The paper 'Government’ s Role in a Market Economy" is a great example of macro and microeconomics coursework. 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. The 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, the government provides an economy with 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 legislation, 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). The 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. The 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 the 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. The government also has a role in the 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 the 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.
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
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