Unit 1 - The Market System: Chapter 11: Mixed Economy

The Market System and The Mixed Economy

Learning Objectives

• Understand the difference between the public and private sectors.
• Understand how the ownership, control, and aims of private and public sector organizations differ.
• Understand what is meant by a mixed economy and how the problems of what to produce, how to produce, and for whom to produce are resolved.
• Understand market failure and why government intervention may be needed.
• Understand the role played by the private and public sectors in the production of goods and services, including public goods.
• Understand the relative importance of the public and private sectors in different economies.

Getting Started

• Goods and services are produced to meet consumer needs and wants.
• The way countries organize the choice, production, and distribution of goods varies.
• Some countries rely on privately owned businesses, while others rely more on the state.
• Most countries have a mix of state and private businesses providing goods and services.

The Public and Private Sectors

• Economy: A system that attempts to solve the basic economic problem of deciding what to produce, how to produce, and for whom to produce.
• Private Sector: Provision of goods and services by businesses owned by individuals or groups of individuals.
• Public Sector: Government organizations that provide goods and services in the economy.
• In the private sector, individuals are free to set up businesses and supply goods and services.
• In the public sector, organizations like government departments provide services that might be supplied inefficiently by the private sector.
• Public sector services like healthcare, education, and defense are often provided free and paid for by tax revenue or borrowing.

Private Sector Organizations

• Goods and services are provided by businesses owned and controlled by individuals or groups.
• Most consumer goods are provided by the private sector.
• Private sector enterprises vary in size and type of ownership:
  • Sole Traders: Owned and controlled by one person (e.g., retailers, plumbers).
  • Partnerships: Owned and controlled by two or more people working together (e.g., accountants, solicitors).
  • Companies: Owned by shareholders who elect a board of directors to run the business (found in various sectors like manufacturing and finance).

Ownership and Control in the Private Sector

• Most private sector businesses are small, including sole traders, partnerships, and small companies.
• A minority of businesses are large, including multinationals with operations worldwide.

Aims of Private Sector Firms

• Aims are determined by owners, with the main aim being to make a profit.
  • Survival: Initial aim for new firms or during difficult trading conditions (e.g., during the 2008-2009 recession).
  • Profit Maximization: Firms aim to make as much profit as possible, with dividends paid to shareholders.
  • Growth: Bigger businesses can reduce average costs by exploiting economies of scale. Growth benefits stakeholders like workers and managers, but may lead to reduced dividends.
  • Social Responsibility: Firms aim to please a wider range of stakeholders due to pressure from government, media, and other parties.

Public Sector Organizations

• Owned and controlled by local or central government.
  • Central Government Departments: Managed by teams or boards led by a government minister (e.g., Ministry of Defence, Department of Health).
  • Public Corporations/State-Owned Enterprises (SOEs): Government selects the people who run the organization and is responsible for key policies. They have a separate legal identity, can sue and be sued, and are state-funded. They can operate commercially with the aim of making profit.
  • Local Authority Services: Delivered by local councils, including recreation, emergency services, and housing, run by elected councillors.
  • Other Public Sector Organizations: Run by a trust or board led by an expert selected by a government body (e.g. BBC, Post Office).

Aims of Public Sector Organizations

• Different aims than the private sector; specific aims depend on the services provided.

  • Improving the Quality of Services: Using performance indicators to monitor quality (e.g., reliability and punctuality in the railway industry).
  • Minimizing Costs: Minimizing waste due to scarce government resources.
  • Allow for Social Costs and Benefits: Taking into account the needs of a wide range of stakeholders and externalities.
  • Profit: In some countries, governments own large businesses that aim to make a profit (e.g., Emirates Airline in the UAE).

Types of Economy

• Different economies have different approaches to providing goods and services.
• The type of economy varies according to the role played by the public sector.
  • Market or Free Enterprise Economy: Relies least on the public sector. Market forces determine resource allocation. The public sector provides a legal system, monetary system, key state services, and ensures competition (e.g., Singapore, Australia, USA).
  • Command or Planned Economy: Relies entirely on the public sector. All resources belong to the government, and the state is responsible for planning and coordinating production. (e.g., Cuba, Myanmar, North Korea).
  • Mixed Economy: Relies on both the public and private sectors (majority of countries).

The Mixed Economy

• Decisions about what to produce, how to produce, and for whom to produce are made by both consumers and the state.

  • What to Produce: Consumer goods are best provided by the private sector, while goods like education and roads are more likely to be provided by the state.
  • How to Produce: Private sector firms aim to maximize quality and minimize costs through competition. Public sector services are provided by government organizations.
  • For Whom to Produce: Private sector goods are sold to those who can afford them, while public sector goods are provided free to everyone and paid for from taxes.

Market Failure and the Need for Government Intervention

• Market failure occurs when markets lead to inefficiency.
  • Externalities: Firms may not take into account all the costs of production, such as pollution. External costs like poor air quality are imposed on society.
  • Lack of Competition: A market may fail if it is dominated by one or a small number of firms, leading to exploitation of consumers through higher prices.
  • Missing Markets: Public goods are not provided by the private sector.
  • Lack of Information: Markets are only efficient if there is a free flow of information to buyers and sellers.
  • Factor Immobility: Factors of production need to be mobile, but can be immobile in practice (e.g. specialized machinery).
• Government spending as a proportion of national income varies widely:
  • Singapore: $10.4\%$.
  • Ireland: $29.4\%$.
  • France: $57\%$.

Role of Government Intervention

• Businesses that impose externalities may be regulated or fined.
• Governments can use legislation to prevent businesses from dominating markets.
• State money can be used to provide public goods and merit goods.
• Legislation can force firms to provide more information about products.
• Retraining workers can help make factors more mobile.

Role of the Private and Public Sectors in the Production of Goods and Services

• The private sector is responsible for providing everyday goods and services.
• The public sector provides public services and focuses on the provision of public and merit goods.
• Public goods have two characteristics:
  • Non-excludability: Individuals cannot be prevented from consuming the good.
  • Non-rivalry: Consumption by one individual does not reduce the amount available to others.

Public Goods and Market Failure

• Governments have to provide public goods because of market failure.
• The private sector faces a free rider problem, where individuals benefit without paying.

The Public Sector and Private Sector in Different Economies

• The balance between public and private sector activity varies in different countries.
• Some countries have dominant public sectors (e.g., China, Hungary, Russia).
• Other countries favor greater private sector involvement (e.g., USA, Singapore, Australia).

Privatization

• Many economies have become more market-oriented.
• Privatization involves transferring public sector resources to the private sector.