why is it a good idea that the government should not interfere with the economy?

Question

why is it a good idea that the government should not interfere with the economy and be left to natural forces?

Answer 1

Meg, on this issue, I would beg to differ.

The only time a government should ever interfere with a market is when there is a market failure. If there is no market failure, then the market is already operating at the socially optimal equilibrium, and any government interference will only move the market away from social equilibrium, and make society worse off as a whole.

A market failure typically results only in situations that involve externalities. Externalities can come in two forms: negative externalities (external costs) and positive externalities (external benefits).

An external cost would be something like pollution. If a factory moves next to a farm and begins to pollute on a pollution-per-unit basis, the farm is worse off (due to the pollution) for each additional unit produced in the factory. The factory produces the optimal amount of whatever unit it produces given its own costs, while ignoring the costs it creates for the farmer. When looking at the bundle of goods produced by the factory and the farmer, it is not the social equilibrium because production is not being based on all the costs combined. A solution would be for a private entreprenuer to enter the area, purchase both the farm and the factory, and force the factory to produce at the socially optimal output level (where the cost of pollution is factored into the factory production). This is called "internalizing the externality." Another solution would be for the government to tax the factory for every unit produced, thereby lowering production, hopefully the the socially optimal level.

The problem is, government interference is only good if it improves the situation, which is not always the case. Firstly, it is very difficult for the government to find out what the optimal tax should be: the farmer will probably lie to the govt, overstating his costs from pollution (demanding a higher tax on the factory), and the factory will probably lie, understating its external costs to the farmer (to get a lower tax rate). If the government overtaxes, society could be even worse off than before! Secondly, every time the government uses resources or collects a tax, money is "lost" (in terms of gets funnelled out of the market) in the form of administrative and buerecratic costs.

Similar market failures and similar government interference failures can occur in the case of external benefits, just in reverse (with subsidies).

As you can see, the probability that the government will improve is already very small, and that's assuming the government correctly identifies the social optimum, which is hard to do in and of itself. It is this reasoning that leads people to think that the government should avoid market interference except in rare scenarios.

Answer 2

Government does interfere with the economy. There are taxes, price supports, subsidies, and many laws to help improve one groups control of the economy over another.

Answer 3

Most economist do not think it is a good idea. They only argue about how much interference is necessary. I have not heard anyone suggest that banks should not be regulated, or that the Fed should not have provided liquidity to the financial markets during the recent problems on Wall Street.