30-06-2016

Business, Government and

Society in India
Session 2
Delivered by
DR. KASTURI DAS
Associate Professor
Economics & International Business
IMT Ghaziabad
2016

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The Market Capitalism Model

The market capitalism model depicts business as
operating within a market environment,
responding primarily to powerful economic
forces.
The market acts as a buffer between business
and non-market forces.

The Market Capitalism Model

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According to the Market Capitalism

Model
1.The proper measure of corporate performance is profit.
2.The only constituency that really matters is
shareholders. The ethical duty of management is to
promote the interests of shareholders.
3.Given an opportunity, business people will cheat or cut
corners.
4. We live in a world of limitless physical resources, so we
dont need to pay attention to our impact on the
environment.

The key assumptions of the Market

Capitalism Model
Adam Smith in his book, The Wealth of Nations
described self-interest and competition in a market
economy as the "invisible hand" that guides the
economy.
Adam Smith described it this way:
"It is not from the benevolence (kindness) of the butcher,
the brewer, or the baker that we expect our dinner, but
from their regard to their own interest."

Self Interest is the motivator of economic activity.

Firms are self interested.

Consumers are self-interested too. They are also
informed about products and prices and make rational
decisions.

There are many producers and consumers in competitive

markets.

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Doesn't self-interest lead to over-charging,

corruption
and
cheating?
According to Adam Smith, the invisible hand of the
market generally keeps such behaviour under check.
Because other self-interested people are competing
in the marketplace, my self-interest is held in check.
Moral restraint accompanies the self-interested
behavior of business.
Thus, the Invisible Hand of markets disciplines
private economic activity to promote social welfare.

Other key assumptions of the

Market Capitalism Model
Individuals can own private property: most of the
resources - land, labour, and capital are owned by
individuals, who control their use through voluntary
decisions made in the marketplace.
Government interference in economic life is
minimal and undesirable as it lessens the efficiency
with which free enterprises operate to benefit
consumers (laissez-faire).
Basic institutions such as banking and laws exist to
ease commerce.

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Business-Government
Relationships

Government roles vis--vis business

Governments roles vis--vis business may be placed at
any point on the following continuum.

Cooperation

Conflict

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Government roles contd

Cooperation
Government sometimes cooperates and works
closely with business. For example:
When the aim is to achieve a mutually
beneficial goal
Adequate supply of medicines by business on an urgent
basis to combat an epidemic.

When both groups encounter a common

problem or enemy requiring joining of forces
US visa rules having impact on movement of natural
persons by Indian IT-ITES firms

Government roles contd

Conflicts
Government may sometimes have an adversarial
relationship with business. For example:
When governments goals and businesss
objectives are at odds with each other.
Drug price control.

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Governments public policy roles

What is public policy?
Public policy is a plan of action undertaken by
government with the aim of achieving certain
purpose affecting a substantial segment of
the public.
Governments generally do not choose to act on a
policy unless a substantial segment of the public
is affected and some public purpose is to be
achieved.
This is the essence of the concept of
governments acting in public interest.

Types of public policies

Economic policies
Examples:

Fiscal policy
Monetary policy
Trade policy
Industrial policy

Social policies
Examples:
CSR-related policies
Work place safety-related policies
Drug price control policies

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Regulation

Concept and purpose

What is regulation?
Regulation is one of the key instruments to achieve
public policy goals.
Regulation refers to the rules of conduct established by
government for individuals and organizations.
Regulations impose some limitation or constraint on
the actions, operations or behaviour of individuals
and/or organizations (as the case may be).
A regulatory agency is the institution that monitors and
enforces the regulation.
Regulation may come from any level of government
central (federal), state, local.

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Examples of various types of regulations

Government may set a price for the market.
Government may impose a limit on market
quantity.
Government may restrict market entry.
Government may ban an activity.
Government may mandate a quality standard.
What else?

Why does government regulate?

Government regulation may come up for diverse
reasons and in diverse situations, such as:
Monopolies (including natural monopolies)
Externalities (positive or negative)
Public goods
Asymmetric information
Social and/or ethical

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Monopoly
What is a monopoly?

One firm supplies the whole market.

What would happen if monopoly is left
completely unregulated?
Unregulated monopolies can earn high profits by
supplying less goods to the market and charging high
prices.
Hence the need for regulation to uphold consumer
interests.
Example?
Competition Commission of India keeps a watch on
mergers and acquisitions.

Natural Monopoly
What is a natural monopoly?
The dominant feature of natural monopoly is the existence of
huge sunk costs.
In case of a natural monopoly the economies of scale are so
substantial that a single firm can produce total business output at
a lower unit cost, and thus more efficiently than two or more
firms.
After one player has entered the market and created the requisite
infrastructure and system for operation, it will be inefficient for a
second player to enter the market.
The huge sunk costs act as an entry barrier.
Natural monopoly thus poses the difficult dilemma of how to
organize these industries so as to gain the advantages of
production by a single firm, while minimizing all the vices
resulting from non-competitive markets.

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Contd
Examples of Natural Monopoly?
Electricity
An electric company is a classic example of a natural
monopoly, where competition may lead to an inefficient
market outcome. Once the huge sunk cost involved with
power generation and power lines are paid, each additional
unit of electricity costs very little. Having two electric
companies split electricity production, each with its own
power source and power lines, would lead to a near
doubling of price.

Railways
Oil & gas pipelines, etc.

Externalities
What is externality?
The uncompensated impact of one persons actions on
the well-being of a bystander.

Negative externality
Impact on the bystander is adverse
Cost to society (of producing a good) is larger than the
cost to the producers of the good
Positive externality
Impact on the bystander is beneficial
Social benefit is higher than private benefit

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Market Failure
In the presence of externalities, buyers and sellers
neglect the external effects of their actions when
deciding how much to demand or supply.
Fails to maximize the total benefit to society as a whole.
Market equilibrium, therefore, becomes characterized by
inefficient allocation of resources.
Externalities lead to market failures.

Can the government do anything to

correct the market failure and maximize
social welfare?
Government can intervene in the market to correct market
failures arising out of externalities
How can the government achieve this objective?
By internalizing the externality by way of altering incentives
so that people take account of the external effects of their
actions
Negative externalities
Markets - produce a larger quantity than is socially
desirable
Government: tax
Positive externalities
Markets - produce a smaller quantity than is socially
desirable
Government: subsidy

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Public goods

A public good requires two conditions:

Non-rival consumption: One person consuming the good
does not prevent other people from consuming the good or does
not reduce the availability of the good for consumption by others.
Non-excludable consumption: Those who are not willing to
pay for it cannot be excluded from the consumption of the good.
It causes Free riders problem:
Free riders are those who consume public goods, but do not pay
for it.
Examples of public goods?
Clean air, street lights.
Since businesses cannot restrict consumption of the public goods by
non-payers, hence, private businesses undersupply public goods.
Hence the need for government intervention.

Asymmetric information
Asymmetric information refers to a situation where either the
buyer or the seller has more information than the other party.
Asymmetric information may occur in markets, where
consumers have difficulty inspecting the good or service.
Some producers could provide low-quality, defective, or even
harmful goods in such situations.
Consumers can also sometimes exploit asymmetric
information to get undue advantage from business.
Government can regulate markets with asymmetric
information to protect the buyers and/or sellers.
Examples of regulation in cases of asymmetric
information?
Product standards
License of doctors
Rules governing insurance claims

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Social or ethical reasons

If government sees a societal problem it may
intervene with regulations.
Example: Exploitation of workers

Government often regulates on ethical grounds

also.
Example: CSR-related requirements

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