The Role of the Government in the Market Place

BEC 30325Managerial Economics

Sajitha Dishanka

SCARCITYNEEDS & WANTS

MARGINALITYOPPORTUNITY COST

ALTERNATIVES

CHOICE / DECISION

Economic Rationale

2

Rationale of the Market Economy

CHOICE / DECISION

3

Activities in a Market Economy(Circular Flow of Income & Expenditure)

Factors of Production

Factor Payments

Goods & Services

Expense on Goods & Services

FINANCIALSECTOR

GOVERNMENT

INTERNATIONALSECTOR

Imports (M)

Exports (X)

Investment (I)

Savings (S)

4

Composition of GDP

• When economists think about year-to-year movements in economic activity;– they focus on the interaction between production, income

and demand

Production Income

Demand

5

Cyclical Effect

1. Changes in the demand for goods lead to changes in production

2. Changes in production lead to changes in income

3. Changes in income lead to changes in the demand for goods

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Demand for Goods

• Decision to go to a restaurant by a consumer (C)

• Purchase of a machine by a firm (I)• Purchase of combat airplanes by the central

government (G)• Aggregate Demand GDP

– Trade balance– Inventory investment

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Composition of GDP($ billions) % of GDP

1. Consumption (C) 7,064 69

2. Investment (I)

- Non-residential 1,246 12

- Residential 446 1,692 5 17

3. Gov. spending (G) 1,839 18

4. Net exports

- Exports (X) 1,051 11

- Imports (M) -1,380 -329 -14 -3

5. Inventory invest. -58 -1

GDP (Y) 10,208 100

8

Macroeconomic Policies

• Demand-side policies– Affect aggregate demand/expenditure– Short-run focus

• Supply-side policies– Affect aggregate supply/output– Long-run focus

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Demand-side Policies

• Major macroeconomic policies– Monetary Policy

• Changes in the money supply implemented by the government– Fiscal Policy

• Changes in government spending and/or taxes

• How & when to apply...?– Expansionary effects

• Increase aggregate demand if the economy is below its potential output

– Contractionary effects• Decrease aggregate demand if the economy is above its potential

output10

Supply-side Policies

• To increase potential output by encouraging– Labour productivity – Innovation (R&D)– Investment– Technology advancement

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Competitiveness of an Economy

Source: GCR 2014/2015

12

Factor-driven Stage

• Countries compete based on factor endowments– primarily unskilled labor and natural resources

• Companies compete on the basis of price and sell basic products or commodities– low productivity reflected in low wages

13

Required…in the factor-driven stage

• well-functioning public and private institutions• appropriate infrastructure• stable macroeconomic framework• healthy and literate workforce

14

Efficiency-driven Stage

• Wages rise with advancing development• More efficient production processes and increase

product quality• Competitiveness is increasingly driven by;

– higher education and training– efficient goods markets– well-functioning labor markets– sophisticated financial markets– large domestic or foreign market– ability to harness the benefits of existing technologies

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Innovation-driven Stage

• Sustain higher wages and the associated standard of living by;– competing with new and unique products

• Companies must compete through;– new and different goods (innovation)– using the most sophisticated production processes

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Weights of the three main groups of pillars at each stage of

development

Pillar Group

Factor-driven

Stage (%)

Efficiency-driven

Stage (%)

Innovation-driven

Stage (%)

Basic requirements 60 40 20

Efficiency enhancers 35 50 50

Innovation & sophistication factors

5 10 30

Source: GCR 2014/201517

The Concept of Political Economy

• Collectivism– “Individual rights should be sacrificed for the good

of the majority and that property should owned in common.”

- Plato (427–347 BC)

• Individualism– “Private property is more highly productive than

communal property and will thus stimulate progress.”

- Aristotle (384–322 BC)

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Overview of Economic SystemsMajor types Main characteristics National differences

Planned economy • State control• Collectivist ideology

• North Korea – highly authoritarian

• Cuba – some liberalization

Liberal market economy

• Capitalist free market• Individualist• Democratic values• Minimum government

intervention

• US – free market model, but increased role of government

• UK – elements of social market models, belief in self regulation

Social market economy

• Markets tempered by social values

• Democratic values• Government welfare role

• Scandinavian – emphasis on social welfare, extensive state ownership

• Northern European – emphasis on social protections, state ownership in key sectors

Mixed economy• Capitalist elements• Elements of state control• Weak individualism

• China – strong state intervention, authoritarian political system

• India – market reforms under state guidance, democratic political system

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Economic TransitionPolitical System

Economic System

Democratic

Totalitarian

Planned Mixed Market

Russia China Chile

UK

India

Mexico

Russia

IndiaChile

Mexico

China

UK

20