this is organizational behaviour

1. CHAPTER TWO
MARKET AND EFFICIENCY
Welfare Economics for MSC Students of PPM

2. PART ONE
DEMAND, SUPPLY AND MARKET
EQUILIBRIUM

3. Demand
 Demand for a good or service is defined as
quantities of a good or service that people
are ready (willing and able) to buy at
various prices within some given time
period, ceteris paribus.
 The inverse relationship between the price
of the commodity and the quantity
demanded per period is called the law of
demand.
 A decrease/increase in the price of a good,
all other things held constant, will cause an
increase/decrease in the quantity
demanded of the good respectively.
3

4. Changes in Demand
 Non-price determinants of demand
 Tastes and preferences
 Income
 Prices of related products
 Future expectations
 Number of buyers (size and
composition of Population)
 Change in Fiscal Policy
 Change in Weather
 Advertisements
4

5. Changes in Demand
 Changes in price result in changes
in the quantity demanded.
 This is shown as movement along the
demand curve.
 Changes in nonprice determinants
result in changes in demand.
 This is shown as a shift in the demand
curve.
5

6. Exceptional Cases to the Law of Demand
a) Conspicuous Consumption /Ostentation/
Veblen effect
b) Inferior Goods
c) Giffen Goods
d) Fixed Demand
6

7. Law of Supply
 The supply of a good or service is defined as
quantities of a good or service that people are
ready to sell at various prices within some
given time period, other factors besides price
held constant.
 The direct relationship between the price of
the commodity and the quantity supplied per
period is referred to as the law of supply.
 A decrease/increase in the price of a good,
all other things held constant, will cause a
decrease/increase in the quantity supplied of
the good respectively.
7

8. Changes in Supply
 Non-price determinants of supply
 Costs and technology
 Prices of other goods or services
offered by the seller
 Future expectations
 Number of sellers
 Weather conditions
8

9. Abnormal/Exceptional Supply
1. Fixed/Perfectly inelastic supply
 The quantity supplied is the same irrespective of
changes in price. This case may represent the supply
of perennial crops in the short-run, also supply of
land.
2. Perfectly elastic supply curve
 In this case, any quantity can be supplied/sold in the
market at the given price. E.g. Unskilled labour
3. Backward-bending (labour) supply curve
 This is found in the labour market. As workers
supply more and more hours of labour, their incomes
increase up to a point they do not want any more
increment. So they work less and prefer leisure. The
tax system of a country may also discourage effort in
work after a certain level of income is attained.
9

10. Market Equilibrium
 Market equilibrium is determined at the
intersection of the market demand curve and
the market supply curve.
 Equilibrium price: The price that equates the
quantity demanded with the quantity supplied.
 Equilibrium quantity: The amount that
people are willing to buy and sellers are willing
to offer at the equilibrium price level.
 An increase or decrease in the demand or
supply curve, it defines a new equilibrium
point.
10

11. Market Equilibrium
11

12. Price Elasticity of Demand
/
/
P
Q Q Q P
E
P P P Q
 
  
 
12
 The price elasticity of demand (Ep) is
measured by the percentage change in the
quantity demanded of the commodity divided
by the percentage change in commodity’s
price, holding constant all other variables in
the demand function.
2 1 2 1
2 1 2 1
P
Q Q P P
E
P P Q Q
 
 
 
Point Definition/ Elasticity
at given point
Arc Definition

13. Price Elasticity of Demand
13
 The price elasticity of demand (Ep) mainly
depends on the following factors:
a) Existence of substitutes effect
b) The portion of money allocated in the
budget
c) The time period after changes in price

14. Arc Elasticity of Demand- Example
Market
A
B
C
D
E
F G
0
2
4
6
8
0 200 400 600 800 1000 1200
Qdx
Px
14
 Find arc Ep between points B and C
 Ep=(Q2-Q1)/(P2-P1) (P2+P1)(Q2+Q1)
 Ep= (400-200)/(4-5) (4+5)/(400+200)
 Ep=-3
 Absolute value of Ep
 Greater than 1- elastic
 Equals 1- unit elastic
 Less than 1- inelastic

15. Graphically Showing Elasticities
15
PX
1
P
E 
1
P
E 
1
P
E 
QX
1200
0
6

16. Income Elasticity of Demand
2 1 2 1
2 1 2 1
I
Q Q I I
E
I I Q Q
 
 
 
0
I
E 
16
Point Definition
Arc Definition
Normal Good Inferior Good
Luxuries Good
Necessities Good
0
I
E 
1
I
E  1
I
0 < E <
/
/
I
Q Q Q I
E
I I I Q
 
  
 

17. Cross-Price Elasticity of Demand
2 1 2 1
2 1 2 1
X X Y Y
XY
Y Y X X
Q Q P P
E
P P Q Q
 
 
 
0
XY
E  0
XY
E 
17
Point Definition
Arc Definition
Substitutes Complements
XY
E 0
No relationship
/
/
X X X Y
XY
Y Y Y X
Q Q Q P
E
P P P Q
 
  
 

18. Income, Cross and Arc Elasticises- Example
Market
A
B
C
D
E
F G
0
2
4
6
8
0 200 400 600 800 1000 1200
Qdx
Px
18
 Find arc EI for the change income from $10000 to
$11000 that led to the change in demand for
commodity X from 400 to 600.
 EI=(Q2-Q1)/(I2-I1) (I2+I1)(Q2+Q1)
 EI= (600-400)/(11-10) (11+10)/(600+400)
 EI= 4.2
 Thus commodity x is normal and luxury.
 Find arc Exy for the change in the price of y from $1 to
2, which caused a shift in demand X from 400 to 600.
 Exy=(Q2-Q1)/(P2-P1) (P2+P1)(Q2+Q1)
 Exy= (600-400)/(2-1) (2+1)/(600+400)
 Exy= 0.6
 Thus commodity y is substitute compared to
commodity X
0
XY
E 
Substitutes

19. How do you interpret?
19

20. How do you interpret?
20
 1 percent increase in price leads to a
reduction in the quantity demanded of
clothing of 0f 0.90 percent in the short-run
and 2.90 percent in the long-run.
 Price elasticity of demand for gasoline is
three times higher in the long-run.
 Both elasticities are very small.
 It seems that people cannot find suitable
substitutes for gasoline.

21. How do you interpret?
21

22. How do you interpret?
22
 Income elesticity of demand is 2.59 for wine
and -0.36 for flour. This means that a 1
percent increase in consumers’ income leads
to a 2.59 percent increase in expenditure on
wine but to a 0.36 percent reduction in
expenditures on flour.
 Thus wine is a luxury while flour is a inferior
good.
 Electricity is also a luxury and so European
cars, Asian cars, and domestic cars in the U.S.
While cigarettes, beer, chicken and pork are
necessities. Beef is a borderline commodity

23. How do you interpret?
23

24. How do you interpret?
24
 The cross price elesticity of demand of margarine
with respect to the price of butter is 1.53
percent. This means that a 1 percent increase in
the price of butter leads to a 1.53 percent
increase in the demand for margarine.
 Thus margarine and butter are substitutes in the
U.S.
 The cross price elesticity of demand of cereals
(e.g. Bread) with respect to the price of fresh
fish is -0.87 percent. This means that a 1
percent increase in the price of cereals leads to a
0.87 percent reduction in the demand for fresh
fish.
 Thus cereal and fresh fish are complements.

25. How do you interpret?
25

26. How do you interpret?
26
 The price elesticity of demand of beer is -0.23 percent.
This means that a 10 percent increase in the price of beer
leads to a 2.3 percent reduction in the quantity of beer
demanded and thus an increase in consumer expenditures
on beer.
 The price elesticity of wine is -0.40 and spirits is -0.25 so
that an increase in their price also leads consumers to
demand a smaller quantity of wine and spirits, but also to
spend more on the alcoholic beverages.
 The cross price elesticity of demand for beer with respect
to the price of wine is 0.31 and with respect to spirits is
0.15. This means that wine and spirits are substitutes for
beer, with wine being better substitute.

27. How do you interpret?
27
 Thus a 10 percent increase in the price of wine will
lead to a 3.1 percent increase in demand for beer, while
a 10 percent increase in the price of spirits leads to a
1.5 percent increase in demand for beer.
 a 10 percent increase in consumer income will lead to
a 0.9 percent reduction in the demand for beer, but
50.3 percent increase in demand for wine, while a 12.1
percent increase in demand for spirits.
 Thus beer can be considered an inferior good, while
wine and spirits can be regarded as a luxury goods.
 Wine seems much stronger luxury than spirits.

28. Application Exercise
28
 Worldwide, the average coffee grower has increased the
amount of acreage under cultivation over the past few
years. The result has been that the average coffee
plantation produces significantly more coffee than it did 10
to 20 years ago. Unfortunately for the growers, however,
this has also been a period in which their total revenues
have plunged.
a) In terms of an elasticity, what must be true for these
events to have occurred?
b) Illustrate these events with a diagram, indicating the
quantity effect and the price effect that gave rise to
these events.

29. Application of Elasticity to Policy Decisions
29
There is a debate about whether sterile hypodermic needles
should be passed out free of charge in cities with high drug
use. Proponents argue that doing so will reduce the incidence
of diseases, such as HIV/AIDS, that are often spread by
needle sharing among drug users. Opponents believe that
doing so will encourage more drug use by reducing the risks
of this behavior. As an economist asked to assess the policy,
you must know the following: (i) how responsive the spread
of diseases like HIV/AIDS is to the price of sterile needles and
(ii) how responsive drug use is to the price of sterile needles.
Assuming that you know these two things, use the concepts of
price elasticity of demand for sterile needles and the cross-
price elasticity between drugs and sterile needles to answer
the following questions.
a) In what circumstances do you believe this is a good
policy?
b) In what circumstances do you believe this is a bad
policy?

30. PART TWO
MARKET STRUCTURES & EFFICIENCY
OF RESOURCE ALLOCATIONS

31. 31
What is a price?
 Price represents the value placed upon scarce
items/resources, usually identified by some common
denominator used as a medium of exchange, that is,
money.
 Prices are set differently in different economic
systems.
 The term market structure refers to all the
features that may affect the behaviour and
performance of the firms in a market (for example,
the number of firms in the market or the type of the
product that they sell)
 Competitiveness of the market refers to the extent
to which individual firms have power to influence
market prices or the terms on which their product is
sold. The less the power an individual firm has to
influence the market, in which it sells its product, the
more competitive that market is.

32. 32
The Short-Run, The Long-Run and Costs
 Total cost is the cost of all the productive resources
used by the firm.
 Total Cost = TC = f(Q)
 Average total cost (or average cost): ATC = TC/Q
 Marginal Cost: MC = ΔTC/ΔQ
 The MC, AVC and ATC curves are generally U-
shaped attributed to increasing and diminishing
returns from a fixed-size plant in the short run.
 MC curve always intersect AC and AVC curve at the
minimum of the AC curve
In the Short run
Variable inputs/costs (VC)
Fixed inputs/costs (FC)
In the Long run
Only Variable
inputs/costs

33. 33
Profit Maximization and Efficiency Criterion
Profit Maximization
 Regardless of the market structure, firm maximize profit by
producing where MR = MC.
a) Perfect Competitions b) Imperfect Competitions
Efficiency Criterion
 Firms have to operate at the point where P=MC=AC
MR
Mc
Qe
MC
MR=P
MC
MR
P
MR
Mc
Qe
Q
Q
MC AC
MR=P
MR
Mc
Qe
Q

34. 34
Profit Maximization
A) Profit Maximization in Perfect Competitions
B) Profit Maximization in Imperfect Competitions

35. 35
I. Pure/Perfect Competitions (PC)
 Assumptions under perfect competition industry model:
 Many buyers and many sellers
 Large number of firms
 Homogenous products
 Perfect knowledge of the market conditions
 Free entry and/or exit
 Every firm can obtain any amount of inputs at the prevailing
price. Firms determine their level of output.
 No transaction costs
 The demand curve facing a competitive firm is perfectly
elastic as the market determines price which is equal to MR.
 The PC firm maximizes its own profits and at the same time
end up meeting the efficiency criterion i.e. P = MC = ATC
 NB: The Supply curve of an industry is the MC curve above
the AVC curve

36. 36
Equilibrium output and price determination
Perfectly Competitive Markets in the Long Run
 In the short-run, a firm can make supernormal/ economic
profits, normal profits or even losses.
 In the long-run, the firm will only make zero/normal profits
since supernormal profits attract new entrants while losses
make some firms to exit the industry (see graph next slide).
 NB: Firm price is always the industry price under PC but the
quantity demanded differs.

37. 37
Equilibrium output and price determination
Advantages of PC markets
 There is efficient allocation of resources including its ability
to create an environment that preserves and encourages
producer freedom and consumer sovereignty.
 The goods and services produced in a competitive system
are governed by market demand in relation to production
costs and supply.
 Free entry and exit assures society of the elimination of any
economic (supernormal) profits in the LR
Limitations of PC markets
 Constrained technology and scale: PC market system may
not entail using the most efficient production technique
since in the LR firms earn zero profit, then inventions
requiring heavy R&D expenditures could be retarded.
 It limits the consumer choice b/c of standardized products.
 All assumptions of PC market are not applicable in real life.

38. 38
II. Imperfect Competition
 The term imperfect competition is generally used to
describe all degrees of imperfections in a market.
 Imperfect market structures arise from the existence of
firms which have some ability to influence market price.
a) Monopoly
 Monopoly refers to a single decision making process (it
could be a single firm or a group of firms)
 No close substitutes
 Entry barriers exist and substantially big
 The demand curve is downward sloping and the monopolist
MR curve is less than the price charged to consumers at
every level of output.
 Monopolists are price setters (Single price or applies price
discriminations)

39. 39
Monopoly
Benefits of Monopoly
 Economies of single ownership - a monopolist may be
able to benefit from economies of scale that are not
attainable by the individual perfectly competitive firms.
 Technical progress (TP)- the existence of high profits and
larger resources allows the monopolist to devote a large
amount of expenditure to R&D hence innovations which lead
to an increased rate of TP and thus economic growth.
Disadvantages of Monopoly (welfare implications)
 Price in Monopoly is higher than in PC while quantity in
Monopoly is lower than in PC.
 Production is not at P=MC=AC (at minimum point hence
misallocation of resources). (inefficiency - deadweight loss)
 There is price discrimination.
 Consumer is deprived of choice from different products/
differentiated products.
 Poor quality goods since there is no competition.

40. 40
b) Monopolistic Competitions (MCs)
 Assumptions/characteristics:
 Large number of producers each making similar products
(close substitutes) but differentiated in some ways.
 Because of differentiation, MCP firms engage in non-price
competition (e.g. advertising) thereby achieving some
degree of price control.
 The demand curve for any one firm is expected to have a
negative slope and be extremely elastic because of the
large number of close substitutes.
 Relatively free and easy entry into the industry but
substantial barriers to entry into leading products.
 There are no transport costs.
 There is free mobility of factors and goods.

41. 41
Monopolistic Competition
Advantages of MCp
 The differentiated products allow a wider array of consumer
choice and some product differentiation may be of real
value to consumers.
 The monopolistic competition firm earns normal profits
unlike monopoly.
 Advertisements may be useful in that they can improve
consumer satisfaction by conveying information, improving
services, permitting wider choice and encouraging more
rational consumer decisions.
Disadvantages of MCp
 Advertisements can cause resource wastage, confuse
consumer choice and result to higher product price by
raising the unit cost of output.
 Monopoly like inefficiencies also exist

42. c) Oligopoly
 Assumptions/Characteristics
 Few firms producing the total output of the product
(Duopoly - a special case of oligopoly)
 Product-price manipulation is carefully applied but firms
practice non-price competitions.
 Interdependence is an integral part of the theory of
oligopoly. i.e., the actions of each firm in the industry will
have important effect on the decisions/ actions of others.
 Each firm’s price and output decisions are therefore
influenced by its views or expectations about how other
firms will react to it is decisions.
 Substantial barrier to entry due to merger, cartel etc
 Sticky or rigid price due to agreements and ‘follow the
leader philosophy’
 Firms face kinked demand curve.
 Homogenous or differentiated
42

43. Oligopoly
Advantages of oligopoly
 High profits (incentive for innovation and product
development or processes)
 Simple choices
 Competitive prices
 Better information and Goods
Disadvantages of Oligopoly
 Difficulty to Forge A spot (entry)
 Less Choices
 Fixed prices are bad for consumers
 Less competitions hence less creative and innovative
43

44. 44
Consumer and Producer Surplus (CS & PS)
 CS is the difference between the maximum that a consumer would
be willing to pay for a unit of a good and the amount that he/she
actually pays.
 PS is the difference between what producers receive for a unit of a
good and the minimum they would be willing to accept.
 NB: Under monopoly, CS is smaller and PS is larger. In PC market,
CS is larger than PS.
 The total of producers and consumers surplus is smaller under
monopoly. This is because some potential gains from trade go
unrealized. This is the dead weight loss i.e. benefit lost by one
party but not gained by another. Dead weight loss refers to the
net fall in welfare as a result of the monopolist’s restrictions of
output. This also leads to a pareto sub-optimal allocation of
resources.

45. Price Ceiling and Floors
 Price is also sometimes prescribed by a central
organization to protect consumers/producers.
PRICE CEILING
 It is a maximum price or a price above which a good or
service cannot be sold.
 To stop the price of a particular good from rising to an
unacceptable level, thereby protecting consumers.
 It is set below the market equilibrium creates excess
demand since equilibrium price already hurts consumers.
PRICE FLOORS
 It is a minimum price or a price below which a good or
service cannot be sold e.g. wage legislation, maize.
 To guarantee producers a certain return on their sales
and is common for agricultural products.
 Price floor set above the market equilibrium causes a glut
since equilibrium price already hurts producers.
45

46. PART TWO
MARKET FAILURE AND THE ROLE OF
GOVERNMENT

47. Introduction
 Should the government intervene in the market?
 The framework presented in markets might be
called the invisible hand framework.
 Invisible hand framework – perfectly
competitive markets lead individuals to make
voluntary choices that are in society’s interest.
Conditions for the market to achieve efficiency
 Requires clear price signals and there must be
 Perfect Competition
 Perfect Information
 Perfect Mobility
 Consumer Sovereignty
 No Externalities or public goods

48. Market Failure
 A market failure occurs when the invisible
hand pushes in such a way that individual
decisions do not lead to socially desirable
outcomes.
 Any time a market failure exists, there is a
reason for possible government intervention
into markets to improve the outcome.
 Because the politics of implementing the
solution often leads to further problems,
government intervention may not necessarily
improve the situation.

49. Market Failures
 Markets may fail to generate efficient results
due to
 Monopoly
 Externalities
 Public Goods, Merit and Demerit Goods
 Open Access
 Incomplete Information

50. Externalities
 Externalities are the effect of a decision on a
third party that is not taken into account by the
decision-maker.
 Externalities can be both positive and negative.
 Negative externalities occur when the effect of
a decision on others that is not taken into
account by the decision-maker is detrimental to
the third party.
 Examples include second-hand smoke, water
pollution, and congestion.
 Positive externalities occur when the effect of
a decision on others that is not taken into
account by the decision-maker is beneficial to
others.
 Examples include innovation, education, and new

51. Externalities
Negative Externalities
 When negative externalities ensue third parties
are hurt and hence marginal social cost (MSC) is
greater than marginal private cost (MPC).
 MSC includes all the marginal costs borne by
society.
 MSC is calculated by adding the negative
externalities associated with production to the
MPC of that production.
Postive Externalities
 Private trades can benefit third parties not
involved in the trade.
 Marginal social benefit equals the marginal
private benefit of consuming a good or service
plus the positive externalities resulting from

52. The Effect of a Negative
Externality
Marginal social
benefit
Marginal private cost
Marginal social cost
Cost
Quantity
0 Q0
P0
Q1
P1
Marginal cost
from externality

53. A Positive Externality
Cost
Quantity
0
Marginal benefit of an externality
D0 = Marginal private benefit
D1 = Marginal social benefit
Q0
P0
Q1
P1
S = Marginal private and social cost

54. Public Goods
 A public good is one that is nonexclusive (no
one can be excluded from its benefits) and
nonrival (consumption by one does not preclude
consumption by others).
 There are no pure examples of a public good.
 The closest example is national defense.
 Technology can change the public nature of
goods.
 Roads are an example.
 Once a pure public good is supplied to one
individual, it is simultaneously supplied to all.
 A private good is only supplied to the individual
who bought it.

55. Informational Problems
 Perfectly competitive markets assume perfect
information.
 Real-world markets often involves asymmetric
information.
 When there is a lack of information, buyers and
sellers do not have equal information, markets
may not work properly.
 Adverse Selection is a pre-contractual
opportunism while moral hazard is a post-
contractual opportunism
 Screening and Signalling are good approaches
to reveal information and reduce adverse
selection
 Optimal contracting helps to reduce moral
hazard

56. Merit and Demerit Goods
Merit Goods
 Merit goods are products that society values and judges
that society should have regardless of whether an individual
wants them.
 The Market mechanism underproduces such goods
 Examples: nurseries, schools, colleges, universities etc
Demerit Goods
 Demerit goods are those products that society deems as
bad.
 The Market mechanism overproduces such goods
 Examples: Alcohol, smoking, Drugs, Gambling, foods that
make you obese
 A product that the government believes consumers
overvalue because of imperfect information.
 A demerit good is ‘ socially undesirable ’ and ‘worse’ for a
consumer than the consumer realizes

57. Alternative Methods of Dealing with Externalities
 Externalities can be dealt with via direct
regulation, incentive policies, and voluntary
solutions.
Direct Regulation
 A program of direct regulation is where the
amount of a good people are allowed to use is
directly limited by the government.
 Economists do not like this solution since it does
not achieve the desired end as efficiently (at
the lowest cost possible in total resources
without consideration as to who pays those
costs) and fairly as possible.
 Direct regulation is inefficient because it
achieves a goal in a more costly manner than
necessary.

58. Alternative Methods of Dealing with Externalities
Incentive Policies
 Incentive programs are more efficient than
direct regulatory policies.
 The two types of incentive policies are either
taxes or market incentives.
 A tax incentive program uses a tax to create
incentives for individuals to structure their
activities in a way that is consistent with the
desired ends.
 Often the tax yields the desired end more
efficiently than straight regulation.
 This solution embodies a measure of fairness
about it – the person who conserves the most
pays the least tax.

59. Regulation Through Taxation
Marginal social
benefit
Marginal private cost
Marginal social cost
Cost
Quantity
0 Q0
P0
Q1
P1
Efficient tax
• Another way to handle a negative externality is
through a pollution tax or effluent fees.
• Effluent fees – charges imposed by
government on the level of pollution created.

60. Market Incentive Policies
 An alternative to direct regulation is some type
of market incentive program.
 Market incentive program – a plan requiring
market participants to certify total consumption
– their own or other’s – has been reduced by a
specified amount.
 A market incentive program is similar to the
regulatory solution in that the amount of the
good used is reduced.
 A market incentive program differs from a
regulatory solution in that individuals who
reduce consumption by more than the required
amount are given a marketable certificate that
can be sold to someone else.

61. Voluntary Reductions
 Voluntary reductions leave individuals free to
choose whether to follow what is socially
optimal or what is privately optimal.
 Economists are dubious of voluntary solutions.
 A person’s social conscience and willingness to
do things for the good of society generally
depend on his or her belief that others will also
be helping.
 If a socially conscious person comes to believe a
large number of other people will not
contribute, he or she will often lose their social
conscience.
 This is another example of a free rider
problem – individuals’ unwillingness to share in
the cost of a public good.

62. The Optimal Policy
 An optimal policy is one in which the marginal
cost of undertaking the policy equals the
marginal benefit of that policy.
 Should pollution be totally eliminated?
 Some environmentalists say “yes.”
 Economists would answer that doing so is costly
so marginal costs should be balanced against
marginal benefits.
 The point where MC = MR is called the optimal
level of pollution.
 Optimal level of pollution – the amount of
pollution at which the marginal benefit of
reducing pollution equals the marginal cost.

63. Government Failures and Market Failures
 Market failures should not automatically call for
government intervention.
 Why? Because governments fail too.
 Government failure occurs when the government
intervention in the market to improve the market failure
actually makes the situation worse.
Reasons for Government Failures
 Governments do not have an incentive to correct the
problem.
 Governments do not have the information to deal with the
problem.
 Intervention in the markets is almost always more
complicated than it initially looks.
 Government intervention does not allow fine-tuning, and
so, when the problems change, the government solution
often responds far more slowly.
 Government intervention leads to more government
intervention.

64. The Role Of Government In the Economy/Business Regulator
 The government applies regulation in cases where the
private sector allocates resources inefficiently. In this case
the imposition of rules can provide incentives for more
efficient private sector production without the government
having to take over production itself.
 For e.g., the market doesn’t provide regulations/judicial
system for the enforcement of contracts, labor/trade
legislation, health and safety standards etc. in this case, the
government steps in and either provides these services
directly or regulate the providers of these goods and
services.
 The government also ensures stability of regulation. This s
because one of the most damaging sources of state action is
uncertainty. An entrepreneur needs to be assured that the
rules and regulations of an economy, the protection of the
property rights and the provision of public goods are not
subject to continuous change. Only in this way we can
society function optimally and act as an attraction for
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65. The Role Of Government In the Economy/Business Regulator
As tax-gatherer
 The government collects revenue from the public in the
form of taxes to fund government programmes like health
and education, to pay debts, and to build public
infrastructure such as roads.
 Taxes can be powerful instruments in how they affect
people’s behaviour. Empirical studies have shown that
how a government imposes taxes can be a key factor in
determining the amount of savings and investment in an
economy, as well as how much people work, when and on
what they spend their incomes, and on the structure of
business.
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66. Provision of public goods
 The government aids in the provision of public goods.
These are goods that can be enjoyed by an unlimited
number of people where one cannot exclude others from
using them. Besides, public goods are indivisible because
they are produced in large quantities (hence can’t be sold
to individual buyers) making it not feasible to charge for
the consumption of public goods and therefore private
suppliers will lack the incentive to supply them.
Legal and social framework
 The government creates a sound legal framework to
ensure the right and protection of private ownership. This
is a key factor in encouraging entrepreneurship in a
country. By establishing legal rules, government directs
the relationships between businesses, resource suppliers
and consumers, hence improving resource allocation,
which in turn aids the poverty alleviation effort.
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The Role Of Government In the Economy/Business Regulator

67.  The government uses three institutions to protect
individual rights. These include: national defence, police
protection and the courts and criminal justice system. The
government also facilitates the enforcement of contracts,
which allows citizens to operate with confidence that legal
remedy is available should a colleague or a client fails to
fulfil their commitments.
Redistribution of Income
 The government uses public policy to improve the well-
being of those members of society who are least
fortunate to enjoy some minimal standard of living. The
government also desires equality for all people by
increasing everyone’s standard of living. This is because
although a market economy benefits society as a whole, it
does not benefit everybody. There are always winners
and losers. The government fosters redistribution of
incomes via public policies and amenities.
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The Role Of Government In the Economy/Business Regulator

68. Consumer
 The government acts as a consumer of products produced
by the public in use for its daily operations. This in turn
means that the government injects into the economy and
thus allows for flow of income.
Research and development
 The government conducts and finances research and
development for various issues affecting the economy and
the country as whole and comes up with ways of remedying
them. These include research in agriculture and new ways
of farming, new medicines to curb sickness etc.
Protection
 The government protects consumers from businesses. This
is by instituting antitrust laws to control or break up
monopolistic business combinations that become powerful
enough to escape competition.
 The Gov’t also addresses consumers’ grievances about
business fraud and enforce recalls of dangerous products.
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The Role Of Government In the Economy/Business Regulator

69. Security
 The government provides security services for example,
national defence, administration of justice to its people.
This gives the public confidence that they are in a free
country where they can operate without fear.
Producer
 The government owns assets for example, schools and
hospitals, military equipment and police stations. In some
cases, the government operated businesses, which
generate income for its day to day operations.
International and diplomatic relations.
 The government promotes international and diplomatic
relations with other countries thus creating conducive
environment for business through exports and imports.
This enables a country to market itself in other countries.
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