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The Role of Government in the Economy. Historical Connections. As Canada entered the 21 st Century, government involvement continued to attract controversy.
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Historical Connections • As Canada entered the 21st Century, government involvement continued to attract controversy. • Both federal and provincial governments continued to scale back involvement in the economy and in turn began to dismantle the social welfare “safety net” that distinguished Canada among industrialized nations. • Privatization and deregulation led to more economic freedom and responsibility for individuals and groups.
Historical Connections The Great Depression • Among industrialized countries, few human tragedies parallel he pain and suffering inflicted by the Great Depression in the 1930s. • In Canada, unemployment soared to 20% and production levels dropped 37%. Canada was arguably the nation that suffered the most.
Up to this point most “glitches” in the economic system seemed to correct itself but now this economic tragedy persisted and no end was in sight. • By 1933 it was clear that something radically had to be done in order to prevent this disaster from becoming worse.
To combat this, a British economist by the name of John Maynard Keynes, suggested that governments spend their way out of the Depression by hiring unemployed workers for major public works projects. • His plan worked as the workers spent their wages which stimulated economic activities in the private sector. • Keynes’ plan, along with the beginning of WWII led the way for the Canadian economy to return to full employment.
So why do governments become involved in the operation of the market? • To answer this we have to further consider the writings and theories of Adam Smith. • He believed that the free-market system would channel selfish, egoistic motives toward the betterment of society. • The term “invisible hand” was introduced to describe the effect that a free-market economic system has on directing the self-interests of individuals toward a common goal.
He wrote about how the free-market will tend to allocate resources to their most efficient use. • For example, if you start a business and you are not successful than that means that not enough consumers want your product. • If enough people buy your product you will earn a living, your welfare increases and so does that of your customers.
If you are successful at your business this will attract competition. • In order to continue to sell your product or service it will be necessary that you make your good or service more attractive. • This can be done by lowering prices or improving the quality of the product or service.
Possible Shortcomings of a Free-Market System • Leading to the Great Depression some deficiencies lead to more governmental intervention. Market Imperfections • Consumers and suppliers may not have satisfactory information with which to make decisions. Advertising often helps to fill this gap although more often than less it is meant to persuade rather than inform.
Market Imperfections • Health standards, government building codes, Industry Canada and Service Canada are designed to fill these gaps.
Market Imperfections Market Imperfections The second imperfection in the marketplace is lack of effective competition. • 2. The marketplace does not always create sufficient competition. • If new firms are prevented from entering the industry then there would be higher prices and lower quantity of product.
Market Imperfections • Under the Competition Act it is illegal for firms to get together and fix prices, or sell a product at a loss to eliminate competitors, or for manufacturers to refuse to sell to retailers who do not charge a set price for the product*. • In situations where natural monopoliesarise it is inefficient to have more than one firm supply a product or service. The government either provides the service or regulates the company that provides the service. • ex) NB Power, ulilities such as gas, water, electricity, phone, and cable…
Shortcomings - Third Party Effects • A market transactions may affect someone other than the buyer and seller, this third-party may be affected in a positive or negative manner. • Government action, either in the form of a tax or the requirement to install new equipment, may be implemented when there is a negative third-party effect, such as polluting a river during production of paper.
Third-Party Effects • In a truly Free Market the people and environment in the surrounding area will suffer if the mill is allowed to operate without any environmental regulations. This is an additional cost or effect. • Govt. will step in in these situations to impose taxes or restrictions that shifts the supply curve due to increased costs and therefore a higher equilibrium price.
Unmet Public Goods • The market may not be able to provide a number of goods and services that are important to society – such as national defense, policy protection or water supply. • The benefits from these services are spread over such a large segment of the population that it is difficult to charge a fee for their use based on the benefits received. • These unmet public goods are provided by the government or contracted out to private companies.
Shortcomings • Unmet Public Goods – describes those goods and services not provided by the Free Market System due to the difficulty of charging a fee to the beneficiary of the good or service.
Shortcomings Distribution of Income • One of the main advantages of the free-market system is competition, competition among businesses and individuals. • In the pursuit of earning an income, individuals compete with each other for jobs. • If a person is unable to compete in a free-market system, he or she will not be able to earn an income. In these situations the government has intervened in order to achieve a more equitable distribution of income.
Shortcomings • Social welfare programs, such as assistance to the elderly and disabled, and employment insurance, are financed with a progressive income tax. • Income differentials in Canada would not be a serious problem if every Canadian earned enough money to meet his or her basic needs. • Poverty is defined in terms of a minimum income necessary for an individual or family.
Shortcomings • The presence of regional income differences has prompted the federal government to transfer tax dollars in the form of equalization payments to the lower-income provinces and to undertake economic development projects. • In Canada social-welfare spending accounts for the largest portion of all federal government spending and approximately one-fifth of all provincial and local government spending.
Economic Stabilization • Classical economists believed that fluctuations in economic growth, employment, and prices were temporary and the free-market system would make adjustments to return to a period of more stable economic activity. • The Great Depression changed this attitude of many policy makers. The adjustments of government spending and tax policy to economic conditions is know as fiscal policy.
Impact of Govt. Intervention Price Ceilings • A price ceiling is a government imposed maximum price. • It is used when the government believes that the equilibrium price established in the market is too high and many people feel that they cannot afford to buy the product.
Price Floors • A price flooris a government imposed minimum price. • It is illegal to set a price below a price floor. as a result a surplus occurs. • A limit on the quantity produce is one method used to eliminate a surplus. • Another method is to shift the demand to the right through advertising which may cause increased interest in the product or service.
Excise Taxes • An excise tax is one levied by government on the suppliers of certain products. • Excise tax on liquor and tobacco is a source of revenue for the government. • Excise tax on air conditioners in automobiles is meant to reduce the sales of air conditioners for environmental reasons.
Price elasticity of demand and supply determine the incidence of tax, or who bears the larger burden of the tax. • If the demand is more inelastic than supply than the consumer bears the larger burden of the tax, and vice versa. • If the government wants to raise tax revenue it will tax a product which has an inelastic demand. • If the government wants to reduce consumption than it will tax a product which has an elastic demand.
