Governments Role in a Market Economy - Coursework Example

Government’s Role in a Market Economy There is no single definitive definition of the term phrase “market economy,” but simply put, it is an economic system in which capital is individually owned, and production and employment are decentralised (Taylor & Weerapana, 2007, p. 36). This definition can be taken to imply that in a market economy, decisions about investment, production as well as distribution are based on demand and supply forces, and that market prices are determined in a free price system or a “free-market” economy. But this is not always true as state governments usually play a role that may affect the price system of some goods, or control the business environment - which creates a mixed economy. In this regard, this paper examines the role played by governments in a market economy and demonstrates why there can never be a truly “free-market” economy. The role of government in a market economy can be understood by first analysing the environment in the market economy. In a market economy, it would be assumed that markets have the ability to collect and distribute information on costs and benefits in a way that enables sellers and buyers to make effective, responsive decisions (Diane Publishing Company 1996, p. 191). Additionally, private markets have the advantage of preserving incentives to produce efficient outcomes. In such markets, sellers and buyers directly reap the benefits and bear the costs of their demand and supply decisions (Diane Publishing Company 1996, p. 191). But even though markets can generally outperform government, they need to be checked to function effectively. Deals must be enforced and fraud discouraged. Furthermore, there has to be proper government legislation to guarantee property rights and enforce contracts, market exchange and corporate organisation, without which all these would be virtually impossible. Government also has other roles beyond acting as a referee for private transactions. Left on their own, markets sometimes produce inefficient outcomes. For example, markets efficiently transmit information and offer proper incentives only when sellers compete with adequate intensity to drive prices down to cost. But they may also collude to maintain high prices, or merge to a point where individual decisions substantially affect prices (Diane Publishing Company 1996, p. 192). The overall functions of government in the market economy are discussed below. As mentioned above, government provides an economy a legal structure by acting as a referee and as a business regulator. This is the first and most significant role of government, without which an economy may collapse (Aly, 2008, p. 1). The function necessitates government to guarantee property rights, act as an arbitrator, provide enforcement of contracts, and impose penalties for foul play. To fulfil this role, the government furnishes the economy with legislations, regulations, and means that guarantee product quality, enforce contracts and define ownership rights (Aly, 2008, p. 1). There is no doubt that in a market economy, disputes are likely to arise, for instance over adherence to stipulations of a contract, property ownership and so on. The government therefore intervenes to settle such disputes (Baumol & Blinder 2011, p. 33). Government also promotes competition in an economy by encouraging producers and suppliers to respond to price signals as well as consumer sovereignty (Aly, 2008, p. 2). The government also fights monopoly and non-competitive business behaviour by fostering fair play in the business environment. Hence, antimonopoly laws are created to regulate business behaviour and promote competition. For instance, there are antitrust laws or competition laws in different countries which protect competition against possible encroachment by a monopoly (Baumol & Blinder 2011, p. 33). Without such laws, giant monopolistic companies such as Microsoft would be able to prevent entry by would-be competitors and therefore determine what to offer to the market and at what price, which denies consumers choice and preference. According to McEachern (2011, p. 350), through competition, consumers benefit as firms compete by offering lower prices, superior products, and new services to retain existing customers and attract new ones. Competition also ensures that the economy’s resources find their most efficient uses as firms come up with means to develop new and better products, services and methods of doing business (McEachern, 2011, p. 350). Another role of government in a market economy is to promote the redistribution of income (Aly, 2008, p. 2). In a market economy, a person’s income depends on the supply and demand for that person’s labour, which in turn depends on natural ability, human capital, compensating differentials, membership to unions, incentive effects, discrimination and so forth (Aly, 2008, p. 2). But so as to create an ambience of equality, the government provides relief to the poor, handicapped, dependent and unemployed. Thus, there are welfare, social security and medicare programmes that are introduced by government to support the sick, poor and elderly (Aly, 2008, p. 2). Such programmes are premised on transferring income from the high income earners to lower income groups through progressive taxes (Leach, 2004, p. 391). Governments may also redistribute incomes through price support programmes such as farm input subsidies and offering low interest loans to students based on the level of their family incomes (Aly, 2008, p. 2). Without doing so, the corollary would be that only high income earners would be able to access essential but costly services. Government also has a role in provision of public and quasi-public utilities. The market economy cannot be totally relied upon to provide the required goods or correct amounts of certain services or goods, and the government has to intervene to fill the vacuum. Examples of services that the market cannot provide adequately and equally include defence, the judicial system, police protection and security. Even if the market could produce such services, it cannot prevent people from using them, hence the term public goods (Lipsey & Chrystal, 2007, p. 13). The market also cannot reliably provide health services and education (which are examples of quasi-public goods) to suffice the needs of entire population at an affordable cost. The government therefore has a responsibility to offer the services mentioned in the first category (public goods) and to help in the provision of quasi-public goods (Aly, 2008, p. 2). For instance, many countries’ governments have decided that some level of minimum provision of the quasi-public goods or merit goods must be available to all (Lipsey & Chrystal, 2007, p. 13). If such goods were to be controlled by the market economy, they would not be available to sections of the population that cannot afford them. Another key role of government in a market economy is to promote economic growth and stability. The government promotes macroeconomic growth and stability by increasing GDP, fighting inflation, and controlling unemployment through a number of changes in its monetary and fiscal policies (Aly, 2008, p. 2). Governments offer support to the players in the market economy by maintaining property rights and political stability. Government policies can influence the economy’s growth rate in many ways: by promoting saving and investment, encouraging investment from overseas, fostering education, allowing free trade, promoting research and development of new technologies, and controlling population growth (Mankiw & Taylor, 2006, p. 522). The standard of living in an economy depends on the economy’s capacity to produce goods and services. This in turn depends on the physical capital, human capital, natural resources, and technological and knowledge available to workers (Mankiw & Taylor, 2006, p. 522). Thus, by intervening through encouraging investment and creating a stable environment for the investment, the government ensures that these resources are utilised efficiently to boost economic growth. From the discussion above, it is apparent that even in a market economy, government has a significant role to play for efficient, reliable operations. As the Diane Publishing Company (1996, p. 191) points out, it should be noted that markets and governments can and do work together. Thus, even though in market economies market transactions are done between people who voluntarily decide on whether or not to transact, such decisions have to be monitored to guarantee their authenticity. As such, since many areas of the market economy cannot stand on their own without government involvement, it is not possible to attain a truly “free-market” economy. As it has been discussed, there is no doubt that markets do fail in many ways, thus requiring government intervention to streamline them. Moreover, since government is the only institution that can reliably deal with the problems that affect markets (Lipsey & Chrystal, 2007, p. 299), its intervention is required, thus ruling out the idea of a “free-market” economy. Consequently, many markets have mixed economies, in which the government plays a very large role (Taylor & Weerapana, 2007, p. 36). In conclusion therefore, governments have a significant role in the market economy as they act as referees and as business regulators; they promote competition, which is necessary for the business environment; they help to redistribute income in countries; they help in provision of public and quasi-public utilities; and they play a fundamental role in promoting economic growth and stability. Hence, it is not possible to have truly “free-market” economies because of this important role played by governments. References Aly, H Y 2008, “The role of government in a market economy,” MarionStar.com, accessed 05 March 2012, from http://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cts=1330934203934&ved=0CC8QFjAA&url=http%3A%2F%2Fwww.econ.ohio-state.edu%2FAly%2Fdocs%2FThe%2520role%2520of%2520government%2520MS%2520Article%25209-27-08.pdf&ei=1HBUT7ioGYG50QWLpuHICw&usg=AFQjCNFfLtK3VxhYVYnnOSLDkS1TU7e-kA&sig2=Jcu11-O4yed0bZu5Wk4DIA Baumol, W J & Blinder, A S 2011, Economics: Principles and Policy, 12th edn., Cengage Learning, New York. Diane Publishing Company 1996, Economic Report of the President of the United States, 1996, Diane Publishing, New York. Leach, J 2004, A Course in Public Economics, Cambridge University Press, Cambridge Lipsey, R G & Chrystal, K A 2007, Economics 11th edn, Oxford University Press, Oxford. Mankiw, N G & Taylor, M P 2006, Economics, Cengage Learning EMEA, New York. McEachern, W A 2011, Economics: A Contemporary Introduction, 9th edn, Cengage Learning, New York. Taylor, J B & Weerapana, A 2007, Economics, 6th edn, Cengage Learning, New York. Read More