Government Intervention

Definition

Exchange Rates

Free Market Economy

Market Failure

Externalities

Definition

• When the state interferes with the working of an individual market e.g. through price controls. I.e. any form of government interference with market mechanisms. Intervention is the act of intervening in a market to try to influence the market outcome. An example of intervention is that the Bank of England intervenes daily in the money markets to ensure that interest rates are maintained at the level set by the Monetary Policy Committee. They could also intervene in the foreign exchange market to try to influence the exchange rate, though this has not been done for a number of years.

Exchange Rate

• The exchange rate is determined by the supply and demand for sterling. This diagram shows the government intervening by buying sterling to try to prevent the exchange rate falling.

Exchange Rate

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Demand and Supply

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Exchange Controls

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Free Market Economy

• A system where resources are owned by households: markets allocate resources through the price mechanism; and income depends upon the value of resources owned by an individual.

Ten Ethical Objections to the Market Economy

Free Market Economy

• A free-market (free-trade or neo-liberal) economy is an idealized form of a market economy in which buyers and sellers are permitted to carry out transactions based on mutual agreement on price without government intervention in the form of taxes, subsidies, regulation, or government ownership of goods or services.

• The free market is considered the mainstay of ideologies such as minarchism and libertarianism and Western definitions of capitalism.

Free Market Economy

• It is anathema to communism and some variants of socialism, as defined in the West, although most variants of socialism seek to mitigate what they see as the problems of an unrestrained free market.

• In reality there are no totally free or ideal markets in operation. Lack of perfect knowledge, monopolistic practices, cartels, taxes and government regulation bias the equilibrium points of most large markets in existence today.

Free Market Economy

• Participants engage in information bias practices such as insider trading and price fixing. Some believe that the notion of a free market is inherently unachievable because they believe that governments are fundamentally involved in markets through the creation and enforcement of property rights.

• Others argue that the concept of property comes from natural law and therefore it is incorrect to see governments as creating markets.

Laissez Faire

• The term "laissez-faire" is used to describe an economic system where the government intervene as little as possible and leave the private sector to organise most economic activity through markets. Classical economists were great advocates of a laissez-faire system with minimal government intervention. They believed free markets were the best organisers of economic activity.

Laissez Faire

• Laissez faire is short for "laissez faire, laissez passer," a French phrase meaning to "let things alone, let them pass". First used by the eighteenth century Physiocrats as an injunction against government interference with trade, it is now used as a synonym for strict free market economics. Laissez-faire economic theories were popularized by Adam Smith.

Laissez Faire

• Laissez faire (imperative) is distinct from laisser faire (infinitive), which refers to a careless attitude in the application of a policy, implying a lack of consideration, or thought.

Laissez Faire

• The laissez-faire school of thought, or libertarianism, holds a pure capitalist or free market view, that capitalism is best left to its own devices - that it will dispense with inefficiencies in a more deliberate and quick manner than any legislating body could. The basic idea is that less government interference makes for a better system.

Planned Economy

• Economies in which the state decides what goods are produced, the methods of production, and who gets the goods.

• In the middle of the 20th century, dozens of countries and millions of people believed that central planning was the best way to run their economies. 

Planned Economy

• Even today there are many people who can’t quite understand why market economies invariably outperform planned economies; it would seem that at least some of the planned economies should have flourished. 

• After all, there are advantages to centralizing economic decisions:  virtually full employment is possible; income can be distributed more equally; central coordination should be more efficient; directing resources into investment should spur growth.  So why did planned economies fail? 

Command Economy

• In a democracy it is a choice to attempt to provide equal opportunity for all, the planning is still shared with the people.

• In a dictatorship decision making is in the hands of a few, who use the economy in a manner which protects the state.

Command Economy

• Decisions are made about:– What to produce, Where to produce it, Who produces it,

Who will be eligible to purchase it, How much and How to produce and What to charge.

– The state allocates resources, and sets production targets and growth rates according to its own view of people's wants. The state allocates resources, and sets production targets and growth rates according to its own view of people's wants.

• Elements of the Command Economy

Market Failure

• Market failure occurs when the workings of the price mechanism are imperfect and result in an inefficient or grossly unfair allocation of resources from the perspective of society. Examples include, the education and defense markets.

The Myth of Market Failure

Those opposed to laissez faire capitalism and the free markets through which it operates love to shout "market failure" as a rationale for government intervention into economic activities. Only by limiting citizens' freedom, they claim, can the state correct the failings of an imperfect market.

by Russell Madden

The Myth of Market Failure

By "market failure," these governmental meddlers into private interactions mean a number of different things. They may refer to:

• the unequal distribution of wealth; • the belief that some "public goods" such as

roads, utilities, postal service, lighthouses, libraries, schools, or operas would not be adequately provided in a free market;

The Myth of Market Failure

• the "free rider" problem where those who do not pay for a service nevertheless enjoy its benefits;

• the notion that resources often go to produce such "frivolous" items as pet rocks, junk food, or trashy movies;

• the fact that certain objectively superior goods will be under-produced or ignored;

• or just overall "inefficiency" in matching human needs and desires with economic goods.

Government Failure

• When a government fails to intervene in a market economy to correct inefficient allocation of resources

Price Mechanism

• Prices act as a signal to firms and consumers to adjust their economic behaviour. For example a rise in price encourages producers to switch into making that good but encourages consumers to use an alternative substitute product.

Externalities

• Externalities are common in virtually every area of economic activity. They are defined as third party (or spill-over) effects arising from the production and/or consumption of goods and services for which no appropriate compensation is paid. 

• Externalities can cause market failure if the price mechanism does not take into account the full social costs and social benefits of production and consumption.

Externalities

• The study of externalities by economists has become extensive in recent years - not least because of concerns about the link between the economy and the environment.

Negative externalities

• Impacts on `outsiders` that are disadvantageous to them and for which they receive no compensation. The externalities are occurring where the actions of firms and individuals have an effect on people other than themselves. In the case of negative externalities the external effects are costs on other people. They are also known as external costs. There may be external costs from both production and consumption. If these are added to the private costs we get the total social costs. An example of negative externalities would be the side effects of production processes e.g. the pollution (noise, dust, vibration) endured by people living next to a quarry.

Negative Externalities in Consumption

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Negative Externalities in Production

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Positive externalities

• Impacts on `outsiders` that are advantageous to them and for which they do not have to pay. Externalities occur where the actions of firms and individuals have an effect on people other than themselves. In the case of positive externalities the external effects are benefits on other people. These are also known as external benefits. There may be external benefits from both production and consumption. If these are added to the private benefits we get the total social benefits. An example of positive externalities would be the side effects of production processes e.g. the benefits to some local people that stem from the growth of a major industry causing traffic.

Positive Externalities in Production

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Positive Externalities in Consumption

• If there are positive externalities in consumption then the marginal social benefit will be greater than the marginal private benefit.

Positive Externalities in Consumption

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Marginal Private Benefit

• The increase in private benefit resulting from the consumption of one more unit or the production of one more

Marginal Private Benefit

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Marginal Private Benefit and Social Benefit

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References