Market Economy Government Regulation and Intervention

Question: Discuss about the Market Economy for Government Regulation and Intervention. Answer: A: Adam Smith is concerned about the market economy. According to him, invisible hand works in the course of market economy and for the efficient functioning of the market there would be no need for the government regulation and intervention. However if we want to look at the market economy, we need to understand the inherent market structure and market structure differs depending on the goods and services the market is trading. There are four types of market structure perfect competition, monopoly, monopolistic competition and oligopoly. These four market structures have different characteristics and on the basis of these features we can differentiate among different types of market. In the real world scenario, perfect competition and monopoly are the two extremes and we rarely can see such market structures. However monopolistic competitive and oligopolistic market structures are common in the economy. Perfect Competition: We will start with the perfectly competitive market. Perfectly competitive market has certain features like there are larger number of buyers and sellers in this market. Buyers and sellers have complete information regarding commodity and prices. The large number of buyers and sellers signify that single buyer or seller is very insignificant in the market and each seller has very small amount of market share. This aspect of market structure denotes that a single seller does not have any influence on market price and he cannot change the market price to attain higher market share or to earn higher profit. Another aspect behind the given market price is that each seller produces standardised product and for reason it is impossible for each seller to influence the market price. Each seller has to accept the market price that is determined by the interaction of market supply and market demand. Hence each seller and buyer is price taker.Hence H Another feature of perfectly competitive mar ket is that there is no barrier to entry or exit into the market that means there is free entry and exit facility for each firm into the market. Example of perfectly competitive market: One of the most important example of perfectly competitive market is wheat and corn market. In this market the farmers cannot differentiate in terms of product quality and for this reason final product is standardised. There are large number of farmers and buyers in the agricultural market and for this reason one single farmer or consumer is unable to affect the price of product. Hence each farmer is price taker and he has to sell its product at the market price. The farmers have the option of free exit and entry from the corn or wheat market depending on the profit or loss. If in the short run they incur profit, in the long run there will be entry of other firms while in case of short run losses, there will be exit of farmers in the long run. As the farmers are price taker, they have to sell their product at market determined price and for this reason corn or wheat market has horizontal or perfectly elastic demand curve. As there is large number of option for corn or wheat, the cons umers have good number of substitutes (as each farmer sell same corn or wheat) and for this reason the demand curve of each firm is perfectly elastic. Monopoly: Monopoly is a market structure where we can see the emergence of single seller in the industry. Hence in case of monopoly market supply and the supply of firm is same as the industry consists of the single firm. Monopoly firm is given the government protection. The government considers that it would be cost efficient for on single firm to serve the entire market and the government also considers that the large monopoly firm will be able to secure economies of scale (larger production will reduce average cost of production) eventually and they will also undertake research and development activities. Considering all these aspects the government provides monopoly status to a firm so that efficiency of the market can be attained and consumers can be benefited from lower prices and good quality product or service. For this reason government gives tax exemption and regulate the monopoly market so that no competitor can enter into the market. Hence in case of monopoly market structure there is strict barriers to entry and without any competition the monopoly firm can serve the market to earn higher level of profit. However most of the time it can be seen that the monopoly firm is not fulfilling its commitment to the society and produce lower output and charge higher prices to satisfy its profit maximization criteria. Hence the monopoly firm faces downward sloping demand curve. Example of monopoly firm: One good example of monopoly firm is US postal services. According to 19th century law it is illegal for any other company of firm to deliver letters and the sole authority of delivering letters had been given to US postal services. However it can be seen that US postal service deliver letters at a minimum price of $3 and it can be said that if private companies and competitors will be present in the market, the consumers can deliver letters at much lower cost. US postal services have been exempted from state and federal taxes and there are a numbers of government regulations so that US postal service can be competitors free. However in 2002 it can be seen that fiscal deficit of the postal service is of $4.5 billion and that lead the government to consider imposing some regulations on postal department to improve its efficiency ("US Postal Service: A Government Protected Monopoly | Capitalism Magazine", 2016). Monopolistic competition: The other market structure is monopolistically competitive market. In this market structure we can see that there are large numbers of small sized firms. One of the important aspect of this market structure is that each firm tries to bring certain differentiation in its product so that on the basis of this product differentiation it can charge some different price and can improve its market share and profit in the industry. The product differentiation and ability to influence the market price lead to downward sloping demand curve for these firms. The firm adopts advertisement campaign to increase their market share and profit. This industry has low barriers to entry and exit into the industry and depending upon profit and loss entry and exit can happen in the long run. Example of monopolistically competitive firm: Starbucks and McDonald are under monopolistically competitive industry. In fact the fast food industry belongs to this monopolistically competitive market structure. There are larger number of firms in this fast food industry like star buck, McDonald, KFC, Pizza Hut, Burger King and others. They acquire small market share and produces and sells similar product. However these firms have adopted different strategies to bring product differentiation so that with it, they can attract larger customer base. Like McDonald have recently adopted special breakfast menus to bring some fresh look into its menu. This strategy has been advertised largely so that its market share can improve. In this fast food industry we can see firms can enter and exit into the market easily and there is no such strict barriers for entry and exit ("Starbucks or McDonald's? - Econlife", 2010). Oligopoly: Another market structure is oligopolistic market. In this market structure we can see that there are few firms in the industry and they acquire larger market share. As there is few large firms and each firm incur high cost of production to remain in the industry, barrier to entry in the industry is high and new firm has to face significant barrier to entry into the industry. The product that the market serves in standardised and unique in nature. The most crucial aspect that we can observe in this industry is that interdependence among existing firms. As there are few large firms, one firms pricing or quantity strategy affect other firms. We can say that if one firm reduces its price, other firms also reduces their price; however rise in price will not be matched by other firms as in this case price rise will result to lower amount of profit. However in this oligopolistic industry, existing firms can enjoy monopoly profit if they decide to collude that means if they collectively deci de how much output to produce and what price to charge for their product. Example of oligopolistic market: US airline industry is an example of oligopolistic market. Boeing and Airbus are two popular airline firms in the US airline industry. These two firms face stiff competition for decades as they supply fixed output in terms of number of airservices and infrequent aircraft orders. This competition also depends upon their strategic behaviour on deciding price and quantity and quality of service. They secure large market share and earn higher profit. Huge initial and ongoing investment by these two firms lead new entrants to deter their entry into the industry (Cook, 2008). b: Externality arises when the action of somebody has some effects on the welfare of third person (who is not associated with the action). Negative externality arises when the action of one party imposes cost on the welfare of other party. During the phase of negative externality we can see that social cost is greater than private cost and without any government intervention the party who creates negative externality does not compensate the society for the social cost. Hence in the presence of negative externality we can see that the externality is not internalised and market output is greater than socially efficient level of output. In the above figure we can see example of negative externality. In the economy market equilibrium level of output gets equal to social efficient level of output when the when there is no externality and marginal social benefit equal to marginal social cost. However when negative externality arises into the economy, marginal social cost is higher than marginal private cost as there is external cost and in this case if there will be no government regulation the market output will be Q and negative externality generating firm charges P price. This is the market output whereas the socially optimum output should be Q1 (where marginal social cost equal to marginal social benefit) and the firm should charge higher prices at P1. In the above example we can see without any government regulation in the presence of negative externality the economy produces higher output and charge lower price which is not socially optimum combination. Hence government regulation is required. The government can regulates with the help of two measures imposing tax on negative externality generating firm and creating tradable permits. Imposition of tax: First method is imposition of tax on pollution (as pollution is considered as negative externality). When the government imposes tax on pollution generating firm, the supply curve shifts leftward (in the above diagram it can be represented as leftward shift of marginal private cost curve to marginal social cost curve) and for this reason the pollution generating firm will produce Q1 output and charge P1 price ("Pollution Permits | Economics Help", 2016). Advantages of imposition of tax on pollution generating firm: In this manner social efficiency is reached as the firm continues to produce where marginal social cost equalises to marginal social benefit ("Pollution Permits | Economics Help", 2016). In this manner the government can earn tax revenue and that can be utilised in productive sectors like health and education ("Pollution Permits | Economics Help", 2016). Disadvantages of imposition of tax on pollution generating firm: It is very difficult to measure the amount of pollution and tax accordingly ("Pollution Permits | Economics Help", 2016). Tax can create inequality. If the demand for the good is inelastic, imposition of tax will not reduce its demand and will not reduce pollution as well ("Pollution Permits | Economics Help", 2016). Tradable pollution permit: In this kind of pollution control strategy the government determine certain level of pollution unit that the entire industry can generate and on the basis of it, the market players can trade (buy and sell0 those pollution permits. This is considered as the most efficient way of reducing pollution in certain industry ("The Pros and Cons of Cap and Trade | Steve Richey", 2016). Advantages of tradable permits: In this way the firms which require low cost to reduce pollution can sell their pollution permit to those firms which require high cost to reduce their pollution level. In this manner, total pollution unit in the industry will remain in its pre determined form and the society can reduce pollution at cost efficient manner. In this manner the firms that have the prospect for development do not need to compromise on the ground of reducing pollution units ("The Pros and Cons of Cap and Trade | Steve Richey", 2016). The government can auction the pollution permit and can generate revenue out of it ("The Pros and Cons of Cap and Trade | Steve Richey", 2016). Disadvantages of tradable permits: The major disadvantage of tradable pollution permit is that firms that emit coal, gas and carbon-di-oxide in higher percentage will continue to emit that amount and that will degrade environmental quality ("The Pros and Cons of Cap and Trade | Steve Richey", 2016). There is a higher chance that the firms engage in this kind of trading involve in cheating and that can hamper overall, efficiency of the market economy ("The Pros and Cons of Cap and Trade | Steve Richey", 2016). Real example of negative externality and reduction: Many economies now engage in pollution reduction strategies as pollution or more specifically emission of green house gases degrade the quality of our environment. Hence many economies and countries like Singapore is engaging itself to reduce carbon emission and they have been initiating Kyoto protocol. This has been one of the popular means of reducing pollution and with the help of it, the countries can trade their pollution permit. Auction of this permit happen and amount of permit is decided on the basis of historical record of demand and number of available auctions. The countries bid their prices for the permit and according to it final trade (buy and sell) of pollution permits are finalised (NorregaardRepalin Hill, 2000). C: The US economy has witnessed the growing level of negative externality that has been generated by the tobacco companies and these tobacco companies are imposing higher health hazards to the entire economy. These tobacco companies are marketing, lobbying tobacco practices and for this reason larger proportion of population become smokers. This smoking habit is considered as one of the most deadly habits and this actually degrade overall health of the economy. As these tobacco companies increases their advertisement, marketing and sale of tobacco products, number of smokers in the economy is going to increase and this imposes serious threat to the entire market economy (Biglan, 2016). Generally young people and students are more prone to such habits and for this reason entire economy will be going to suffer. As healthy individuals are considered as the important human capital of the economy, increase in smoking habits degrade human capital and further the growth prospect of the economy, Smoking is going to create negative externality as smoking do not adversely impact the welfare of the direct smokers but also degrade the health condition of passive smokers and finally the entire economy. Hence human capital of the economy gets adversely affected. In the above figure we can see that how smoking generates negative externality in an economy and how it adversely impact the well being of the entire society. When people smokes negative externality generates, but without government intervention the tobacco producing companies do not need to pay taxes or any compensation. For this reason they continue to produce Q output and charges P price. However if negative externality is internalised and government regulates the market properly, socially optimum level of output is generated. Socially optimum or efficient level of output is generated when marginal social benefit curve equals to marginal social cost curve and the firm produces Q1 level of output and charges P1 market price. With the absence of any government regulation negative externality creates deadweighted loss which occurs due to the difference between market output and socially optimum level of output. In the above figure dead weighted loss is denoted by the shaded region (t raiangle) (Biglan, 2016). In the year of 1950, significant action against the use of tobacco has been raised in the US economy when empirical researchers found that smoking causes large amount of health hazards including cancers. Due to this empirical findings large proportion of people and organizations had started their campaign and awareness programs against the use of cigarettes. They showed that from the beginning of adolescence large proportion of young people starts smoking and that actually disrupts the growth prospect of an economy. The tobacco control program by different organizations has been specifically meant to increased number of awareness programs (Biglan, 2016). Large number of evaluating strategies for reducing smoking had been emerged these days. These include media campaign, school based preventive measures, ban on advertisement on tobacco products, claim for clean indoor environment and tax on cigarettes. All these are expected to reduce the demand for and that will finally result to lesser occurrence of smoking incidence (Biglan, 2016). During that period advocacy programs were found out to be very effective. They initiated large number of media campaigns and they demanded clean indoor air. That time a number of organizations like American Cancer Society, American Lung Association and American Heart Association formed a number of campaigns and there increased the society for American for non-smokers right and Tobacco free kid. They media campaign attacked the lobbying and marketing procedure of tobacco companies and that finally reduced demanded for tobacco (Biglan, 2016). During that period a large number of surveillance incidents happened and that monitored the smoking habits of adults and adolescents. References US Postal Service: A Government Protected Monopoly | Capitalism Magazine. (2016). Capitalismmagazine.com. Retrieved 26 August 2016, from https://capitalismmagazine.com/2003/09/us-postal-service-a-government-protected-monopoly/ Cook, A. (2008). B OEING V ERSUS A IRBUS : AN ECONOMIC ANALYSIS. Miami University. Starbucks or McDonald's? - Econlife. (2010). Econlife. Retrieved 26 August 2016, from https://econlife.com/2010/06/starbucks-or-mcdonalds/ (2016). Retrieved 26 August 2016, from https://www.colorado.edu/economics/morey/2010/2010BookChapters/KW_Chapter9/KWCh_09_Perfect_Competition_Edward.pdf Pollution Permits | Economics Help. (2016). Economicshelp.org. Retrieved 26 August 2016, from https://www.economicshelp.org/micro-economic-essays/marketfailure/pollution-permits/ The Pros and Cons of Cap and Trade | Steve Richey. (2016). Steverichey.com. Retrieved 26 August 2016, from https://www.steverichey.com/writing-samples/climate-change/the-pros-and-cons-of-cap-and-trade/ Norregaard, J. Repalin Hill, V. (2000). Taxes and Tradable Permits as instrument for controlling pollution: Theory and Practice. International Monetray Fund. Biglan, A. (2016). Corporate Externalities: A Challenge to the Further Success of Prevention Science.