ECONOMIC SYSTEM

The Collins Dictionary of Business defines an economic system as “The systematic and
structural arrangement of a state or country or region which deals with the economic
issues, problems, requirement and challenges in order to tackle all these in a more
efficient and effective way for the prosperity of the country or region”.

Economic system is the way in which a country manages the production and distribution
of goods.
 Market economy
 Command economy
 Mixed economy

ROLE OF GOVERNMENT IN AN ECONOMY SYSTEM

MARKET ECONOMY
Market economy is a type of economy system in which the trading and exchange of
good, services and information takes place in a free market. Free market is governed by
the law of supply and demand. The market itself will demand the price of goods and
services. In this system government should not intervene in the economy as in the system
all the imported recourses are owned by the ordinary people. Firms and individual
decides which goods to produce and in what quality and consumers decide what the want
to purchase and at what quality. The main characteristics of market economy are its
flexibility and decentralized nature.

COMMAND ECONOMY
The second system is command economy which says that all the important resources
should be owned by the government and the government decides about the allocation of
resources. In such economic system, market forces play very little role to allocate the
resources. Government decides what to produce, in what quantity and to be sold at what
price.

MIXED ECONOMY
The third economic system is a mixed economy in which both private sector and public
sector play major role in the allocation of resources as most of the countries are following
mixed economic system it will be better than the other economy. The government will
always have some level of regulatory control but in market economy government attempt
to intervene as little as possible, while mixed economy includes characters of both
capitalism and socialism.

THE STATE ROLE IN THE ECONOMY

The federal government's policies on taxes and spending have a large impact on the
mixed economy. The economic theory of the famous English economist John Maynard
Keynes advocates the use of the government's fiscal policy to offset imbalances in the
economy. According to Keynes, a government should use fiscal policy to stimulate an
economy slowed by a recession by running a deficit, that is, by spending more than it
takes from the economy in taxes. On the other hand, to slow down an economy that is
threatened by inflationary pressures, Keynes urged increasing taxes or cutting spending to
create a budget surplus that would act as a drag on the economy.

Keynes thought fiscal policy could be an automatic stabilizer for the economy because it
automatically responds to changes in economic activity. Government spending on items
such as unemployment benefits generally increases during a recession, whereas
government receipts such as income taxes will fall during a recession, moderating the
extremes of the business cycle. Consequently, fiscal policy, along with monetary policy,
which is dictated by the Federal Reserve, has an important influence on the health of the
economy.

GOVT. INTERVENTIONS IN A MIXED ECONOMY

1. To achieve desirable price level

The stability of general prices is necessary for economic stability. The maintenance of
a desirable price level has good effects on production, employment and national
income. Fiscal policy should be used to remove; fluctuations in price level so that
ideal level is maintained.

2. To Achieve desirable consumption level

A desirable consumption level is important for political, social and economic
consideration. Consumption can be affected by expenditure and tax policies of the
 government. Fiscal policy should be used to increase welfare of the economy through
consumption level.

3. To Achieve desirable employment level

The efficient employment level is most important in determining the living standard
of the people. It is necessary for political stability and for maximization of production.
Fiscal policy should achieve this level.

4. To achieve desirable income distribution

The distribution of income determines the type of economic activities the amount of
savings. In this way, it is related to prices, consumption and employment. Income
distribution should be equal to the most possible degree. Fiscal policy can achieve
equality in distribution of income.

5. Increase in capital formation

In under-developed countries deficiency of capital is the main reason for under-
development. Large amounts are required for industry and economic development.
Fiscal policy can divert resources and increase capital.

GOVERNMENT POLICIES
For demand and supply of money in economy government make policies. Two
government policies are:

1. Fiscal policy
2. Monetary policy

FISCAL POLICY
Fiscal policy aims to level out business cycles achieve full employment, price stability
and sustained economic growth. Fiscal policy is implemented through changes in the
government expenditure and taxation system. Fiscal policy involves changing the level of
public spending and/or taxation to affect the level of aggregate demand.

During an economic recession increasing the aggregate demand for goods and services
can help boost output and reduce unemployment. If private sector spending is too low,
then the government can increase its own spending. This can be combined with cuts in
taxes on people’s incomes and firms profits. This will give them more money to spend.
However there is a risk they will simply save this extra money or spend it on imported
goods and services.

In Pakistan, fiscal policy is being used for attaining objectives such as self reliance,
expansion of exports, containment of import of luxury and non-essential goods,
promotion of investment and reduction in income disparity. The government intends to
expand tax base, bring new areas and sectors under the tax net, reduce dependence on
custom duties and shift it on taxes on income and consumption.

Fiscal policy Involves:

 Taxation and other sources of income

 Government expenditure
 Direct financing
 Transfer payments
 subsidies

MONETARY POLICY

Monetary Policy is concerned with the regulation of money and credit to achieve higher
economic growth and price stability in the economy. Monetary policy refers to the
actions taken by government to try to control either the supply of money in the economy
or the price of money. Interest is reward for saving money or the cost for borrowing
money.

The Monetary policy is the deliberate control of the money supply and, in some cases,
credit conditions for the purpose of achieving macroeconomic goals, or in other words we
can say that the Monetary policy of a country consists of various measure (usually taken
by its central bank) which seeks to influence the supply and demand for money and the
various uses of monetary policy to which loan able funds may be part.

Monetary Policies influence economic activities through:

 Interest rates
 Exchange rates
 Control of the money supply
 Control over bank lending and credit

Two methods are come under the monetary policy

1. Quantitative method
2. Qualitative method
Some reasons for using the monetary policy:

Growth in the money supply can cause inflation:

If the supply of money increases people will have more money to spend on goods and
services. If the output of goods and services available does not rise as fast as money
supply, the increase in demand will cause demand pull inflation.

Changes in interest rates cause changes in aggregate demand:

Interest rates are the price or reward of money. If the interest rate falls, people and firms
will find it cheaper to borrow, while others will be less willing to save money and will
spend it instead. That is, as interest rate falls more people will want to spend money.

interest rates can be used to affect the value of rupee:

If interest rates are higher in Pakistan tan in other countries, wealthy foreigners will
prefer to keep their savings in Pakistan and so earn high rates of interest on their money.
However, to put their money in Pakistan foreigners must buy Pakistani rupee with their
currencies. This increase in demand for rupee will cause their price/value to rise in terms
of other currencies.

AFFECT OF THE TWO POLICIES ON UFONE

FISCAL POLICY
There is a great effect of fiscal policy on UFONE because it is a cellular network
company, which helps the people in communicating with each other in far flung areas. If
government, put high taxes on UFONE then the products of UFONE will increase.
Automatically when the price increases, the demand of that product also decreases.
Customers do not want to buy high price rate products, thus they go for substitute
products. In this case the product level of the UFONE will be affected and their business
will never be expanded. Moreover, if ratio of taxes on their calling and SMS rates is
increased, it will decrease the profit margin of UFONE.

On the other hand if government reduces the taxes and further gives subsidies then the
cost of the UFONE product will no more increase and the product level will also
increase. It will create opportunities for UFONE to expand its services and capitalize on
whatever opportunity is headed their way due to increase in investment. Similarly if taxes
are reduced on products and those charged on calling rates, it will increase the profit
margin of UFONE. In this way customers will be more interested in the product of the
UFONE. Hence the expansion of the UFONE business will occur.

MONETARY POLICY
UFONE is a large mobile network company and every year they earn billion of Rupees.
If UFONE would want to expand its business, it would need loan from bank, for land and
machinery. According to the monetary policy, if the State Bank keeps the interest rate
high, then other local banks will also keep the interest rate higher than the State Bank, for
their profits. Due to high interest rate, the UFONE will take lesser amount as a loan. So
the expansion of UFONE business would be affected and many problems would arise
such as, the credit expansion would be lesser and business would not expand, which
would result in decrease in cash flow, increase in unemployment etc.

Similarly if the interest rate would be low, then UFONE would take large amount as a
loan due to low interest rate for the expansion of its business. So the credit expansion
would increase; increase in flow of cash, employments would also increase.