In medieval times, the aristocracy and town guilds directed much of the economic activity in Europe and Asia. However, about two centuries ago, governments began to exercise less and less power over prices and production methods.Feudalism gradually g”clearway to markets, or what we call the “market mechanism” or “competitive capitalism .

In most of Europe and North America, the nineteenth century became the age of laissez-Claire. This doctrine, which  translates as “leave us alone,” holds that government should interfere as little as possible in economic affairs and leave economic decisions to the private marketplace. Many governments espoused this economic philosophy in the middle of.
the nineteenth century.

Nevertheless, by the end of the century, the unbridled excesses of capitalism led the United States and the industrialized countries of Western Europe to retreat from full laissez-fairer. Government’s role expanded steadily as it regulated
monopolies, levied income taxes, and began to provide a social safety net with sup- . port for the elderly. This new system, called the welfare state, is one in which markets direct the detailed activities of day-to-day economic life while government regulates social conditions and provides pensions, health care, and other necessities for poor’ I families.

Then, around 1980, the tides shifted again, as conservative governments in ! many countries began to reduce taxes and deregulate government’s control over the . economy. Particularly influential was the “Reagan revolution” in the United States, which changed public attitudes about taxes and government and reversed the trends in U.S. federal spending on civilian programs. Even Democratic president William Clinton held that “the era of big government is over.” .Ii The most dramatic turn toward the market .’ came in Russia and the socialist countries of Eastern Europe. After decades of extolling the advantages of a government-run command economy, these countries scrapped central planning and made the difficult transition to a decentralized, market economy. China, while still run by the dictatorship of the Communist party, has enjoyed an economic boom in the last two decades by allowing competition tli operate within its borders.Developing countries like Taiwan, Singapore, and Chile have; enjoyed rapid income growth by embracing capitalism and reducing the role of government in their economies.

This capsule history of the shifting balance between state and market raises many questions. What exactly is a market economy, and what makes it so powerful? What is the “capital” in “capitalism”? What government ‘controls are needed .to make markets function effectively? Why do societies redefine the roles of government and market from time to time? The time has come to understand the principles that lie behind the market economy and to review government’s role in economic life.

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