The Australian Economic System

The Role of Government

In a perfectly competitive market there would be no government intervention, but this could lead to inefficiencies. For this reason, we allow the government to intervene in the economy on our behalf. Although people do complain about the actions of the government from time to time, the truth is that living standards would be lower without them.

Broadly speaking, the government will perform three main roles in the Australian economy.

Stabilisation

The economy moves through a series of phases, and each has its own problems. For example, during a recession many people will lose their jobs, and when the economy is booming it is likely that we will see prices increase faster than incomes. One of the functions of the government is to “smooth out” the fluctuations in the business cycle so that these problems do not affect us as badly as they otherwise would.

For example, in the second half of 2008 it became apparent that the global economic downturn was going to affect Australia, and as a result unemployment would increase. At the time, it was predicted that unemployment in this country could peak at 10% during 2009. The government intervened by providing a fiscal stimulus package. In other words, they injected money into the economy by spending a lot more than they normally would. This helped to achieve the goal of minimising the increase in unemployment, as during 2009 the rate peaked below 6%.

Allocation

Street lights are public goods If left to operate without intervention, it is possible that we would make some bad decisions about the way in which resources should be allocated. For example, it is unlikely that anyone would think to provide street lights – we can’t charge people when they use street lights, and so we can’t make a profit from them. This is an example of a public good; the government supplies public goods because there is no opportunity for a private operator to profit from them. The strict definition of a public good is that it is non-excludable (you can’t stop someone from using it even if they don’t pay) and non-rivalrous (when one person uses the product, it doesn’t stop someone else from using it later). Roads, the defence force and beaches are all examples of public goods.

The government will also act to make sure that we have access to certain essential goods and services. For example, although there are private hospitals and schools, we don’t have enough of them to make sure that everyone who needs access can be assured of getting in. These are known as merit goods; they are in high demand, but they are under-supplied by the free market. The government steps in to make sure supply is sufficient.

It is also true that we tend to over-allocate our resources to some products that are not good for us. For example, if the government did not intervene we would spend a lot more money on cigarettes and alcohol. These products have dangerous side-effects, and so the government places a tax on these items to make them more expensive. As a result, we don’t buy as many of them, which means that producers don’t need to make as many of them. The resources can therefore be used to make other things.

Distribution

It is also true that a freely operating economy could result in a great deal of inequality. Some people might find that they are able to earn very high incomes, while others might not be able to earn an income at all.

If this problem is not solved, then the people who are unable to earn an income will be forced to resort to extreme measures in order to survive. A person who is desperately poor might even choose to commit crimes (such as theft) in order to feed themselves each day. Even those who are able to find enough food to eat could end up expressing their frustration in other ways, such as vandalism.

The government can help to overcome this problem by redistributing the income that flows into the economy. High income earners must pay a higher rate of income tax. This is known as the progressive income tax system. On the other hand, low income earners are more likely to be given access to welfare payments. In this way the gap between high and low income earners is minimised.

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