2.03 The Role of Government in a Market Economy

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A Command Economy

One of the basic questions of an economic system is who owns the means of production and the goods they produce. In a command economy, the factors of production (labor, raw materials, and equipment) are directly controlled (if not outright owned) by the central authority, usually a government.

• All the raw materials of the society are directed according to the government's goals.
• Factories produce according to these goals.
• A person's ability to work, both physically and mentally, is at the whim of the government.
  • A worker may have a love and aptitude for carpentry, but if the central authority needs more metal workers, that is the job they will be given.
  • The government pays the employee according to its own purposes and motives rather than the needs of the employee.

A Market Economy

On the other hand, in a market economy, individuals own many things.

• One person may own property and the natural resources on the property.
• Another person may build and own a factory.

Each individual is control of their own power as a member of the labor force. Individuals make decisions on what to do with their resources based on what will benefit them the most.

• If a person owns land with hardwood trees on the property, many people and companies may want the wood – some for homes, others for furniture, still others for paper.
• The owner may sell to whichever interested party offers the best return.

Many times this value is specified monetarily; that is, the furniture makers may offer a higher price for the wood than the paper manufacturers. These people are making a decision based on profit, or the idea that they will see a return on their goods and services.

Labor

Labor works the same way in a market economy.

• If a person wants to be a carpenter, he or she may be a carpenter if the value of that labor is worth another person's investment.
• If someone has a very valuable skill, such as designing computer chips, he or she may ask for more in return for their labor.

Employers pay employees a wage that will ensure they are receiving a profit from the final product.

Profit

Sometimes the profit is less obvious than a monetary exchange. A landowner might not want to sell their resources to a company that is offering a higher price because of some personal belief.

• For example, someone who is a strict vegetarian may prefer to make less profit by selling a cow's milk rather than selling the cow to be slaughtered for meat.
• Many times people will take jobs that pay them less than other jobs they are qualified for, because of the personal satisfaction the lower-paying job brings.

In a market economy, people are free to make these decisions.

Consumers

Consumers will make these types of decisions according to what is in their best interest. If two products are similar and equal in price, the consumer decides which one to purchase.

• It may be for reasons like color or features.
• The consumer might believe one will last longer than the other.

The saying "The customer is always right" does not mean that customers can do anything they want; instead it means that businesses should do everything in their power to make a product that customers want to purchase.

A king is sometimes called a sovereign, and this concept of the customer as king is called consumer sovereignty.

Consumer sovereignty does not exist in a command economy. With a central authority in control over what is produced, consumers must take what is available. In a command economy, it doesn't matter if you want steak or pizza; if the government says lentils and rice are the commodities made available to the consumers, that's what you get. The consumer is not in control.

To make consumers happy and willing to spend their money in a market economy, businesses compete with each other.

• One business may lower its prices, while another may add special features to its products.
• A company might make its product healthier or better for the environment.
• The same sort of competition that lets landowners choose which buyers offer the greatest profit for their timber allows consumers to decide which seller offers the greatest value.

This competition traditionally forces sellers to keep prices as low as possible and to continually improve their products.

Combinations and Regulations

Most economic systems are neither pure command economies nor pure market economies but some combination.

In most market economies, the government uses regulation to control production to varying degrees.

• For example, in the United States, the government regulates how goods are produced by making rules about the pollution that production creates.
• Still other regulations exist to ensure that products are safe or that businesses treat their employees fairly.

These regulations represent elements of a command economy that are introduced into a market economy. Sometimes they impede the sales of some goods and encourage the sales of others, but they all reflect the values of the society or government about how the economy should work.

Government Regulation

For a market economy to work, a government should:

1. Protect private property rights.
2. Provide public goods that individuals or businesses won't provide.
3. Correct market failures such as external costs and external benefits.
4. Maintain competition by regulating monopolies.
5. Redistribute income through taxation.
6. Stabilize the economy by reducing unemployment and inflation, and promoting economic growth.

Public and Private Goods

A public good is an economic property that is consumed collectively (by all citizens). A public good must be both non-excludable and non-rivalrous.

• Non-excludable goods are those which are offered to everyone whether they contributed to its creation or funding or whether they did not. Examples include roads and police and fire protection.

• For a good to be non-rivalrous, it must be able to be consumed by many people at the same time. Examples include hunting grounds and national security.

A private good must be excludable, which means that you cannot own an item unless you pay for it. Once an item is owned, the owner may exclude others from using it.

An example of a private good is a car. Someone cannot own it unless they pay for it. Once it is owned, the owner can exclude others from driving it.

Public vs. Private

Another example of a public good is a lighthouse. Read the following articles, which highlight the differences between private and public goods, including lighthouses.

• What Should The Government Pay For? Autopsies And Lighthouses! from NPR
• The Lighthouse as a Private-Sector Collective Good from the Independent Institute

The government simply needs to provide public goods to its citizens. An easy example of the need to provide a public good is flood control. Many cities along major rivers must provide flood control to protect its citizens. A city cannot leave the building of levees A levee is an embankment built to prevent the overflow of a river. to the individuals closest to the river.

• If just a few people do not build their part of the wall to hold back a rising river, everyone will be flooded, including those who built their part of the levee.
• To ensure everyone is protected, the city will build the wall to protect all its citizens, even those who do not pay taxes.

Antitrust Laws

The government is tasked with creating an environment that promotes competition. A company that becomes too large has too much power and influence over its competitors.

Antitrust laws are based on the belief that society will benefit if competitive markets are encouraged and monopolies are discouraged or dissolved. Public resentment of trusts A combination of firms or corporations formed by a legal agreement, usually to reduce or threaten to reduce competition. that emerged in the 1870s and 1880s culminated in the Sherman Act of 1890 and was extended by passage of the Clayton Act and the Federal Trade Commission Act in 1914.

There have been two noteworthy examples of the government enforcing laws that prohibit monopolies:

• In the early 1980s, the phone company AT&T was forced to release control of many of its regional companies.
• In 2000, Microsoft was charged with having a monopoly on computer operating software and forced to split into two companies. However, Microsoft appealed the ruling and was allowed to maintain operation as one company.