Quiz 14: Government and Industry: Challenges and Opportunities for Todays Manager


Market economy is a type of market structure in which the production and pricing decisions are determined by the market forces of demand and supply. Government may have the following rational in intervening in a market economy: 1. To provide a social and legal organization to the way the scarce resources of the economy are used to satisfy the unlimited wants of the society. 2. To maintain the competition in the market by regulating the market in a way to ensure that no seller exercises unfair market power. This also means that the government is responsible for coordinating the natural monopolies. Even though their presence is essential for the economy, but it is important to regulate them to ensure that they do not assume too much market power. 3. To deal with the income and wealth inequalities by working towards a redistribution of wealth and income through taxes and subsidies. 4. To reallocate the resources in the economy by correcting for the market failures and externalities. 5. To stabilize the aggregate economy using the monetary and fiscal policies, by focusing on the issues of unemployment and price fluctuations.

Benefit Externalities are the benefits that ensue to individuals other than those who have incurred costs for production of that particular goods and services. These are also referred to as positive benefits, spillover benefits, third-party benefits or social benefits. The demand for the products with external benefits tends to be understated in the market because certain benefits accrue to the third party. For example: A beautiful lawn would always benefit the people who pass by but they will not pay anything for the benefit they have received. The cost is only borne by the owner. Cost Externalities are the costs that are incurred by individuals other than those who produce the particular goods or services. They are also referred to as negative costs, spill-over costs or social costs. The cost for the products with external cost tends to be overstated in the market because in this case the producers do not pay the cost that is generated by the product owned by them. Fr example: Pollution by a private vehicle for which the person who owns the vehicle does not pay.

The role of government in dealing with the benefit externalities is very important. It plays crucial role in encouraging positive externalities and discouraging negative externalities. It encourages positive externalities by making investment or subsidizing in such goods and services. It discourages goods of negative externalities by imposing taxes and making strict laws against them.