A market economy refers to an economy whereby decisions relating to production, distribution and investment are made based on demand and supply (Dick, Blais & Moore 2007, p. 21). This implies that the choices regarding the allocation of resources are principally determined by the markets. However, the interests and the welfare of the whole society may not be considered because firms make decisions that maximize their economic well-being. This in turn makes the markets to fail hence the need for government intervention. Government involvement is thus vital in order to provide mechanisms necessary to ensure efficient operations in a market economy.
The objective of this paper is to identify the role of government in a market economy. Additionally, the paper will show why there can never be a truly free-market economy. According to Merchant (2008, p. 120) government has a role of providing public goods in a market economy. This is because some goods and services like security cannot be provided adequately and sufficiently by the private sector. Watts (2012) emphasizes that the role of government in providing public goods is obligatory because they are subject to the problem of free riding.
This means that once a person produces public goods and services other people can potentially use them without paying for them. Dick, Blais & Moore (2007, p. 23) note that public goods suffer from the free rider glitches because they can be consumed jointly. As a result, public goods may remain unproduced in an economy because firms can incur excessive costs in preventing non-payers from using these products. The role of providing public goods is thus left to the government.
This in turn explains why a true free market economy cannot exist. Government has a role of stabilizing the economy through the use of both fiscal and monetary policies (Langran & Schnitzer, 2007, p. 35). In order to achieve stable economic growth, the government should actively participate in the economic market. This can assist in ensuring price stability and balance of payment equilibrium as well as reducing unemployment and promoting economic growth. According to Watts (2012) this role takes the form of macroeconomic stabilization whereby the government uses fiscal and monetary policies so as to control interest rates and the supply of money.
Fiscal policies encompasses the use of expenditure and taxes so as increase or to decrease the level of aggregate demand. On the other hand, government uses monetary policies in order to control the amount of national output and to control variations in price levels through the supply of money (Mankiw & Taylor, 2010, p. 798). The role of stabilizing the economy cannot be performed by the private sector because their aim is to maximize their earnings. Therefore, government in market economy must play a vital role of stabilizing the economy and this demonstrates why there can never be an economy that is truly free. Dick, Blais and Moore (2007, p.
23) argue that the government has a role of maintaining competition in its market economy. To do this, the government is required to create as well as to enforce antitrust laws so as to regulate the behavior of natural monopolies. Taylor and Weerapana (2011, p. 321) affirm that a key role of government in a market economy is to maintain competitive markets by implementing antitrust policies or by regulating firms.
Competition can be limited in some industries especially when the level of demand is only capable of supporting few companies which are large in size. This can motivate these firms to collude and increase the prices of their products and limit the entry of new firms. Thus, by regulating monopolies, the government can be able to increase competition by enabling new firms to enter these industries. This can assist in improving people’s access to goods and services at affordable prices.
According to Merchant (2008, p. 120) maintaining competition in the market is the most proficient way of ensuring effective allocation of goods and services and at the same time providing alternatives for customers. Additionally, it can help in improving efficiency and making sure that customers are provided with the best services. Government has an obligation of protecting its citizens from exploitation and this implies that it has a role of maintaining competition. Consequently, this demonstrates why a true free market economy cannot be in existence because the government interferes with the markets in order to uphold competition hence protect its citizens.