Government and Business

Piyush Singhal Alumnus IIM(A)

Question
‡ What is the latest problem government is facing from the opposition?

Sugar Prices

‡ What is the issue ‡ What should have government done .

‡ This means you are asking government to intervene .

Types of Intervention ‡ Direct Intervention ‡ Indirect Intervention ‡ Can you give examples .

thus impacting output and consumption in the long run ± Difficult to identify accurately the effects of any single government information campaign . Market failure results from ± Consumers suffering from a lack of information about the costs ± Consumers suffering from a lack of information about the benefits of the products available in the market place Government s role ± To help consumers and producers value the true cost and/or benefit of a good or service ± Examples ‡ Compulsory labelling on cigarette packages with health warnings to reduce smoking ‡ Improved nutritional information on foods to counter the risks of growing obesity ‡ Anti speeding television advertising to reduce road accidents and advertising campaigns to raise awareness of the risks of drink-driving ‡ ‡ Output ± Designed to change the perceived costs and benefits of consumption for the consumer ± No direct effect on market prices but demand influencers.Intervention to bridge the information gap ‡ Sometimes.

Reasons for Economic intervention ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Political or economic objectives Promoting economic growth Increasing employment Raising wages Raising or reducing prices Promoting equality Managing the money supply and interest rates Increasing profits Addressing market failures .

Effects of government intervention ‡ Different forms of government intervention in markets are never neutral ± Financial support given by the government to one set of producers rather than another will always create winners and losers ± Taxing one product more than another will similarly have different effects on different groups of consumers. .

gas and rail transport Criticism ± ± ± Unnecessary burden of costs for businesses Huge amount of red tape Damaging the competitiveness of businesses. electricity. E. ‡ Advantages ± ± Introduce fresh competition into a market E. ± ± Prohibit the sale of cigarettes to children ban smoking in the workplace The laws of competition policy ± ± ± Act against examples of price-fixing cartels Setting maximum working hours Price-floor in the labour market ‡ ‡ Price controls in utilities like telecommunications.Options for government intervention .g.g. attempt to introduce more competition for British Telecom .I ‡ ‡ ‡ Parliament can pass laws .

the government pays private sector firms to carry out operations for NHS patients to reduce waiting lists .g.Options for government intervention .II ‡ Direct State Provision of Goods and Services ‡ Privatization ± State-owned sector of the economy is much smaller now ± State-owned businesses in the UK are the Royal Mail ± Examples in India? ‡ Provide merit goods and services and public goods directly to the population ‡ E.

Concept opposite to Government Intervention ‡ laissez-faire ± Economic system should be driven by free market forces ± Opposite to government intervention .

Economic planning ‡ Planned economic activity in production ‡ Directing of an economy towards specific objectives. or indirect as in the case of indicative planning . ‡ May be direct (directive planning). social or economic.

Government ‡ Body Within a community. laws. and regulations . political entity or organization ‡ Has the authority to make and enforce rules.

Example: United Kingdom .I ‡ Anarchism .Types of Government . It is a Political system controlled by nonelected rulers ± Usually permit some degree of individual freedom ‡ Constitutional monarchy ± A government that has a monarch ± Whose powers are limited by law or by a formal constitution.Governance without an authority of a state ‡ Authoritarian ± Authority of the state in a republic or union.

II ‡ Constitutional republic ± Powers are limited by law or a formal constitution ± Chosen by a vote amongst at least some sections of the population ‡ Democracy ± Rule by a government (usually a Constitutional Republic or Constitutional Monarchy) ± chosen by election where most of the population are enfranchised ± Right to vote is not limited by a person's wealth or race (the main qualification for enfranchisement is usually having reached a certain age) ‡ Dictatorship .Rule by an individual who has full power over the country ‡ Monarchy .Rule by an individual who has inherited the role and expects to bequeath it to their heir .Types of Government .

Types of Government . . ‡ Legalism .enforces the law with rewards to those who obey the laws and harsh punishments to people who go against the law.Rule by a small group of people who share similar interests or family relations ‡ Theocracy Rule by a religious elite ‡ Totalitarian Totalitarian governments regulate nearly every aspect of public and private life.III ‡ Oligarchy .

Government Intervention ‡ Action taken by a government in a market economy or market-oriented mixed economy ‡ Beyond the basic regulation of fraud and enforcement of contracts ‡ In an effort to affect its own economy .

Reasons for policy intervention ‡ To correct for market failure ‡ To achieve a more equitable distribution of income and wealth ‡ To improve the performance of the economy .

or to divest itself of lines of business entirely ± 1984 AT & T divestiture in the United States . Price regulation.g. governments may intervene to prevent a merger of the two major telecom network operators in a market ± E..Similarly. orders prohibiting collusive practices or agreements ‡ Structural ± Affects the market structure of the industry ± E.g. a dominant supplier might be required to separate its operations into distinct corporate entities.g.Another way of classification ‡ Behavioural ± Public authority attempts to modify the behaviour of a particular firm or group of firms ± Through regulation of their behaviour ± E. .

‡ Demand for the GDP of a country when inventory levels are static. ‡ Often called effective demand .Concept Revision Aggregate Demand ‡ the total demand for final goods and services in the economy (Y) at a given time and price level. the amount of goods and services in the economy that will be purchased at all possible price levels.

single good level ± But incorrect at the aggregate level .Question .Aggregate demand ‡ Aggregate demand curve is downward sloping. why? ± Is it because at lower price levels a greater quantity is demanded ± Above is correct at the microeconomic.

gross private domestic investment (I).. net demand by the rest of the world for the country's output .e. i.personal consumption expenditures or "consumption. includes all private sector spending aimed as the production of some future consumable ‡ Gross government investment and consumption expenditures (G) ‡ Net exports (X-M)).Formula for AD ‡ Y = C + I + G + (X ." demand by households and unattached individuals ‡ I .M) ‡ C .

lowers the price of merit goods.g. They are designed to boost consumption and output of products with positive externalities . Reduction in corporation tax. ‡ E. Higher direct tax rates on rich households ‡ Increase in the value of welfare benefits for the poor to make the tax and benefit system more progressive .Tax credits for business investment in R&D.raise the price of de-merit goods and products with negative externalities ± Subsidies to consumers .Fiscal policy ‡ Use of government spending and revenue collection to influence the economy ‡ Overall effect of the budget outcome on economic activity ‡ Achieved through ± Indirect taxes . leads new capital investment and extra employment ± Changes to taxation and welfare payments influences overall distribution of income and wealth. Increase in market supply ± Tax relief .

Effects of Changes in Fiscal Policy ‡ Aggregate demand and the level of economic activity ‡ The pattern of resource allocation ‡ The distribution of income .

Possible stances of fiscal policy .I ‡ A neutral stance ‡ Implies a balanced budget where G = T (Government spending = Tax revenue) ‡ Government spending is fully funded by tax revenue ‡ Overall the budget outcome has a neutral effect on the level of economic activity .

.Possible stances of fiscal policy .II ‡ Expansionary stance ‡ An expansionary stance of fiscal policy involves a net increase in government spending (G > T) through ± rises in government spending ± a fall in taxation revenue ± a combination of the above two ‡ Above leads to ± a larger budget deficit ± or a smaller budget surplus than the government previously had ± or a deficit if the government previously had a balanced budget ‡ Expansionary fiscal policy is usually associated with a budget deficit.

. ‡ Contractionary fiscal policy is usually associated with a surplus.Possible stances of fiscal policy .III ‡ Contractionary fiscal policy ‡ (G < T) ‡ Occurs ± Net government spending is reduced either ‡ through higher taxation revenue ‡ Reduced government spending ‡ A combination of the above two ‡ Above leads to ± a lower budget deficit ± a larger surplus than the government previously had ± a surplus if the government previously had a balanced budget.

resulting in a fiscal deficit ‡ Consumption of fiscal reserves.Methods of Funding ‡ Taxation ‡ Seignorage. the benefit from printing money ‡ Borrowing money from the population..g. land) . ‡ Sale of assets (e.

Funding the deficit ‡ Issuing bonds. like treasury bills or consols ‡ Above pay interest. usually to foreign creditors . a nation may default on its debts. either for a fixed period or indefinitely ‡ If the interest and capital repayments are too large.

without incurring additional debt .Consuming the surplus ‡ A fiscal surplus often saved for future use ‡ Invested in local (same currency) financial instruments ‡ During an economic slump. reserves allow spending to continue at the same rate.

Importance of fiscal policy ‡ To influence the level of aggregate demand in the economy ‡ To achieve economic objectives of price stability ‡ Full employment ‡ Economic growth .

.Monetary policy ‡ Attempts to stabilize the economy by controlling interest rates and the supply of money.

Question ‡ Use of Monetary Policy .

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