Essay 1: Explain some of the problems that may arise if there is heavy reliance on free markets

in an economy. Examine the role that the government can play in resolving some of these
problems.
Joshua Hua YR11

A free market system (laissez-faire) is a system driven by demand and supply as well as the
actions of private firms to make a profit with minimal government intervention. However, the free
market system is not perfect as there is always a tradeoff between equality and equity which
makes the need for government intervention apparent. Market failure, which is the occurence of
inefficient outcomes can arise in the provision of goods and services, income distribution,
externalities, the abuse of market power and economic instability are all issues that force the
government to take an active role of administering. There is heavy debate among society to find
the right balance between too much government intervention, which would limit
innovation,efficiency as well as economic growth, and too little, which would promote instability
and inequality.

To begin with, heavy reliance on free markets could cause a market failure in the provision of
goods and services as firms may fail to provide certain g/s or supply too many of a particular
g/s. Firms in the free market are driven by the incentive of profit which directly influences the
production of public goods. Public goods are g/s that can be characterized as non-excludable
and non-rivaling, meaning that the good can be accessed by everyone and their access does
not diminish the utility of another. Markets tend to fail in the production of these goods as they
will always attract free riders (groups who benefit from the public good without contributing to
the cost) and examples include clean air and national defence. Due to the characteristics of
public goods, markets may sometimes produce an inadequate quantity of an item and these
items are known as merit goods because they have benefits to the community. Furthermore,
just as there are shortages of an item, there are also surpluses of harmful items known as
demerit goods. These g/s have adversely negative effects on the community and include items
like: alcohol, tobacco and gambling. As a result of the negative effects, governments play a key
role in the reduction of consumption of the g/s through imposing licenses (such as the RSA to
sell alcohol) and taxes. Overall,governments are needed to ensure the production of merit
goods and minimise consumption of demerit goods and this is done through indirect financial
aid or direct monopolisation.

Free markets may also fail in the income distribution which directly ties into the argument
between equality and equity. Free markets tend to project towards inequality without
government intervention because once people become wealthy, their wealth tends to generate
even more revenue in the future. High income earners have greater access to the factors of
production which allows them to earn rent and interest as opposed to the low income earners.
This creates the issue of poverty and in Australia, the most common form of poverty is relative
poverty which refers to those whose standards of living are substantially lower than the average
as well as absolute poverty, referring to a situation where individuals are earning incomes barely
allowing them to survive. There are disadvantaged groups in Australia who are vulnerable to the
issues of income distribution such as those with low education levels, english proficiency issues,
and as a result, this inequality can easily develop into a vicious cycle of poverty. For example, a
child growing up in a low income household has a lower opportunity for success when
compared to a wealthy child. To cope with the financial pressures, the child may be forced to
leave school early to obtain a low paying job, repeating the cycle of poverty. Governments can
never truly remove the factors that insinuate inequality but they can help improve opportunities
for those in need. FOrexample, the government provides financial support in the form of welfare
payments and scholarships to boost education levels of the labour force. These interventions
help to improve social mobility and allow for a higher standard of living. Therefore, this evidently
portrays the issues of heavy reliance on the free market as well as the necessity of government
intervention.

Furthermore, the price mechanism of goods and services takes into account only the economic
concerns of buyers and sellers, not the environmental and social costs. This means that the
consumption or production of particular g/s have effects on other people which are known as
externalities and the government aims on internalising these costs/benefits. There are two types
of externalities: positive externalities which upon consumption delivers benefits to those around
you, such as vaccinations. Vaccinations not only benefit the individual but the community as
well as it prevents the spreading of contagious diseases which leads to a healthier more
sustainable workforce. Heavy reliance on the free market would cause a depreciation in the
consumption of vaccinations as the service would take up a higher proportion of household
incomes. Governments solve this issue by providing financial assistance (medicare) as well as
the promotion of the positive externalities. The other type is negative externalities which are the
harmful effects on society due to the consumption of particular g/s. An example of this is the
carbon emissions that result from firms burning fossil fuels in the production process.
Environmental damage is one of the most important negative externalities and the heavy
reliance on the free market would cause an excessive use of these fossil fuels, destroying the
environment. Governments resolve this issue by levying taxes such as the carbon emissions tax
to make it less attractive to use non-renewable resources. hence , it is evident how the heavy
reliance on the free market would cause a market failure in externalities.

Continuing on, without government intervention there will be imperfect competition regarding
firms which creates a market failure in the abuse of market power. Market structure is a key
concept in the free market and firms in highly concentrated industries have the power to exploit
consumers without government regulation. Firms may abuse their powers through
monopolisation, where a firm imposes itself as the dominant force which gives them price
setting powers whilst preventing other firms from entering the industry. This would pose a
serious issue for society as private businesses would be given unprecedented price setting
powers over perfectly inelastic goods such as water, potentially inflating the prices to extreme
levels. The abuse of power could also occur when a firm sells the same g/s in the free market at
different prices. For example, cinemas charge higher prices to adults whilst offering lower
prices to students as their scheme is based on the consumers willingness to spend. Without
government intervention there would be an inequality problem in the market. Exclusive dealing
is also an abuse of power which occurs when a firm sets conditions for supply that could
exclude dealings with others. Government regulation is necessary as this promotes anti-
competitive behaviour and is illegal under the competition and consumer act 2010. Finally
collusion could happen which occurs when firms make agreements on pricing, essentially giving
them pricing setting powers. This is also illegal and is regulated under the competition and
consumer Act.

Finally, heavy reliance on the

business cycle without
government intervention would
cause a market failure in
economic stability. The
business cycle refers to the
fluctuations in the level of
economic growth and the boom-
bust nature of the free market
(without government
intervention) would cause either
massive booms or drastic recessions. For example, In the case of an economic boom, soaring
levels of inflation would reduce consumer purchasing power and distort business decisions. In
turn, there would be increased interest rates which would then cause a recession, leading to
high levels of unemployment and slowed economic growth. This cycle will continue to repeat
itself without government intervention, disallowing stable levels of economic growth.
Governments solve this issue through the use of macroeconomic policies which are policies
aimed to maintain a sustainable rate of economic growth, these include: monetary policy and
fiscal policy. These policies are counter cyclical to the business cycle, meaning that they oppose
the current situation of the economy. As evident in graph 1, without the intervention of
governments, there would be an endless cycle of booms which lead to a drastic decline into a
recession. Evident in graph 2, the government aims to smooth out these fluctuations which
leads to an overall stable and sustainable level of economic growth. Overall it is indicative how
the heavy reliance on free markets would cause a market failure in the stability of economic
growth.

Therefore, the free market is a practical system of capitalism that is driven by the incentive of
profits. However, heavy reliance on this market would cause the market failure in the provision
of goods and services, income distribution, externalities, abuse of market power and economic
instability. Governments play a crucial role in resolving these issues by acting as a regulatory
party.