The market economy is also said to be a free-enterprises economy because the government restrictions on production and distribution are the least possible in such an economy. A capitalist economy is also called a free-market economy because supply and demand forces are allowed a free pay in the markets for factors as well as for products. This type of economy is also known as laissez faire economy because the government in this economy is supposed to intervene into the functioning of an economy only where it is must.
The economic problem is solved by the freely functioning price mechanism. The rise and the fall in the prices of products and factors of production in the markets give signals to the producers and consumers who respond to correct the disequilibria wherever they exist. If there is problem of unemployment that would be solve by reducing wage rate. If a particular commodity is in short supply, then its price will rise in induce producers to increase its output. On the other side, a surplus of a commodity will lead to a fall in its price thereby inducing its producers to contract its production. Thus, it was believed for a long time that a freely functioning price mechanism automatically solves the economic problem in the capitalist economy.
The functioning of capitalist economies for the last three hundred years has proved that a capitalist economy is unable to solve all the economic problems automatically. There are some instances of market failure where the price mechanism is unable to take the correct decisions from the society’s viewpoint. These instances of market failure are popularly known as ‘those goods’, ‘external effects’, ‘market imperfections’ and ‘distribution justice’. The government in a capitalist economy has to intervene in the markets to cover these points of market failure. Thus, the role of the government in a modern capitalist economy can be summed up in the following:
1) Supply of public goods
| Those goods and services such as roads, telephone, telegraph, defense, police and justice are called public goods and services. This is because these goods and services are supplied and consumed publicly. No private party will be prepared to build and supply these public goods at which people in general need it. In the capitalist economy, the government at reasonable cost provides these public goods. |
2) Management of the external effects
The government is required to tax those people who are in their private production or consumption inflict losses on the other people. Factory-owners, whose production spoils the air and water in the locality are taxed heavily. Similarly, those rich people who tend to make a vulgar show of their wealth are taxed and the proceeds of these taxes are given to the poor people. Further, the government builds health resorts and national parks for which the visitors are charged a toll tax. All these examples are those of external effects.
3) Corrective polity for market imperfections
The price mechanism can work properly only when the markets are competitive and work normally. But there are many imperfections in the market, which tend to go against the national interest.
Firstly, some firms try to build a monopoly to influence in the market through cartels and mergers or through secret understanding. In such cases, the government enforces its anti-monopoly laws to protect the consumers against exploitation.
Secondly, sometimes the speculators in the stocks markets or commodity markets tend to create panic in these markets, which disturbs their normal functioning. The government then partially or wholly bans the functions of these speculators to restore normalcy in these markets.
Thirdly, the association and unions in some markets are deliberately encouraged legally, protected to enhance the bargaining power of the working sections so that they are not exploited by their employers.
4) Public policies against unemployment
In a capitalist economy, there are serious problems of booms and depressions, unemployment and wastage of resources. Governments in capitalist countries are committed to following anti-inflation policies. These policies are of public works, fiscal measures and monetary management. Whenever the capitalist economy shows signs of slackness or stringency, the government comes forward to use the appropriate policies.
5) Redistribute policies
Governments in capitalist economies are also committed to the reduction of income inequalities to a socially tolerable level. The rich people are taxed heavily through tax on income, wealth or expenditure with a view to building large funds to be used for the welfare of the weaker sections. These payments to the poor made from funds obtained through taxation of the rich are called compensatory payments.
In short, the role of the government in a capitalist economy is of a regulatory and protective nature. The effort is to give the maximum of economic freedom allowable to producers and consumers.
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