The Role of the Government in the Market Place BEC Managerial Economics Sajitha Dishanka

SCARCITYNEEDS & WANTS MARGINALITYOPPORTUNITY COST ALTERNATIVES CHOICE / DECISION Economic Rationale 2

Rationale of the Market Economy CHOICE / DECISION 3

Activities in a Market Economy (Circular Flow of Income & Expenditure) Factors of Production Factor Payments Goods & Services Expense on Goods & Services FINANCIAL SECTOR GOVERNMENT INTERNATIONAL SECTOR Imports (M) Exports (X) Investment (I) Savings (S) 4

Composition of GDP When economists think about year-to-year movements in economic activity; – they focus on the interaction between production, income and demand ProductionIncome Demand 5

Cyclical Effect 1.Changes in the demand for goods lead to changes in production 2.Changes in production lead to changes in income 3.Changes in income lead to changes in the demand for goods 6

Demand for Goods Decision to go to a restaurant by a consumer (C) Purchase of a machine by a firm (I) Purchase of combat airplanes by the central government (G) Aggregate Demand  GDP – Trade balance – Inventory investment 7

Composition of GDP ($ billions) % of GDP 1. Consumption (C)7, Investment (I) - Non-residential1, Residential4461, Gov. spending (G)1, Net exports - Exports (X)1, Imports (M)-1, Inventory invest.-58 GDP (Y)10,

Macroeconomic Policies Demand-side policies – Affect aggregate demand/expenditure – Short-run focus Supply-side policies – Affect aggregate supply/output – Long-run focus 9

Demand-side Policies Major macroeconomic policies – Monetary Policy Changes in the money supply implemented by the government – Fiscal Policy Changes in government spending and/or taxes How & when to apply...? – Expansionary effects Increase aggregate demand if the economy is below its potential output – Contractionary effects Decrease aggregate demand if the economy is above its potential output 10

Supply-side Policies To increase potential output by encouraging – Labour productivity – Innovation (R&D) – Investment – Technology advancement 11

Competitiveness of an Economy Source: GCR 2014/

Factor-driven Stage Countries compete based on factor endowments – primarily unskilled labor and natural resources Companies compete on the basis of price and sell basic products or commodities – low productivity reflected in low wages 13

Required… in the factor-driven stage well-functioning public and private institutions appropriate infrastructure stable macroeconomic framework healthy and literate workforce 14

Efficiency-driven Stage Wages rise with advancing development More efficient production processes and increase product quality Competitiveness is increasingly driven by; – higher education and training – efficient goods markets – well-functioning labor markets – sophisticated financial markets – large domestic or foreign market – ability to harness the benefits of existing technologies 15

Innovation-driven Stage Sustain higher wages and the associated standard of living by; – competing with new and unique products Companies must compete through; – new and different goods (innovation) – using the most sophisticated production processes 16

Weights of the three main groups of pillars at each stage of development Pillar Group Factor- driven Stage (%) Efficiency- driven Stage (%) Innovation- driven Stage (%) Basic requirements Efficiency enhancers3550 Innovation & sophistication factors Source: GCR 2014/

The Concept of Political Economy Collectivism – “Individual rights should be sacrificed for the good of the majority and that property should owned in common.” - Plato (427–347 BC ) Individualism – “Private property is more highly productive than communal property and will thus stimulate progress.” - Aristotle (384–322 BC ) 18

Overview of Economic Systems Major typesMain characteristicsNational differences Planned economy State control Collectivist ideology North Korea – highly authoritarian Cuba – some liberalization Liberal market economy Capitalist free market Individualist Democratic values Minimum government intervention US – free market model, but increased role of government UK – elements of social market models, belief in self regulation Social market economy Markets tempered by social values Democratic values Government welfare role Scandinavian – emphasis on social welfare, extensive state ownership Northern European – emphasis on social protections, state ownership in key sectors Mixed economy Capitalist elements Elements of state control Weak individualism China – strong state intervention, authoritarian political system India – market reforms under state guidance, democratic political system 19

Economic Transition Political System Economic System Democratic Totalitarian Planned Mixed Market RussiaChinaChile UK India Mexico Russia India Chile Mexico China UK 20