3 minsUsually, when the term ‘Free Market’ is used, it is often conceptualized as an entity without any interference in matters, as stated in the term itself. Nonetheless, governments often get involved in the economy to stabilize markets, modulate transactions, provide frameworks for economic flow, and regulate property and contractual rights. Additionally, governments interfere when there is an economic crisis. We can take the 2001 economic recession or the 2008 banking crisis as an example of when governments implemented fierce regulation on the market, more so in the United States, where the economic regulations are lax. In this article, we will be looking into a few ways that a government can influence an economy.
The Fed will typically tighten or decrease the money supply during inflationary periods, making it harder to borrow money.
frankie on – tight budget – CC BY 2.0.
(https://open.lib.umn.edu/exploringbusiness/chapter/1-7-governments-role-in-managing-the-economy-2/)
Fiscal Policies:
Fiscal policies center around the use of government revenue and spending to influence the economy, specifically the economic conditions of the state. The policies mainly tackle employment, inflation, demand, and economic growth. For these objectives, governments influence the economy by altering the allocation of spending, tax rates, and borrowing limits. This way, governments influence the resources and how the resources are used both directly and indirectly in an economy.
Price Ceilings and floors:
Price controls are an example of government economic intervention, as mentioned previously. They are frequently employed to assist the economy in a specific direction. For instance, consumer staples (like energy, water, and food) frequently have price ceilings, ensuring that the necessity never reaches unaffordable prices.
Ignoring the numerical values on the graphs, let’s dive into how price ceilings and floors affect the economy. The original level of consumer surplus(the difference between the price the consumer is willing to pay and pays) is T+U, and producer surplus is V+W+X(24a). To make an essential, in this case, let it be a new drug, a more affordable government decides to set up a price ceiling. Now, producers produce less drugs. With this forced cap, inefficiency occurs as the total surplus of the society is reduced without compensation. This results in what we call deadweight loss (the new consumer surplus is T+V and producer surplus is X; thus, U+W is deadweight loss). Another way of seeing this is transferring area V from producer to consumer surplus.
Figure 3.24 Efficiency and Price Floors and Ceilings (3.4 Price Ceilings and Price Floors - Principles of Economics 3e | OpenStax )
On the other hand, figure (b) presents a price floor. Governments often use them to incentivize industries that are lagging behind and need support. Price floors are often implemented on agricultural products to protect the agriculture industry. However, recently, they have been used on industries affected by COVID, such as theaters. G+H+J is the original consumer surplus and I+K is the original producer surplus. As this industry, cinema, in this case, has been affected by an outside factor, the government interferes in supporting the industry. Ticket prices rise, the consumer surplus lowers, yet the producer surplus grows, supporting the producer. Deadweight loss is also created with the price floor; in this situation, J+K is the deadweight loss.
In conclusion, governments wield power to influence the economy through fiscal policies and price controls. Governments can deliberately use taxation, pending, and borrowing through fiscal policies to influence variables like employment, inflation, and GDP. Price ceilings and floors serve as examples of price controls. Although they can achieve particular economic objectives, they create deadweight loss and inefficiencies. Even in markets that are called ‘free markets,’ government interference does occur to ensure safe and fair practices occur, as well as to boost the economy in tough times.
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