Not all the time, market is left on the vagaries of sentiments of surplus seeking consumers and producers. If the volatility breaks the tolerance range, government has to step in to recorrect. As a last resort, government improves market outcomes.
List of 10 basic principles of economics
1.People face trade offs
2.The cost of something is what you give up to get it.
3.Rational people think at the margin.
4.People responds to incentives.
5.Trade can make everyone better off
6.Markets are usually a good way to organize economic activity.
7.Governments can sometimes improve economic outcomes.
8.The standards of living depends on country’s production.
9.Prices rise when the government prints too much money.
10.Society faces a short run trade offs between inflation and unemployment.
Need for government interventions
Many a times, commodities do not carry actual cost onto the final consumers. Either negative or positive effect of commodity is indirectly borne by someone else who may not be the part of.
Simply, the extra cost is directly or indirectly borne by the third party in the form of positive or negative externalities. Governments can sometimes improve market outcomes.
In such situation, market fails to allocate given resources efficiently. Therefore, for proper correction, the role of government to improve market outcomes become indispensable.
The idea of invisible hand Vs government interventions
In the previous principle of economics, “Markets are usually a good way to organise economic activity”, we came to know that in market economy, there are certain invisible forces that act as an insurance against the any types of market failures and are enough to ensure reasonable functioning equilibrium in market.
If the role of invisible hand in market is so effective to allocate resources efficiently, why do we need for interventions by governing authority?
Certainly, there might be some limitations for the so called the idea of invisible hand in maintaining proper functioning.
What does market failure mean?
When the commodity fails to carry actual cost to the consumer in market, the extra cost may either be borne by bystanders or third party in the form of positive or negative externalities.
We call such economic impact in the form of market failure. Besides, market failures can happen when there is imbalance in the efficient allocation of resources due to over demand or lower supply.
Simply, market failures are the product of mismatch between demand and supply or negative or positive externalities for bystanders. Here, the role of government to improve market outcomes become utmost important.
Role of externalities in functioning of market
Suppose, government is constructing a dam on a particular region to minimise the impact of flood, support growing urban settlements, and generate hydropower.
Indirectly, apart from this there, that dam is going to benefit thousands of farmers to irrigate theirs lands by the means of lift irrigation for that they haven’t paid anything. Despite paying anything, the farmers are getting indirect benefits of irrigation is called positive externalities.
Positive and negative externalities for third party
Externality is nothing but the negative or positive impact of a thing or actions of a person for bystanders or third party.
Externalities can be positive as well as negative depending on actions of the person in question.
For example, pollution created as a by-product by a firm is a negative externalities for the people living in the region is termed as negative externalities.
Whereas, the indirect benefits received by the region where quality highway is constructed is classified as positive externalities for third party.
Relations between market power and market failure
In the absence of perfect Market competition and forces the prices of identical products can’t be same due to control of market power by some firms.
Whenever a single person or group possess abilities to affect the outcome of price of given product in the absence of perfect competitive market, it is said that the firm or group has power to influence price or has market power regarding the product in question.
Government interventions over invisible hand
Like earlier situations, here too, product doesn’t carry the actual cost. Hence, the burden or benefit is shared by anybody else.
Probably, to correct market failures due to ineffectivity of invisible hand in market economy, government needs to design effective interventions in the form of texes, rules and regulations, and institutions.
Final thought on government improves market outcomes,
Final thought on government improves market outcomes,
This is the reason why this principle, “Government can sometimes improve market outcomes” deserve due attention by most of the economists. When the forces of market fluctuat beyond tolerant range, government has to step in.
At the end, even in the perfect competitive markets, the chances of market failure can’t be avoided by only invisible hand. Therefore, the role of government to improve market outcomes is out of compulsion.
Visible and invisible trade balance