1 Role of the Government in the Economy Name Institution Course Instructor Due Date ROLE OF THE GOVERNMENT IN THE ECONOMY 2 The objective of this post is to discuss the three competing economic theories; Supply-side economics, Keynesian economics and laissez-faire economics on the role of the government in the economy. Laissez-faire theory in economics advocated for a free market system characterised by zero or minimal government intervention. It coincided with the classical economics theory which argued that the economy operates best when forces of demand and supply are left to correct their disequilibrium (Naggar, 1977). The prices of goods and services adjusted on their own naturally led to stabilisation. The assumption was that individuals are rational and are able to self-regulate themselves. Therefore, producers and consumers should be left to freely conduct their activities in the market. The criticism of this theory from Keynes was that some variables such as prices and wages were rigid and did not automatically adjust to changes in the market. The second problem with this theory was that the idea of natural forces adjusting to equilibrium was only applicable in the long run leaving the adverse effects in the short run (Vaggi, 1996). Keynesian theory was founded on criticisms of the classical and laissez-faire ideology. It was especially crucial during the great depression period and financial crisis when classical thought failed to address the problems. Keynesian economics argued that to cater for these shortrun economic problems, the government needed to play a crucial role through fiscal and monetary policies in promoting consumption and investment in the economy (Jahan et al., (2014). According to Keynes, consumer demand was dependent on income which was not at full employment level. the criticism was that government intervention caused budget deficits that led to crowding out effects in the private sector thereby increasing the interest rates, cost of borrowing, reducing investments and finally decreasing economic growth. ROLE OF THE GOVERNMENT IN THE ECONOMY 3 Supply-side economics was based on the aggregate supply side of the economy. It postulated that economic growth could be achieved through the promotion of production and investment from the producer’s side of the market by government intervention (Canto et al.,2014). It was founded on the Laffer curve theory which established a relationship between taxes and government revenue. Tax reduction caused increased investment job creation and increased output which allowed governments to collect more revenue. In the USA, this theory was criticised during the 1980s since it did not necessarily lead to expected levels of economic growth. In Japan when employed on the Abenomics project, it led to the depreciation of the Japanese yuan. ROLE OF THE GOVERNMENT IN THE ECONOMY 4 References Canto, V. A., Joines, D. H., & Laffer, A. B. (2014). Foundations of supply-side economics: Theory and evidence. Academic Press. Jahan, S., Mahmud, A. S., & Papageorgiou, C. (2014). What is Keynesian economics. International Monetary Fund, 51(3), 53-54. Naggar, T. (1977). Adam Smith's laissez faire. The American Economist, 21(2), 35-39. Vaggi, G. (1996). Adam Smith and the economic policy of laissez-faire. History of Economic Ideas, 107-147.
