EID 2010

TASK II
1. Imperfect market is one of the major issues in the economy. What the
government should do for a better market.
Imperfect market is generally referred to as a market that deviates from the
assumptions of perfect market. Perfect market is a market with the most sellers and
buyers in transaction. In this type of market, the product that provided are mostly
homogenous. There are no barriers to get into this market. Both the buyers and
seller are price takers. As such, in this market, price is not the factor that could
influence revenue of firms. Realistically, all markets are imperfect to some degree.
In a perfect world where there is existence of competitive markets, firms do not
perceive they have any market power. Generally, imperfect markets can be
categorized into 4 market structures namely, monopolistic, oligopoly and monopoly
which is an extreme structure of an imperfect market.
A monopoly is a market situation where a single seller exists and has complete
control over an industry. Since it is the only firm active in the market, its actions have
a large impact on the market. In a monopolistic market, the firm, to an extend has its
own independence. This means that the firm is hardly affected by their competitors
act or decision as the products are heterogenous in this market, allowing for product
differentiation. Not similar with monopolistic market, oligopoly market is
interdependent. The decision that is made by the firm operating in the oligopoly
market will affect the other firms that operate in the same market. Oligopoly is the
only market where firms would need to pursure non-price competition, where each
oligopolist artificially create barriers for competitors to combat an important product
improvement.
In an imperfect market, it is often the case that sellers can increase profits at the
expense of consumer through their ability to control quantity or price. This is an
advantage for the seller as it negatively affects society as a whole. When markets
are imperfectly competitive there are three major downsides that erode the welfare of
society which are ; too little is produced , too high of a price is charged for what is
produced and there is a resulting dead-weight loss to the economy. All three of these
effect occur concurrently due to the firms behavior of maximizing profit instead of
attaining allocative efficiency. Since, firms in imperfect markets are producing at a
level of output that it too small, firms can no longer utilize its advantages of
economics scale. The difference between the actual output of the firms production
and the output required for firms to utilize the economies of scale is known as the
excess capital of the firm. In short, imperfect markets cost the economy in terms of a
misallocation of resource.
When a market structure has very few sellers typically an oligopoly market, there
are possibilities for a cartel to be formed. A cartel is defined as a group of firms that
gets together to make output and price decisions. It should be noted that, the
formation of a cartel can only work if the firms participating hold large market shares,
thus it replicates the monopoly of a monopolist. Even though ,countries like the the
USA have banned from the cartels to operate, however, internationally there is no
restrictions for the formation of one. A perfect example would be the Orgnization of
Petroleum-Exporting Countries (OPEC), where OPEC members meet regularly to
decide how much oil each member of the cartel will be allowed to produce. Since
cartels have similar monopoly characteristics and will also look after its own interest,
consumers are risk of exploitation due to the price and quantity manipulation carried
out by members of the cartel.
Government all over the world should address market inefficiencies created by
imperfect market structures. The government could adopt antitrust laws to promotoe
healthy competition among sellers. Antitrust laws prohibiy anticompetitve conduct
and mergers that may deprive consumers, taxpayers and workers of the benefits of
competition. To promote fair competiton the law could prohibit various unfair
business practives such as an illegal merger when two companies join together that
may substainially lessen competiton or creating a monopoly in a market. Besides
that, the law could also cover unfair pricing methods carried out by business such as
predatory pricing where a firm sets is price extremely low, often below cost to drive
competitors out of business. This unethical practice hinders the sustainability of start
ups that are just entering the market.
Besides antitrust laws, governments can intervene through fiscal efforts such
as deregulation and privatisation. Deregulation involves removing unnecessary
regulations that may be preventing new firms from entering the market. For instance,
the Airline Deregulation Act of 1978 in the US which removed many controls such as
regulatory approval to serve any route has allowed low-cost carriers to increase
market share providing consumers with cheaper alternatives. As for privatization, it
involves the transferring the ownership of public sector entities to the private sector,
increasing the number of firms in the market.Through the increased productivity and
productivity of privatized firms, services which was once offered by government
owned industries would be improved. For an example, through the 1983 National
Privatisation Policy, Tenaga Nasional Berhad (TNB) had undergone privatization
process which brought many benefits to the people including improved services and
productivity.
In dealing with imperfect markets where competition is limited, the government
can take steps for a better market. Imperfect markets, like monopolies and
oligopolists, often lead to problems such as high prices and reduced choices. To
address this, governments can enact antitrust laws to encourage fair competition and
prevent harmful mergers. They can also use fiscal tools like deregulation and
privatization to open up markets, allowing more players to enter and compete. These
measures aim to create a fairer and more efficient market, benefiting consumers and
the economy as a whole.
2. Soft Budget Constrain or Hard Budget Constrain: Which way?

The concept of “budget constraint” has been introduced by the theory of

household consumption. In this context, “budget” is of general and serves to
denote the plan for revenues and expenditure of any economic unit for
instance ; household, enterprise, non-profit institution. It is worth noting that,
budgeting is not restricted exclusively to the fiscal plan of a government but it
remains a critical aspect of economic governance. A soft budget constrain is
one that permits the budgetary limits to be followed with flexibility, allowing
entities to stray without severe and immediate consequences. On the other
hand, a hard budget constraint, emphasis financial discipline and
responsibility by enforcing strict limits.

Soft budgets offer a certain amount of flexibility which can be helpful

in certain economic situations. A soft approach enables government and firms
to react quickly during times of emergency of economic downturn. This
flexibility is relevant for governments dealing with catastrophic events such as
floods, earthquake and even medical emergencies such as the Covid-19
pandemic. Through the loose limitations set in a soft budget, government are
able to increase their public expenditure instantly allowing them to stimulate
the economy during times of crises. During a recession, governments may
choose to implement stimulus measures to provide a rather instant and
momentary financial relief for its citizens. Nevertheless, there are also issues
with the flexibility associated with soft budget constraint. Due to the lack of
immediate consequences, deviations from the actual budget may lead to
inefficiencies and moral hazard. Firms and insitutitions may grow comfortable
due to the lack of severe consequences of going over budget. In short, the
lack of stringent financial discipline incentivizes inefficient management,
discourages innovation and risk-taking.

Hard budget constraint, on the other hand, represents a stricter

approach, with a greater emphasis on financial responsibility and discipline
than soft approach. Entities are expected to operate within certain pre-defined
financial constraints. Failure to do so may face consequences like bankruptcy
or closure for persistent underperformance. One of the primary advantages of
hard budget constrain is its method of emphasising efficiency and
encouraging prudent resource allocation and financial management. For an
example, a developing country may rely heavily on foreign aid or its limited
natural resources. This harden the nation’s budget as it would need to
strategically allocate its resource to critical sectors such as infrastructure and
education. This pushes the nation to work within their means and provide the
best outcome despite a very constraining budget. However, critics have warn
that a stringent regime has the potential to impede the provision of basic
public services, especially in times of economic recession or unanticipated
crisis. This lack of flexibility can exacerbate economic challenges, leading to
prolonged downturns and increased social hardships.
 The ideal fiscal governance approach lies in striking a balance between
soft and hard budget constraints. A one-size-fits-all approacj would be
ineffiective. The optimal balance depends on a multitude of factors, including
the specific entity involved, the economic context and the underlying social
safety net. In the case of essential public services like emergency response,
healthcare and education, a degree of flexibility in the budgetary constraint
might be necessary. This guarantees that essential services continue to be
available and operational even under challenging times. To avoid
inefficiencies and resource mismanagement, this flexibility should be
combined with strict performance monitoring and accountability procedures.
Transparency and public scrunity are critical in this regard.

Conversely, sectors exposed to market competition, such as state-

owned business, may gain from a more strictier application of a hard budget
constraint. Encouraging efficiency, innovation and competitiveness is
achieved while reducing financial strain on taxpayers if there were to be any
bailouts made by the government. A good example of tax payer’s money
being used for bailout is the US government response towards the 2008
financial crisis. The federal government has a law passed by Congress to
allow the Treasury to buy up $700 billion of troubled assets to restore liquidity
in financial markets. However even in these cases, safeguards should be in
place to prevent the collapse of critical and large industries and having a big
impact on society.

In summary, the debate between soft and hard budget constraints

underscores the complexities of fiscal governance. Navigating the landscape
of soft and hard budget constraints requires a nuanced approach.
Acknowledging the merits and drawbacks of each approach enables us to find
the optimal balance that fosters fiscal responsibility without sacrificing the
provision of essential public services. By strategically employing fiscal tools,
embracing transparency, and promoting accountability, we can ensure that
public resources are utilized effectively, paving the way for sustainable
economics growth and a healthy society.