Mixed Economic System
Chapter 15
Mixed Economy
Combination of the features of a
planned and a market economy.
Some firms are privately owned and
some are government owned.
Some prices are determined by market
forces of demand and supply and some
are set by govt.
Both consumers and govt. influence
what to produce.
Benefits of government intervention
Consider all costs and benefits
Encourage the consumption of products that
are beneficial for the consumers.
Discourage the consumption of products that
are harmful for the consumers.
Govt. finance the production of the products
that can't be charged.
Govt. can prevent private firms from
exploiting consumers by charging high price.
Benefits of government intervention in
Mixed economy
• Government make maximum use of
resources.
•Devote more resources to capital goods.
•Govt. can help vulnerable groups.
Consider all costs and benefits
If the railway line and
station would not make
a profit in the private
sector, they would be
maintained by the state
if the benefit to society is
greater than the cost.
Encourage the consumption of beneficial products.
Discourage the consumption of
harmful product
Govt. finance the products that can't be charged.
Water Barrage
Defense
Prevent private firms from exploiting consumers.
Government make maximum use of
resources.
Devote more resources to capital goods
Power Plant
Water purification
plant
Govt. can help vulnerable groups.
Tribal People
Maximum and minimum prices
A government may limit firms’ ability to set their own prices by
imposing price controls.
They may set a Maximum Price (Price ceiling)
They may set a Minimum Price (Price floor)
Effect of a maximum price
It is done in order to enable the
poor to afford basic necessities.
It has to be set below the
equilibrium price, to have any
impact.
Problem: It will create shortage
situation.
Methods of product allocation:
Queuing
Rationing
Lottery
Effect of a minimum price
-To encourage production of a product
Govt. may set a minimum price.
-To have an impact on a market, it has to
be set above the equilibrium price.
-Problem: It will create surplus in the
market.
-To prevent the price being driven down,
the surplus has to be bought by the govt.
or some other official body.
Government Measures to address market
failure
Subsidies and indirect taxes
Competition policy
Environmental policies
Regulation
Nationalization and privatization
Direct provision
Unfairness
Effectiveness of government intervention
Subsidies and indirect taxes
Govt. taxes firms’ profit, which has an impact on the ability and
willingness of firms to invest.
Indirect taxes raise firms’ costs of production
Income tax lowers consumers’ disposable income, and as a
result demand for firms’ products.
Subsidies and indirect taxes
The effect of subsidy given to producers is influenced
by the size of the subsidy and the price elasticity of demand.
Subsidies and indirect taxes
The impact of a tax is again influenced by the size of the tax and the Price
elasticity of demand.
The higher the tax, the greater is its impact.
A tax on a product with inelastic demand would have a greater effect on
price than quantity sold
A tax on a product with elastic demand would have a greater effect on
quantity sold than price.
If govt. wants to raise revenue, it should tax products with inelastic demand as
the quantity sold will not fall by much.
If govt. wants discourage consumption of demerit goods, it will be more
successful if demand is elastic.
Competition policy
Prevention of mergers which will not be in the interest of
consumers.
Removal barriers to entry and exit into markets
Regulation of monopolies and prohibition of uncompetitive
practices( e.g predatory pricing and limit pricing)
Predatory pricing: Charging a price below the cost to drive a rival firm or
firms out of the market.
Limit pricing is setting the price low enough to discourage the entry of new
firms into the market.
Environmental policies
Govt. may place restrictions on the amount of pollutions emitted by
firms into the air, sea and rivers. It may then fine any firms which
exceed these limits.
They may issue tradable permits means allowing firms to pollute up
to a certain limit and to sell a part of their allocated limit, if they
pollute less.
Regulation
Govt. may regulate the target audience of a product, the quality of
products and mode of staff management by firms.
Problems of imposing regulations:
they do not compensate those who suffer as result of market failure
regulations may be too restrictive- reducing market flexibility and creating
barriers to entry.
Nationalization and privatization
To benefit the public and to improve economic performance, a govt. may set up
an industry or nationalize a private sector industry.
Industries owned by govt. are known as state owned enterprises, public
corporations and nationalized industries.
The chairman and board of managers are appointed by government. They are
responsible for the day to day management, but accountable to the government.
There are no shareholders in state owned enterprises. The funds come from the
government, from govt. approved loans and from the private sector.
State-owned enterprises do not always seek to make profit. Their prime aim is to
work in the public interest.
Advantages of SOE
They base their decisions on the full costs and benefits involved.
They can be used to influence economic activity. To boost the country’s output,
public corporations can be directly encouraged to increase their output.
In cases where is practical to have only one firm in the industry, such as rail
infrastructure, a state –owned enterprise would not abuse its market power.
Ownership of whole industry by the govt. makes planning and coordination
easier.
It is important to ensure that basic industries, such as electricity and transport,
survive, charge low price and produce good quality, as other domestic industries
depends on them.
Disadvantages of SOE
They can be difficult to manage and control.
They may become inefficient.
They will need to be subsidized if they are loss making.
Private Sector
Private sector firms are likely to produce the products desired by
consumers, at a low cost and offer them low prices.
High quality, greater choice
Freedom from govt. regulations may reduce administration costs
and enable managers to respond quickly to changing conditions.
There may, also, be less risk of under-investment in the private
sector.
Privatisation
Selling of state owned asset including
SOE to private sectors can rise revenue.
Comparison of Expenditures by Public and
Private sectors
A new Air port could be build by the Private or public sector:
Private sector
Public Sector
Private sector
Advantages:
Profit incentive and force of competition will work
High quality
Low cost
Less time consuming
Disadvantages:
monopoly firm will not keep the costs down and will charge high price
They’ll consider only private costs and benefits
Public Sector
Advantages:
CBA will be done: CBA means Cost Benefit Analysis. It is a method of assessing
investment project which considers social cost and benefit.
Private Benefit: Big investment, revenue.
Private costs: Land, Labour, Materials needed, maintenance
External benefits: Employment, tourism, more attractive as a site for domestic firms and
MNCs.
External costs: Environmental damage, noise pollution, risk of accidents, congestion
near the airport etc.
Decision:
If, SC>SB then Govt. will not proceed with the project
If, SB>SC then Govt. will proceed with the project
To decide whether private sector will do the project or public sector we have to
consider the opportunity costs also.
Direct Provision
Most governments produce at least some goods and services that they think are essential.
Such as Housing, education and healthcare and also other merit goods.
Unfairness
Effectiveness of Govt. intervention
Cost benefit analysis (CBA)
A method of assessing investment projects which takes into
account, social costs and benefits.
Multinational companies (MNCs): companies which produce in
more than one country