Market Economy and Positive Investment Climate - Assignment Example

Economics Inserts His/her Inserts Grade Inserts (01, November, Question Market Economy and Positive Investment Climate The idea of a free market is not new in economics. Market economy is an economy in which prices are set by the demand and supply of a particular commodity or service (Campbell & Stanley, 2005). In such an economy there is not government intervention and it is also known as free market system. The market system is said to be a very just system where everyone gets what he or she deserves and there are no monopolies and government control on prices. There are many reasons why market system is considered the best mechanism of allocating scare resources. People believe that market system can help in creating a positive investment climate because the society as a whole decides upon what they want to pay for a particular good and services. This decision cannot be influenced by any other force except buyers and sellers. The idea is that the buyers and sellers will work out the price and this price will be just. Because it is set by the people everyone will be happy. Also firms will try to avail the opportunity to earn profits and will come and invest. They will supply what they think people will demand and everyone in the society will benefit or in other words investment climate will improve. Market system is also supported by many due to the increased competition between firms. When many firms are operating and there are no major subsidies or restrictions laid down by the government then all firms have equal opportunity to excel. This brings all the firms on the same level and then innovation increases as the firms want to do better than the other firms. As a result consumers get a variety of products and monopoly of suppliers is hindered. This also improves the investment climate of a country. If a firm comes up with a great idea then it temporarily enjoys abnormal profits. But because there are no trade barriers other companies also try to replicate the same idea and the profits of the first firm come back to normal. This is how market system encourages a positive investment climate. The interests of the firms, the consumers and the society as a whole are preserved and this is why many people think market system as the best mechanism for allocating scarce resources. In a market system of economy people’s need are catered well. Firms supply product or services if the buyers demand a particular product or services. Also people spend money on things they think will improve their life style so they are more contended. People also believe that resources are distributed evenly in a market economy. This is because government does not favour any particular city or province and leaves everything for people to decide. Efficiency is increased as a result and resources are equally distributed among all factions of the society because every firm can enter the market and produce whatever they want (Pesch & Rupert, 2000). Firms will produce what people will demand and in this way resources will be equally distributed among people of a society. Question 2 Role of Government and Positive Investment Climate Many people argue that market system is not enough and government intervention is necessary in encouraging positive investment climate. The proponents of command economy suggest protectionist policies that lure new firms into brining investment in the country and thereby improving the investment climate of the country. There are other arguments given in favour of government role in encouraging positive investment climate. Firms look for greater profits. This is a reality so they can only be attracted if government offers them special grants and subsidies. This argument holds weight as if firms are given incentive to start business in a country then that will bring employment as well. In this way the whole society will benefit from this. Positive investment climate will improve if more firms come and start doing business in the country so government can relax its regulations in order to lure international firms. Government intervention is also supported because without it the work force will be in a bad situation. If perfect competition exists then firms will be forced to lay off workers in order to reduce their cost and this will decrease the unemployment. Also lower wages will be given to workers in market economy. For these reasons government intervention is necessary in order to ensure that rights of the workers are secured and the labour force is satisfied. There are sectors that require government attention and not everything can be left to the firms like medical and health industry needs to be overlooked by the government (Dr. Feldman, 2010). Policies are required in order to ensure that basic necessity of life is provided to all. Government also intervenes to make sure that cheap goods are provided to people. In a poverty driven nation this is very important for the development of people. Also there are sections of the society who cannot work due to disability or over age. Rights of such people are to be protected by the government and for this reason supply and demand cannot always be allowed to set prices of commodities. Investment climate can also be improved if firms are provided with better financing options. Government can give these firms loan on lower interest in order to attract them to start business in the country. This will be in the interest of the whole society as people will get goods as well as employment. Government also has a role to play because history suggests that market does not always come to equilibrium by itself. The economic depression of 1929 gave this important lesson to economist that the role of government is sometimes necessary in order to avert catastrophe. This is also a very good argument as government can avoid economic recession by intervening in the economy. They can increase or decrease money supply or change the interest rate or can present bailout packages for firms who are at the brink of bankruptcy. Question 3 Improving Investment Climate in Saudi Arabia Saudi Arab is a country rich with oil reserves. The country had a budget surplus of over $10 billion is budget surplus (US Department of State, 2008). The great income which Saudi Arabia generated has kept the policies of the country closed towards foreign investment. The rules and regulations did not allow firms to operate freely in the country. The wealth of oil made the country rich and therefore Saudi Arabia did not need to attract the foreign investment in the country. But things have been changing and since 2000 the government has realized that it is not possible to rely on incomes from oil. (World Bank, 2010 cited in Australian Government export finance & insurance corporation website) The country has now relaxed its policies and has started to attract private investment. In 2000 the country allowed the foreign companies to invest in many sectors but investment in some industries was not allowed. But now the companies are getting more and more liberty in Saudi Arabia. The above figure shows that the country’s credit ratings and Previously foreign companies were required to include local partners in order to operate in Saudi Arabia but this restriction has been removed from some sectors. This is an attempt by the country to improve its investment climate. Ownership of real estate is also allowed in the country now to the foreign companies. Companies can also call foreign employees and can send money abroad to their parent company. All these reforms are a very good step in taking the country forward and improving the investment climate of the country. A development fund has been set up by the Saudi government in order to give long term loans to private investors (US Department of State, 2008). This is playing a pivotal role in improving the investment climate of the country. More and more companies are setting up their offices in Saudi Arabia and these loans are proving beneficial for the small and medium size enterprises. Saudi Arabia is a very attractive market for businesses as there are high income customers in the country. This can prove very beneficial to firms and this is a major reason why firms are setting up businesses in the country. In petroleum and gas sectors government is allowing private companies to take part. Many private companies are now trying to invest in the rich oil reserves of the country. Shell is one example. But there are still weaknesses in the policies. Foreign companies have an obligation to employ locals and strict visa policies are a hindrance in achieving a liberalize policy. The culture of Saudi Arabia is also very strict and the country laws also ask for strict compliance to the culture. All this is a major obstacle in foreign investment. The judicial system is also not based on strict legal framework as disputes are not decided on the basis of evidence and intervention of local Kings in disputes is common. All this shows that although the government of Saudi Arabia has taken stern measures to improve private sector investment in the country much needs to be done in order to further improve the investment climate of the country. Part B Monopoly Power of Firms: Pros and Cons Monopoly is type of market structure in which only one firm or entity has control over a commodity or service. In monopoly there is no competition as one firm has a strong position in the market. That firm sets the price of the commodity and people are forced to buy at that price because there is no other firm producing the product or service. People argue whether monopoly is in the interest of the people or it works against the benefit of the society. Some experts suggest that monopoly is actually in the benefit of the people while others argue that firms exploit the consumers when in a monopoly situation. First we will discuss the possible benefits of monopoly and then we will come to the demerits of monopoly. One possible benefit of monopoly can come to the consumers in the form of lower prices. Actually if one firm has the entire market share then it can achieve economies of scale and can lower its costs and in turn can offer product at a lower price to consumers. This holds true for industries that have a very high fixed cost. It is not possible for many firms to enter in a highly capital incentive industry. If many firms will enter in such an industry then due to higher fixed cost and competition they will not be able to sustain profits. For this reasons monopoly of firms in high fixed cost industries is beneficial for consumers. Only if monopoly exists and company is able to earn high profits then lower prices are possible otherwise not. A very good example of high fixed cost industry is airline industry. Monopoly of a firm in an industry or product also saves many cost of the firm. For example advertisement cost is lowered as there is no competitor of the company in the market. Advertisements cost are huge in a competitive market and in the absences of such a cost firm can reduce its overall cost and thereby reduce the price of the commodity it produces. Another reason why some people argue that monopoly is in the interest of the costumers is innovation that it can bring in the market. A firm having monopoly power will use its profits to engage in research and development and will introduce innovative products in the market. Impact of monopoly power has been seen in the small markets as monopoly introduces new products in smaller markets (Acquaye & Traxler, 2005). This is possible because firms enjoy abnormal profits so they are able to extend their product to small markets as well. Monopoly power also makes firms more productive and efficient. Because they enjoy great profits they are able to develop an expertise in a particular field. Such firms have monopoly powers but they also provide excellent products to the consumers and such excellence cannot be provided by other firms. This is another way how monopoly can work in the interest of the end users. In some cases monopoly power is the only way through which a particular product can be made available to the consumers. Pharmaceutical companies are very good companies in this regard. They are offered patents which give them monopoly power and only then they invest heavily in different forms of medicine. In such cases governments have no option but to allow the firms to operate as a monopoly. People also get what they would not have gotten in a competitive environment as a result of monopoly. There are many reasons why monopoly firms are criticized by experts. Monopoly power of firms is considered by some not be in the best interest of the consumers. One reason for this is that fact that monopoly firm has an opportunity to exploit consumers and charge a very high price. It is true that firm has an opportunity to sell at lower prices but critics of monopoly power suggest that firms usually do not lower prices. On the contrary they increase prices and earn abnormal profits. This criticism is valid as many firms increase prices and because the consumers have no other place to go they end up paying high prices. Another argument is given by critics of monopoly power and that is regarding the buying power of consumers. They believe that consumers do not get higher quality goods in a monopoly. On the contrary quality of goods and services decreases as consumers have no choices. Firm enjoys monopoly so it will become less cautious about its products and will lower quality to increase its profit. This is one reason why monopoly is not appreciated by many people. Suppliers to monopoly firms also suffer. Because these suppliers have nowhere else to sell their goods they are forced to sell them to firms. Firms exploit these suppliers as they are the only buyer of supplies. This is another criticism on monopoly power of firms. Another problem of monopoly power is that firm reduces its overall research and tries to enjoy the profits. This restricts innovation and consumers do not get newer and better products. Critics of monopoly power suggest that firms do not want to invest in research and development if they are not afraid of competitors and for this reason competition is very important to boost innovation. Resources may also get wasted if only one firm has monopoly power in the industry. Suppose there is only one sugar producing firm in a region. Because no other firm exists all the sugar produced must be sold to one firm and all the other sugar is wasted. This is another reason why monopoly power of firm is dangerous to consumers. Precious resources may be lost if only one firm has full control of a particular commodity. Firm will have a production capacity and after exceeding that capacity resources will be wasted. Monopoly also causes problems for other businesses. Monopoly power firm introduce barriers to entry in a particular industry and as a result many firms do not have the opportunity to come into the market. For example if a firm enters in an industry that is dominated by one player, then that player will reduces prices significantly and will bear losses temporarily but the new firm will go out of business. This is another reason why monopoly power of firm is said to be dangerous. Indian Government Policies against Monopoly Power Indian government has introduced many policies against monopoly power. The competition act of 2002 is the pivotal in restrictions of cartel or other price discriminatory techniques. Government of India is trying very hard to ensure that all such policies are met and therefore strict vigilance is conducted. Several policies are given below which are set to control monopoly power and its abuse. (World Bank, 2010 cited in Australian Government export finance & insurance corporation website) The above figure shows that doing business is not very easy and therefore it encourages monopoly by protecting investors, but this whole is changing rapidly. Doing business is not easy and until this is problem is not solved competition cannot thrive in India. However not all is supporting monopoly power in India. There are strict policies enforced to counter anti competitive agreements in India. These policies put a restriction on firms to collude and increase the price. Such practices are banned under the competition act of 2002. Firms are also no allowed to deny the supplying of a particular product to any other firm or people in order to prevent them from entering the market (Section 2.5.5, Competition Act 2002). Companies are also not allowed to use their dominant position to their advantage. This means that firms cannot influence the prices or supply of a particular product just because they have a considerably dominant position in the market. This law actually protects competition as many powerful firms use their dominant position to restrict competitors to enter in the market. Also firms can increase the prices of a particular commodity by simply stock piling it. Shortage of that product will increase the prices of that product and the firm will end up earning abnormal returns. To counter this abuse of monopoly government of India has laid down this rule of dominant position. Acquisitions and mergers are also heavily regulated in India. Government keeps a close eye on all the proceedings of a merger or acquisition in order to ensure that there is no formation of cartels in the process. A firm cannot merge with another firm without the prior approval of competition commission. It is necessary for all firms going through the process of merger to report to the commission and then it will decide whether all rules and regulations are followed or not (Dalal, 2007). This is another measure taken to ensure that no firms can exploit the customers by making cartels. Officials are also at an authority to raid down offices in order to check whether all the rules are followed or not. Moreover these officials also keep an eye on the supply lines of the firms and see whether firms are not using their dominant position to benefit themselves. All these laws and policies are taken by the Indian government in order to control the abuses of monopoly. Bibliography Acquaye, A. & Traxler, G., 2005. Monopoly power, price discrimination, and access to biotechnology innovations. The Journal of Agro biotechnology Management and Economics, 8(2&3). Campbell R. & Stanley, L., 2005. Economics: Principles, Problems, and Policies. New York: McGraw-Hill Professional. Competition Act 2002. (s. 25.5), New Delhi: ICT Regulation Tool Kit. [Online] Available at: [Accessed 1November 2010]. Dalal, K., 2007. Competition Act amendment may be a deterrent for M&A’s. Live Mint. [Online] Available at: [Accessed 1November 2010]. Export Finance & Insurance Corporation. (2010). Australian Government. [Online] Available at: < http://www.efic.gov.au/country/countryprofiles/Pages/saudiarabia.aspx> [Accessed 1November 2010]. Export Finance & Insurance Corporation. (2010). Australian Government. [Online] Available at: < http://www.efic.gov.au/country/countryprofiles/Pages/India.aspx> [Accessed 1November 2010]. Feldman, E., 2010. Chinas Status as a Non-Market Economy. China US Trade Law. [Online] Available at: [Accessed 1November 2010]. Pesh, H. & Rupert, E., 2000. Free Market Economy or Economic Order. Berlin: Edwin Mellen U.S Department of State, 2008. Investment Climate Statement. [Online] Available at: [Accessed 1November 2010]. Read More