Business, Government and
Society in India

Session 2

Delivered by

Associate Professor
Economics & International Business
IMT Ghaziabad



The Market Capitalism Model 2 . responding primarily to powerful economic forces. 30-06-2016 The Market Capitalism Model • The market capitalism model depicts business as operating within a market environment. • The market acts as a buffer between business and non-market forces.

▫ 2. • There are many producers and consumers in competitive markets. the brewer. • Adam Smith described it this way:  "It is not from the benevolence (kindness) of the butcher. ▫ 4.  Firms are self interested. but from their regard to their own interest. business people will cheat or cut corners. or the baker that we expect our dinner.The proper measure of corporate performance is profit. so we don’t need to pay attention to our impact on the environment.Given an opportunity. ▫ 3. The ethical duty of management is to promote the interests of shareholders. 30-06-2016 According to the Market Capitalism Model… ▫ 1. 3 ." • Self Interest is the motivator of economic activity. The key assumptions of the Market Capitalism Model… • Adam Smith in his book. They are also informed about products and prices and make rational decisions. We live in a world of limitless physical resources.  Consumers are self-interested too.The only constituency that really matters is shareholders. The Wealth of Nations described self-interest and competition in a market economy as the "invisible hand" that guides the economy.

the “Invisible Hand” of markets disciplines private economic activity to promote social welfare. and capital are owned by individuals. my self-interest is held in check.land. ▫ Government interference in economic life is minimal and undesirable as it lessens the efficiency with which free enterprises operate to benefit consumers (laissez-faire). ▫ Moral restraint accompanies the self-interested behavior of business. the “invisible hand” of the market generally keeps such behaviour under check. 4 . • Because other self-interested people are competing in the marketplace. Other key assumptions of the Market Capitalism Model ▫ Individuals can own private property: most of the resources . labour. ▫ Thus. corruption and cheating? • According to Adam Smith. who control their use through voluntary decisions made in the marketplace. 30-06-2016 Doesn't self-interest lead to over-charging. ▫ Basic institutions such as banking and laws exist to ease commerce.

Cooperation Conflict 5 . 30-06-2016 Business-Government Relationships Government roles vis-à-vis business • Government’s roles vis-à-vis business may be placed at any point on the following continuum.

 Drug price control. For example: ▫ When government’s goals and business’s objectives are at odds with each other. 30-06-2016 Government roles contd… • Cooperation • Government sometimes cooperates and works closely with business. For example: ▫ When the aim is to achieve a mutually beneficial goal  Adequate supply of medicines by business on an urgent basis to combat an epidemic. ▫ When both groups encounter a common problem or enemy requiring joining of forces  US visa rules having impact on movement of natural persons by Indian IT-ITES firms Government roles contd… • Conflicts • Government may sometimes have an adversarial relationship with business. 6 .

30-06-2016 Government’s public policy roles • What is public policy? • Public policy is a plan of action undertaken by government with the aim of achieving certain purpose affecting a substantial segment of the public. • This is the essence of the concept of governments acting in public interest. Types of public policies • Economic policies • Examples: ▫ Fiscal policy ▫ Monetary policy ▫ Trade policy ▫ Industrial policy • Social policies • Examples: ▫ CSR-related policies ▫ Work place safety-related policies ▫ Drug price control policies 7 . • Governments generally do not choose to act on a policy unless a substantial segment of the public is affected and some public purpose is to be achieved.

operations or behaviour of individuals and/or organizations (as the case may be). 30-06-2016 Regulation Concept and purpose • What is regulation? • Regulation is one of the key instruments to achieve public policy goals. local. • Regulations impose some limitation or constraint on the actions. • Regulation refers to the rules of conduct established by government for individuals and organizations. • Regulation may come from any level of government – central (federal). 8 . • A regulatory agency is the institution that monitors and enforces the regulation. state.

• Government may impose a limit on market quantity. 30-06-2016 Examples of various types of regulations • Government may set a price for the market. • What else? Why does government regulate? • Government regulation may come up for diverse reasons and in diverse situations. • Government may ban an activity. • Government may restrict market entry. • Government may mandate a quality standard. such as: ▫ Monopolies (including natural monopolies) ▫ Externalities (positive or negative) ▫ Public goods ▫ Asymmetric information ▫ Social and/or ethical 9 .

• Natural monopoly thus poses the difficult dilemma of how to organize these industries so as to gain the advantages of production by a single firm. • In case of a natural monopoly the economies of scale are so substantial that a single firm can produce total business output at a lower unit cost. • The huge sunk costs act as an entry barrier. • Hence the need for regulation to uphold consumer interests. Natural Monopoly • What is a natural monopoly? • The dominant feature of natural monopoly is the existence of huge sunk costs. it will be inefficient for a second player to enter the market. while minimizing all the vices resulting from non-competitive markets. 30-06-2016 Monopoly • What is a monopoly? • One firm supplies the whole market. 10 . • After one player has entered the market and created the requisite infrastructure and system for operation. and thus more efficiently than two or more firms. • What would happen if monopoly is left completely unregulated? • Unregulated monopolies can earn high profits by supplying less goods to the market and charging high prices. • Example? • Competition Commission of India keeps a watch on mergers and acquisitions.

• Railways • Oil & gas pipelines. each with its own power source and power lines. 30-06-2016 Contd… • Examples of Natural Monopoly? • Electricity • An electric company is a classic example of a natural monopoly. Having two electric companies split electricity production. each additional unit of electricity costs very little. etc. would lead to a near doubling of price. Once the huge sunk cost involved with power generation and power lines are paid. • Negative externality ▫ Impact on the bystander is adverse ▫ Cost to society (of producing a good) is larger than the cost to the producers of the good • Positive externality ▫ Impact on the bystander is beneficial ▫ Social benefit is higher than private benefit 11 . Externalities • What is externality? • The uncompensated impact of one person’s actions on the well-being of a bystander. where competition may lead to an inefficient market outcome.

• Externalities lead to market failures. becomes characterized by inefficient allocation of resources. • Fails to maximize the total benefit to society as a whole. 30-06-2016 Market Failure • In the presence of externalities.produce a larger quantity than is socially desirable ▫ Government: tax • Positive externalities ▫ Markets . buyers and sellers neglect the external effects of their actions when deciding how much to demand or supply. Can the government do anything to correct the market failure and maximize social welfare? • Government can intervene in the market to correct market failures arising out of externalities • How can the government achieve this objective? ▫ By internalizing the externality by way of altering incentives so that people take account of the external effects of their actions • Negative externalities ▫ Markets . therefore. • Market equilibrium.produce a smaller quantity than is socially desirable ▫ Government: subsidy 12 .

but do not pay for it. ▫ Non-excludable consumption: Those who are not willing to pay for it cannot be excluded from the consumption of the good. private businesses undersupply public goods. • Examples of public goods? • Clean air. • Since businesses cannot restrict consumption of the public goods by non-payers. • Asymmetric information may occur in markets. defective. • It causes ‘Free riders’ problem: ▫ Free riders are those who consume public goods. 30-06-2016 Public goods • A public good requires two conditions: ▫ Non-rival consumption: One person consuming the good does not prevent other people from consuming the good or does not reduce the availability of the good for consumption by others. • Examples of regulation in cases of asymmetric information? ▫ Product standards ▫ License of doctors ▫ Rules governing insurance claims 13 . or even harmful goods in such situations. • Government can regulate markets with asymmetric information to protect the buyers and/or sellers. hence. • Consumers can also sometimes exploit asymmetric information to get undue advantage from business. Asymmetric information • Asymmetric information refers to a situation where either the buyer or the seller has more information than the other party. • Some producers could provide low-quality. street lights. • Hence the need for government intervention. where consumers have difficulty inspecting the good or service.

▫ Example: CSR-related requirements 14 . 30-06-2016 Social or ethical reasons • If government sees a societal problem it may intervene with regulations. ▫ Example: Exploitation of workers • Government often regulates on ethical grounds also.