1.1.5 The Mixed Economy
Mixed Economy Definition - Syllabus 1.1.5 (a)
Economy = System that attempts to solve the basic economic problem (What, how, for whom to produce?)
Mixed Economy = Economy where goods and services are provided by both public and private sectors.
Private enterprises and government control production means.
Government influences market forces through regulation and interventionist policies.
Capital resources reallocated based on need.
Main driver is profit, but governments use these to improve social mobility.
Free enterprise/market economy = Economy where most goods and services are provided by the private sector.
Managed by the people.
Resource allocation based on market forces (supply/demand)
Public sector limited to providing legal/monetary system to ensure inter-business competition exists.
Businesses decide what to produce based on supply, demand, and free enterprise (price).
Businesses decide how to produce goods/services.
Goods/services produced for consumers.
NO PURE market economies, but USA is close to this.
Command/planned economy = Economy where goods and services are entirely chosen, produced, distributed, organized, and coordinated by the public sector.
Government makes all decisions about what to produce, how to produce, and who goods/services will be distributed to.
Communist governments have command economies.
NO PURE command economies, but North Korea, former Soviet Union, and Cuba are close to this.
Pros: Government inspected goods/services, people have jobs, more people might receive services.
Cons: Government does not have competition, usually poor-quality goods/services, goods/services are not necessarily what consumers want.
Private & Public Sector Definition - Syllabus 1.1.5 (b)
Private Sector = Provision of goods/services by businesses owned by individuals or a group of individuals.
Usually more efficient and better customer service; bad service → out of business
Public Sector = Provision of goods/services by government organizations.
Usually less efficient and worse customer service; bad service → no consequence (they still get money/subsidies from government taxes)
Provision = Act of providing something
Private & Public Sector Ownership, Control, & Aims - Syllabus 1.1.5 (c)
Private Sector Ownership & Control:
Most consumer goods (e.g. durables and groceries) are provided by the private sector.
Durables = Products intended to have a 3+ years shelf life.
Groceries = Food/other goods sold by a grocer or supermarket.
Grocer = Person who sells good and small household goods.
Supermarket = Large self-service (customers select goods independently and pay at checkout) shop selling food and other household goods.
Sole trader = Business owned/controlled by 1 person who has 100% full control but has not filled legal paperwork to be a “company”. E.g: handyman, taxi driver, plumbers, etc.
Partnership = Business owned/controlled by 2+ people working together, they’re often found in professions. E.g: Dentists, lawyers, architects, etc.
Profession = Careers requiring high levels of education/training.
Companies = Business owned/controlled by shareholders which each have a certain amount of control over activity. A board of directors can be elected to run the business on their behalf. E.g: Manufacturing, construction, public transport, media, financial services, oil/gas, pharmaceuticals, engineering companies, etc.
Shareholders = People/organizations that own shares. Shareholders are entitled to company profits in the form of dividends and they’re also the bearer of company losses.
Share = Represents a unit of equity ownership in a company.
Dividend = Part of a company’s profit divided among its shareholders.
Private Sector Aims (Hierarchy):
Survival; To “survive” and not go bankrupt despite unexpected difficulties, global recession, etc.
Recession = Period of temporary economic decline where trade/industrial activity like economic output, employment, consumer expenditure, etc, is reduced.
Profit maximization; Companies pay shareholders dividends. Shareholders want dividends to be as high as possible → main aim of profit maximization. Some firms are content to make just enough profit to satisfy owners/shareholders because they don’t want to take extra responsibility of growth and are happy with satisfactory profit.
Growth; Bigger businesses → ↑ future profit, securing jobs for workers/managers/directors. Profit needed to finance growth, shareholders may not like this as it can lower dividends.
Social responsibility; Firms may aim to please a wider range of stakeholders due to pressure from governments, media, environmentalists, local residents, consumers, and other interested parties.
Public Sector Ownership & Control:
Central Government Departments = Departments controlled by teams/groups led by the government minister or chief executive. E.g: HK Department of Health, Department of Water, etc.
Public Corporations or State-Owned Enterprises (SOEs) = Governments often select a board of directors to run the organization on its behalf.
Government responsible for key policies.
Usually a separate legal identity; they can sue, be sued, and sign contracts under their own name.
Sue = Make a legal claim against someone for them to give you a certain amount of money because they’ve harmed you in some way.
Provides under-allocated goods/services in the economy.
State-funded (all capital is government-provided), all assets and liabilities belong to the state.
Assets = Things/resources belonging to an individual or a business that has value or the power to earn money.
Liabilities = Amount of debt owed or that must be paid.
Can borrow money and re-use revenue from sales of goods/services.
Usually has country name in company name. E.g: Bank of China
Local Authority Services = Councillors elected by local community residents run local authorities, they’re delivered by local councils, including recreation (e.g. sports facilities), emergency services (e.g. fire/police services), housing (e.g. council housing and facilities for the homeless), etc.
Other public sector organizations = Run by a trust/board led by an experienced expert selected by a government body, queen/king/monarch following government advice, etc. E.g: BBC.
Public Sector Aims:
Improving service quality; performance indicators like reliability, professionalism, levels of customer service, speed of service, etc, can be used to monitor quality.
Minimizing costs; Scarce government resources → efficiency and lean production is encouraged/aimed for.
Allow for social costs and benefits; profit ≠ main aim → public sector organizations consider the needs of a wide range of stakeholders.
Stakeholders = Individuals/groups considered an important part of an organization or of society because they have responsibility within it and receive advantages from it.
Profit; In some countries (e.g: Emirates Airline, Dubai World), the government owns numerous profit-aimed businesses.
Mixed Economy & The Economic Problem - Syllabus 1.1.5 (d)
What to produce?
Consumer goods best produced by private sector and dictated by market demand.
Public/merit goods (e.g: education, street lighting, national defense, etc) are under-provided by private sector due to market failure so are best provided by the public sector.
Sectors classified based on processes involved in goods/services’ production:
Primary sector = Economic sector involved in extraction/harvesting of natural products and raw materials. Involves mining, quarrying, fishing, agriculture, foresting, hunting, etc.
Secondary sector = Economic sector involved in processing/manufacturing to produce goods from raw materials obtained by primary sector. Involves automobile production, textiles, chemical engineering, shipbuilding, energy utilities, etc.
Tertiary sector = Economic sector involving services (e.g: retailers, entertainment firms, financial organizations). Provides services to businesses and consumers by selling goods manufactured in the secondary sector. It involves retail sales, transportation, banking, etc.
Quartenary sector = Economic sector including intellectual services (technological advancement/innovation). Involves collecting information and turning it into something useful by research/development, information technology, education, consulting services, etc.
How to produce? (managed by economies)
Private sector → use methods to maximize quality and minimize costs.
Public sector → aims to supply public/merit goods efficiently, but private sector may be better at carrying out work (e.g: motorway construction).
For whom to produce?
Sectors classified based on who is providing the good/service and who it’s produced for:
Private sector → Anyone who can afford the goods/services, market system does allocation.
Public sector → Free to everyone and paid from taxes; unemployed (due to illness/disability) people receive social care and/or financial benefits.
Market Failure - Syllabus 1.1.5 (e)
Market Failure = Where markets lead to inefficiency due to waste, under-allocation, or over-allocation of goods/services (not providing optimal amount of a good/service).
Factors causing market failure (use MELLF acronym):
Missing markets: Public goods are not provided by the private sector because they’re non-excludable, non-rivalrous, and thus not profitable. Merit goods (e.g. education, healthcare) are under-provided by the private sector because they’re expensive and not affordable by everyone.
Externalities: Only production costs from resources (e.g: capital, land, labour, electricity, rent, etc) are considered. External costs imposed on others/society are not considered.
External cost = Damage done to other parties outside the business that are not part of the economic transaction.
Transaction = Instance of buying/selling something.
Lack of competition → 1 or few dominant firm(s) → Dominant firm(s) may exploit customers by charging higher prices or limiting consumer choices.
Lack of information → Consumers don’t always know everything about the product (other prices or product qualities) and producers don’t have all the information either (other resources or alternative production techniques) → Wrong goods may be purchased and/or wrong prices may be paid.
Factor immobility (production factors cannot move freely from 1 use to another) → inefficiency/wastefulness.
E.g: Glass making factory for phones close down and laser machine designed for cutting glass machine has no further use → machine destroyed → wasteful → inefficient
Government Intervention to Market Failure - Syllabus 1.1.5 (f)
Governments may need to intervene to market failure to correct inefficiency/failure associated with public goods, externalities, and/or imperfect competition.
Missing markets → Government use taxes to subsidize provision of public and merit goods; public sectors provide these goods free of charge because they’re important for everyone’s wellbeing.
Externalities → Government will regulate (closely control) or fine firms creating negative externalities.
Lack of competition → Governments can use legislation to prevent firm(s) from dominating markets, ensuring competition, and monitoring/controlling price changes. They can also investigate whether a merger is in consumers’ interest and block the merger(s) if they are not.
Legislation = Law or set of laws.
Merger = 2+ companies/organizations join or merge together to form a larger company.
Lack of information → Governments can pass legislations to force firms to provide more information about their products. However, the internet has improved information flow during recent years.
Factor immobility → Governments can help make some factors (labour) more mobile, such as retraining workers when their previous jobs become redundant. However, little can be done to avoid waste of machinery, capital, and/or perishable resources.
Redundant = No longer needed/useful.
Public Goods - Syllabus 1.1.5 (g)
Public Goods = Goods not provided by the private sector because it’s non-excludable, non-rivalrous, and therefore not profitable.
Merit goods = Goods under-provided by the private sector which would provide external benefits. E.g: education, healthcare, housing, etc.
Demerit goods = Goods that would cause harm and external costs upon your private benefit/consumption. i.e. your private benefit from consuming a demerit good → harm to a 3rd party. E.g: tobacco, alcoholic beverages, drugs, etc.
Non-excludability = Once the public good is provided to the market, consumers cannot be prevented or excluded from consumption, but they also cannot refuse consumption of the good even if they wanted to. E.g: parks, fire security services, police, national defenses, etc.
Non-rivalrous = Where consumption of a public good of an individual does not reduce the amount of the public good available to others (consumers do not need to compete for consumption of the good). E.g: streetlights, lighthouse, etc.
Free rider problem = Problem mainly caused by non-excludability and non-rivalry. It would occur if public goods were provided by the private sector. Individuals are not excluded from public good’s benefit → can consume good without paying → little reason to pay for it → free riders enjoy a good’s benefit but allows others to pay for it (shared resources have burdens created by its use or overuse by people who aren’t paying their fair share to contribute to the resource or aren’t paying anything at all) → no profit incentive for private sector → government provides public goods instead (assuming the government has enough money)
Private & Public Sector Production Roles - Syllabus 1.1.5 (h)
Private sector → Responsible for providing consumer goods/services like food, clothes, durables, groceries, entertainment, holidays, electrical goods, cars, personal household services, etc.
Public sector → Responsible for providing merit goods and public goods that are under-provided by the public sector as it’s virtually impossible for private firms to charge users for their consumption as public goods are non-excludable and non-rivalrous.
Private & Public Sector Relative Importance in Different Economies - Syllabus 1.1.5 (i)
Balance between private and public sector activity varies depending on the country.
Some countries have the public sector (government) play a key role in providing public services like healthcare, education, infrastructure, etc, whilst simultaneously owning large commercial organizations like banks, airlines, etc.
E.g: China, Hungary, Russia, Sweden, UAE (United Arab Emirates)
Some countries have greater private sector activities with less involvement of the public sector during provision of goods and services.
E.g: USA, Singapore, Australie, etc.
Recently, many economies become more market-oriented due to privatization.
Privatization = Company or activity controlled by the government is sold to private investors, often because the government no longer wants to be responsible for managing it.
Privatization Definition, Forms, & Causes - Syllabus 1.1.5 (j)
Privatization = Act of selling a company/activity controlled by the government to private investors. It involves transferring public sector resources to the private sector.
Forms of privatization (Use SSC acronym):
Sale of nationalized industries: Nationalized industries (e.g. British Rail) may have been natural monopolies and serve consumers more efficiently under state control. Though they may be sold off to become private businesses again owned by shareholders of the private sector.
Nationalization = Process of private sector industries, companies, or assets being transferred to the public sector and taken into state ownership under government control.
Natural monopoly = Situation where 1 firm in an industry can serve the entire market efficiently with lower production costs than what would be possible if the industry was composed from many smaller firms.
Monopoly = Situation where a business activity is controlled by only 1 company or by the government, and other companies do not compete with it.
Sale of land and property: For example, people renting local, council-owned properties may be given the right to buy their own homes → Council-owned houses sold to private individuals.
Contracting out = To formally agree you will not take part in something.
E.g: Governments and local authority services contract out of providing school meals, hospital cleaning, refuse collection, etc → This can now be controlled by other private sector businesses (hence why contractors are given changes to bid for public sector services).
Causes of privatization (Use RIG acronym):
Reduce political interference:
Excess/constant government interference → Firms (especially nationalized industries) may be unstable and their performance could be limited or held back.
Privatization → Firms in private sector → not used by government for political aims → free to choose own investment levels, prices, product ranges, growth rates, etc.
Inefficiency in public sector:
Nationalized industries are state-funded by government subsidies (usually from taxes) → no profit incentive (bad customer service → no consequences on them as they still get revenue from the government) → Losses and poor-quality goods/services.
Incentive = Something used to motivate/encourage someone to do something, especially to make them work harder, produce more, or spend more money.
Private sector more accountable (customer needs not met → ↓ consumers → ↓ revenue and ↓ profit → bankruptcy, assuming there was market competition) → Private sector more likely to be efficient, cut costs, improve services, and return profit to shareholders.
Bankrupt = Declared in law as unable to pay your debts due to lack of money.
Debt = Amount of money owed/due.
Generate income: Sale of state assets by privatization → Generates income for the government. The revenue can be used in addition to taxes to fund more economic activities.
Effects of Privatization - Syllabus 1.1.5 (k)
Privatization affects consumers, workers, businesses, and governments.
Effects on consumers:
↑ Competition between businesses → ↑ Efficiency, ↑ quality products, ↑ customer service, ↓ prices, ↑ choices, etc.
OR ↓ Competition between businesses (mergers, takeovers, monopolies) → ↑ prices, ↓ choices, etc.
↑ Subsidies needed from government by private sector businesses → ↑ Taxes needed to be paid to fund ↑ government expenses.
↑ Production cost for firms (even if they receive subsidies from the government) → ↑ selling price for goods/services.
OR Businesses will cut cost for lean production → Potentially ↓ Selling price (depending on firms’ priorities)
Effects on workers:
Successful privatization → ↑ Wages to incentivize workers to be more productive (depends on firm’s culture and if they are willing to share the profit)
Many workers may be made redundant → ↑ job losses (depending on their productivity) → ↓ labour cost but ↑ unemployment → ↓ experienced staff members → weaker companies, and ↑ difficulty as well as ↑ expensiveness for future business growth.
↑ Job losses → ↓ employees → Employees are forced to increase productivity and efficiency → forced to adopt more flexible working practices → potentially ↑ working hours.
Effect on businesses:
No government interference (objectives can switch to profit maximization) but must face competition
↑ Competition →
↑ Efficiency (good for large firms) → ↓ Cost → ↑ Profit → ↑ Investment money (especially for mergers/takeovers)
Small firms have ↓ profit (↑ mergers/takeovers/larger firms dominate) → ↓ investment
Business objectives change (main aim usually becomes profit maximization)
↑ Investment
↑ Takeovers and ↑ mergers
Takeover = Act of gaining control of a company by buying over 50% of its shares.
↑ Diversification into new areas.
Diversification = When a company/economy increases the range of goods/services it produces.
↓ Subsidies from government (compared to when it was state-funded and state-owned) → ↑ production costs
Effect on governments:
↑ Revenue
↑ Cost to privatize as ↑ Money spent on advertising privatization sales, bankers, lawyers, etc → expensive and criticized (because tax payers’ money was spent on TV advertisements for privatization sales rather than on something more useful)
Some state assets sold off too cheaply → Revenue not maximized (won’t generate as much initial revenue, and may lose future revenue if values rise in the future)
Government not responsible for newly-privatized companies’ losses and affairs → Can focus more on other governmental affairs
No more control over the firm.
Too many hostile takeovers of state-owned companies.
Hostile takeover = Takeover where the company being taken over does not want or agree to do so.
Trade union = Organization representing people in a particular industry or profession that protects their rights.
Wage VS Salary:
Wage = Money usually paid for part-time workers on an hourly/daily/weekly basis.
Salary = Money usually paid for full-time workers on a monthly/annually basis.