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The main functions and limitations of state action in today’s economics Assignment

‘Laissez-faire’ is a term which “has been used as convenient shorthand for the general prescriptions of the classical economists and in particular for a belief in the efficacy of a free market economy. In a more precise from it has been regarded as synonymous with free trade.” (Taylor. A 1972 P11) Although many classical economists believed that the free market economy was the best economic system as a nation economic system, in today’s economics, an idea of successful national economy is supported by a powerful and effective state.

In this essay, the economic system’s definition and the characteristics of the three types of economic system will be outlined in turn firstly. It is also provides the fully explanation of the main functions and limitations of government intervention in economy. Finally, the summary that how could government operate well in today’s economy will also be concluded.

Economic system is “a system for coordinating the actions of all the people in a society in order to decide what to produce, how to produce and for whom to produce.” (Economics Lecture Handout, 7th Oct 2004) There are two entire different models of economic system. At the one extreme lies the completely command economy, at the other extreme lies the completely free-market economy. How much the government intervenes is the main difference between these two types of economic system.

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In the command economy, the government is heavily involved and the economic decision-making is centralised, which means all resources are allocated by the government through a planning process. This feature indicates that there is no private ownership in a command economy, resources such as lands and capitals are collective owned and controlled by the state. Another characteristic of command economy is that the economic agents: the planners (government), consumers and workers are not work for there own interests, they assumed to be “self-less” and working together for the common good.

The former Soviet Union’s economy as a typical example of command economy, all the major economic decisions are taken by the government. The government conducts some form of input-output analysis in order to decide that what to produce, how to produce and for whom to produce, and all profits will be generated into the state budget.

By contrast, the free-market economy is regarded as a market which it is operating without the government intervenes, “this is also known as a capitalist or free enterprise economy.” (Economics Lecture Handout, 7th Oct 2004) There are four main characteristics of a free-market economy:

Firstly, private ownership is the factor of production. Every households and firms have their individuals’ ownership rights which protected by law.

Secondly, free decision making by individuals and they are free to make their own economic choices aim to satisfy their self-interest. For instance, consumers try to maximize utility, firms try to maximize profits and workers try to maximize wages.

Thirdly, resource scarcity and consumer preferences are allocated through the price mechanism. The price plays the role of signal to provide information about relative scarcity of resource and incentive for individuals to act on the market.

Fourthly, the government only plays a limited role in the free-market economy. The primary function of government is to enforce law and order, and protect citizens from invasion and violence which means to protect private properties.

According to these main features which mentioned before, free-market economy seems to be the best economic system as many classical economists claimed. However, free-market economy also has its relative disadvantages which in comparison with the command economy. Sometimes market could not allocate resources efficiently, and even Market Failures. The reasons will be mentioned as following:

Public goods such as defence and street lighting will not be provided by the free-market system. Merit goods such as health and education would only be provided for those who willing and able to pay. Demerit goods such as firearms, narcotics and pornography will be freely available in the free-market economy. Lack of social protection for vulnerable group in society and the potential large disparity between the living standard of the rich and the poor will be happened in a free-market economy. Competition may break down especially in industries with very significant economies of scale. “Macroeconomic instability which means market economies tends to fluctuate between booms and recessions.” (Economics Lecture Handout, 7th Oct 2004)

After explored the disadvantages of free-market economy, it is clear that in a real world economy, mixed economy which government uses its functions to intervene in the market will make a successful national economy. Because of the state could use its functions to solve the problems which might happen in the ‘laissez-faire’ economy.

First of all, governments implement a judicial system to protect property rights. Governments determine the legal framework that sets the basic rules for the ownership of property. This is the primary function of government.

Secondly, Governments buy and sell goods and services in order to provide public goods which will not be provided in a free-market economy. Because of public goods would not be able to adequately charge by firms. Firms cannot collect revenue and make a profit from producing public goods. This is due to the public goods have the characteristics of Non-rivalry and Non-excludability, so there is no supply of public goods in free-market economy. And also, governments try to provide merit goods to everyone. Take the case of education. If there were no state education provided at all, there would still be private schools for those who could afford them. Therefore, there would not be nearly enough education provided for everyone to benefit.

Thirdly, in free-market economy, Demerit goods are freely to provide, this will produce negative externalities such as pollution and information failures about the costs. Governments create laws, rules and regulations to control the production of demerit goods. For example, government tax heavily in the tobacco and alcohol in order to discourage people to buy them. And also, governments have banned firearms in many countries.

Fourthly, governments make transfer payment and taxation. Although the gap between rich and poor could never be removed, this will redistribute income to minimize this gap and benefit the vulnerable group. For instance, the VAT tax system.

Fifthly, governments create laws and use the power of taxation in order to correct Market Failures and stabilize the economy. Governments at all levels regulate economic behaviour, setting detailed rules for the operation of business in order to avoid monopolies and monopsonies. For example, the UK Competition Law. In addition, “Governments, through their control of taxes and government spending and through their ability to control the quantity of money in the economy, often attempt to modify fluctuations in the business cycle.” (Begg .D, Fischer .S & Dornbusch .R 1991 P50)

According to the explanations above, it is easily to see that the state plays a very important role in a mixed economy. However, due to the decision-making is centralised, government failure will be happened if the government intervene inefficiently or over intervened.

Firstly, the major problem is the lack of incentive. If the government is over intervened, consumers and firms would loss their personal freedom or democratic decision-making, then the lack of any positive incentives or rewards to produce efficiently will be occurred. For example, producer will produce more amounts of one goods by cutting the quality if the government set award to the one who produced more.

Secondly, “The government might enforce its plans even if they were unpopular.” (Sloman .J 2004 P23) Therefore, intervention may be designed to obtain shot-term political advantages, not to make the economy work more efficiently. The decision-makers’ personal needs may not be always wholly absent from their minds when considering the best policies to adopt.

Lastly, due to decision-making is centralized, highly inflexible in respond to change will also be happened. “Regulation, tax rates and expenditure policies are not easily changed. However, market conditions change often, sometimes rapidly.” (Lipsey .R & Harbury .C 1992 P236) For example, shortages and surpluses may result mainly caused by the lack of price signals to use resources efficiently.

To sum up, as the state intervenes in the mixed economy, it could take an overall view of the economy. Therefore, the governments should collect up-to-date and accurate information, then conduct an appropriate and accuracy input-output analysis so that the state could produce a good distribution of resource investment to achieve high growth rate; could plan the allocation of labour carefully to largely avoid unemployment; could distribute the national income more equally; could take externalities into account and able to predicate these effects and chose to take them into account. With all these conditions achieved, the state would be able to give a powerful and effective support to the national economy, naturally, a successful national economy will be achieved.

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