Download The Role of Government in the Economy

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As Canada entered the 21st Century, government
involvement continued to attract controversy.
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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.
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Privatization and deregulation led to more economic
freedom and responsibility for individuals and groups.
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.
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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.
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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.
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So why do governments become involved in the operation
of the market?
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To answer this we have to further consider the writings and
theories of Adam Smith.
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He believed that the free-market system would channel
selfish, egoistic motives toward the betterment of society.
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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.
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He wrote about how the free-market will tend to allocate
resources to their most efficient use.
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For example, if you start a business and you are not
successful than that means that not enough consumers
want your product.
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If enough people buy your product you will earn a living,
your welfare increases and so does that of your customers.
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If you are successful at your business this will attract
competition.
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In order to continue to sell your product or service it will be
necessary that you make your good or service more
attractive.
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This can be done by lowering prices or improving the quality
of the product or service.
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Leading to the Great Depression some deficiencies lead to
more governmental intervention.
Market Imperfections
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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.
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Health standards, government building codes, Industry
Canada and Service Canada are designed to fill these gaps.
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.
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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*.
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In situations where natural monopolies arise 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…
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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.
 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.
 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.
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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.
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.
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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.
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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.
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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.
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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.
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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.
Price Ceilings
A price ceiling is a government imposed maximum price.
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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 floor is 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.
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Price elasticity of demand and supply determine the
incidence of tax, or who bears the larger burden of the tax.
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If the demand is more inelastic than supply than the
consumer bears the larger burden of the tax, and vice
versa.
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If the government wants to raise tax revenue it will tax a
product which has an inelastic demand.
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If the government wants to reduce consumption than it will
tax a product which has an elastic demand.