher the demand in a market, higher the profit if the demand is met with increase in supply. The market economy is free to operate based on the principles of division of labor. Market economies are decentralized, realistic and unpredictable. The free market mechanism, even though powerful in determination of allocation of resources among competing ends, has its own advantages and disadvantages. According to Ollman, the advantages of the free market may be triggering of competition among business units, innovation in products, huge profit through foreign investments, rapid development of the forces of production, a wide range of consumer goods to choose at different prices, less governmental intervention. The disadvantages of free market may be, concern for indistinct investment into the business which earn more profit rather than to basic needs, exploitation of laborers, unemployment problems, increase of social and economic inequality , increase in corruption in the society , ecological degradation etc In a market economy, the Government plays a little role. However, the government may choose to intervene under certain conditions such as to improve the allocation of resources, to redistribute income and wealth, to enhance the functioning of the economy, and to fix the market failure. The Government establishes rules to control relationships among businesses, resource suppliers and consumers. The Government plays a vital role in enhancing the smooth functioning of the economy by increasing the volume and safety of exchange. This can be achieved by the provision of a medium of exchange, by ensuring the quality of the product, by describing the rights of the owners and by the enforcement of contracts. This paves way to widening of the market and in the good utilization of property and human resources. The Government may choose to interfere in a monopolistic market to encourage competition. Several antimonopoly laws have been enacted by U.S. Federal Government to stop monopoly abuses. Microsoft, which monopolized the market for the Operating Systems for Personal Computers was controlled by the Government’s laws and thus reduced the company’s power in anticompetitive actions. The Government intervention may come in the form of redistribution of the total income. In a society, the wealth may some times get accumulated among certain sections. Therefore, the rich will be becoming richer, while the poor remains the poor. In order to bring the economic justice for low income groups, the government might intervene to redistribute wealth. It can be done through transfer payments, market intervention, Taxation etc. Transfer payments: The Government may try to distribute the wealth to low income groups in the form of transfer payments such as welfare checks, food stamps, unemployment compensation etc. Market intervention: In a market economy prices are established by the market forces. By intervening in the market, the Government modifies the prices of commodities. For example, in agriculture sector, the Government may intervene to provide farmers above market prices for their output. Government may also interfere in the income structure of the firms through its policies. Government might intervene to raise the minimum wages of low income groups so as to bring economic justice to those groups. The government also fixes the minimum working hours through employment laws thus protecting the workers. Taxation: The Government through income tax tries to bring down the income difference between the high income and low income groups. Taxation policy benefits the low income groups; however it costs the high income groups in the form of reduced incentives, less income etc. The Government on the other hand aid research and development businesses through tax credits. In order to provide extra employment and to promote new investment, the Government may reduce the tax on company profits. The Government may exempt tax for a specific period to attract industries in certain geographical areas where industrial development is essential. The Government can levy additional taxes as appropriate to bolster the economy. Government intervention may come during market failures. Market failure according to Campbell & Stanley occurs “when the competitive market system (1) produces the ‘wrong’ amounts of certain goods and services or (2) fails to allocate any resources whatsoever to the production of certain goods.”(79) Taking the case of environmental pollution, a firm may dump its waste in a river or pollute the air without using any filters. By doing this the firm is trying to avoid certain costs. This production cost or consumption cost is imposed on an external party who is not involved in the market transaction of the product. This is called spillover cost or externalities. This helps in the lowering of the price of the commodities and there by producing surplus output. Market failure thus occurs due to the over allocation of resources. The Government takes direct action by passing legislation which compels the firms to pay for the proper disposal of waste. Instead, the Government might also impose a special tax. The Government’s policy to have the compulsory emission check on vehicles is also taken to check air pollution. Spill over benefits on the other hand results in the under allocation of resources of the product. To control the market failure, the Government corrects these benefits by subsidizing consumers, subsidizing producers or by producing the products by itself. To correct the market failure caused by under allocation of resources, the Government provides services such as education, highways, police, libraries, museums etc. Tax obtained from the private consumer firms and consumer goods is used in the provision of services such as post offices, parks etc. The recent Sub prime crisis in United States and other countries is a classic example of the failure of free market in the housing sector which was funded by financial institutions. This market failure has not only affected America but many countries around the world, and has had a cascading effect on the economy. The Government intervention is happening all across the globe, with huge bail-out packages. This intervention came too late, and had led to a public outcry calling for immediate reforms. Even though Government intervention is needed and helpful at certain levels of economy, it might not be fruitful in some cases. The government might fail to bring the desired results in the market. Governmental failure might be caused due to politicians with self-interests. Certain decisions made with political consequences in mind would not function well in an economy, thereby causing market and governmental failure. The failure of a governmental policy may also happen when the decision is taken considering short term solutions. Such decisions taken, neglecting long term consequences causes more economic problems in the future. Policy decisions impacting the public, for example, indiscriminate levels of outsourcing need to have long term plan. Governmental intervention in taxing demerit goods such as cigarettes may encourage grey markets where the transaction is done without payment of taxes. On the other hand, removal of taxes on such goods might cause social injustice. Governmental policy can fail when it is imposed without knowing the preferences of the consumers. The law of unintended consequences: The Government’s policy might fail due to unanticipated reactions from either consumers or producers. Taking the recent sub prime market crisis, the Government encouraged the market in order to help people to build their homes at low interest rates. But the market transaction took unexpected twists and turns leading to a major crisis all over the globe. It has cost the Government in the form of huge bail outs. People find ways to avoid laws and policies and they act in an unexpected manner causing huge financial costs. Governmental failure occurs when the cost of administration and enforcement of a policy exceeds the estimated social benefits that the policy might bring. Although Governmental intervention has its own pros and cons, the advantages weigh more when the economic and social justice is taken in to consideration. Proper Government intervention with correct policies and regulations at the right time will save the economies from collapsing. In summary, Government intervention is needed at the right time for the economy of the country to be in a state of equilibrium. Balanced Government intervention would help achieve gross domestic product targets, foster growth rate, control inflation, reduce unemployment and is critical to the overall development of the nation. Works Cited “Microeconomics, Investopedia entry on Microeconomics”.economypedia.com. Economypedia, 19 Sep. 2008. MediaWiki, Web.30 Oct. 2008 . R. Mc Connell,Campbell. L. Brue,Stanley. R.R. Campbell. Microeconomics: Principles, Problems & Policies. McGraw-Hill Professional, 2004. books.google.com. Google book search, Google, Web.30 Oct. 2008. Works Consulted “Microeconomics, Demand”. Economypedia.com. Economypedia, 19 Sep. 2008. MediaWiki, Web.30 Oct. 2008. “Microeconomics, Supply”. Economypedia.com. Economypedia, 19 Sep. 2008. MediaWiki, Web.30 Oct. 2008. “Microeconomics, Market Economy”. Economypedia.com. Economypedia, 19 Sep. 2008. MediaWiki, Web.30 Oct. 2008. Ollman, Bertell. “Talk on advantages and disadvantages of Market Economy at Nanjing Normal University, Nanjing, China”nyu.edu.Web.30 Oct. 2008. R. Mc Connell,Campbell. L. Brue,Stanley. R.R. Campbell. Microeconomics: Principles, Problems & Policies. McGraw-Hill Professional, 2004.16 ed. 79+. books.google.com. Google book search, Google, Web.30 Oct. 2008. Read More