Role of Government

in a Market Economy

M Manjunath Shettigar, MA, PhD
Professor of Economics,
Department of Professional Studies,
Christ University,Bangalore - 560029




GDP Figures for Select Countries from 1500 to 2003
(in million 1990 International Dollars)
Source: Angus Maddison- Contours of World Economy 1 2030 AD, Oxford
University Press Inc, New York, 2007, pp 117

1500 1700 1820 1950 2003
India
60,500 90,750 111,417 222,222 2,267,136
China
61,800 82,800 228,600

244,985 6,187,984

USA
800 527 12,548

1,455,916 8,430,762
Western
Europe
44,183 81,213 159,851

1,396,078 7,857,394
Japan
7,700 15,390 20,739 160,966 2,699,261

Global ranking by 2050
All institutions are the result of
evolution
Family, religion, educational
institutions, government, economic
system, etc.
As all of you may know human
societies are the result of evolution
Govt too emerged like that only
Political systems too developed like
that
People develop institutions that serve
some purpose/that are required/ that
are rational




1
A
2

3 5
4
B


Donkeys curve

1
A
2

3 5
4
B
Systems developed by us if found to
be defective/dysfunctional,

It will be reformed or replaced
e.g.
Caste system in India
Family system
9
What is a
Market Economy?
An economic system that
answers the What, How, and
For Whom questions using
prices determined by the
interaction of the forces of
supply and demand
10
What is Capitalism?
An economic system characterized
by private ownership of resources
and markets, and where people
enjoy freedom to engage in the
economic activity of their choice
as entrepreneurs and employees.
11
Who was Adam Smith?
The father of modern
economics who
believed that a free
market economy acted
like an invisible hand
12
What is the
Invisible Hand?
A phrase that expresses the
belief that the best interests of
a society are served when
individual consumers and
producers compete to achieve
their own private interests
Markets exist because none of us
produces
all the goods and services we require to
satisfy our needs and wants.
A market is an arrangement
that allows buyers and sellers
to exchange goods and
services.
Specialization is the
concentration of the productive
efforts of individuals and firms
on a limited number of
activities.
Why Do Markets Exist?
The Free Market Economy
In a free market
economy, households
and business firms use
markets to exchange
money and products.
Households own the
factors of production and
consume goods and
services.
The Markets Self-Regulating
Nature
In every transaction, the buyer and seller consider only
their self-interest, or their own personal gain. Self-
interest is the motivating force in the free market.
Producers in a free market struggle for the money of
consumers. This is known as competition, and is the
regulating force of the free market.
The interaction of buyers and sellers, motivated by self-
interest and regulated by competition, all happens
without a central plan. This phenomenon is called the
invisible hand of the marketplace.
Advantages of the Free Market
Economic Efficiency
As a self-regulating
system, a free market
economy is efficient.
Economic Growth
Because competition
encourages innovation,
free markets encourage
development of
technology, which
contributes to faster
growth.





Economic Freedom
Free market economies have
the highest degree of
economic freedom of any
economic system.
Additional Goals
Free markets offer a wider
variety of goods and services
than any other economic
system.
Equality
Encouragement of hard work,
merit & risk taking


17
What is
Consumer Sovereignty?
The freedom of consumers
to cast their Rupee votes
to buy, or not to buy, at
prices determined in
competitive markets
18
What are Criticisms of a
Market Economy?
Inadequate competition
Inequality of income and wealth
Less/no production of certain goods
public/ merit/ essential goods
Externalities
Unethical practices
Uncontrolled
greed/selfishness/materialism
Economic instability
Options for government
intervention in markets

Government Legislation and
Regulation
Competition policy
State Provision of Public/Merit
Goods
Taxes & subsidies
Macroeconomic Policy
Intervention
Social security/safety

The effects of government
intervention

One important point to bear in mind is
that the effects of different forms of
government intervention in markets are
never neutral financial support given
by the government to one set of
producers rather than another will
always create winners and losers.
Taxing one product more than another
will similarly have different effects on
different groups of consumers.

The law of unintended
consequences
Government intervention does not always work
in the way in which it was intended or the way
in which economic theory predicts it should.
Part of the fascination of studying Economics is
that the law of unintended consequences
often comes into play events can affect a
particular policy, and consumers and
businesses rarely behave precisely in the way
in which the government might want!
We will consider this in more detail when we
consider government failure.

Possible Causes of
Government Failure

(a) Political self-interest
(b) Policy myopia
(c) Regulatory capture.
(d) Government intervention and
disincentive effects
(e) Government intervention and evasion
(f) Policy decisions based on imperfect
information
(g) The Law of Unintended Consequences
(h) Costs of administration and enforcement

What are the main reasons for
government intervention?

The main reasons for policy intervention
are:
To correct for market failure
To achieve a more equitable
distribution of income and wealth
To improve the performance of the
economy

Thank You
M Manjunath
Shettigar