The operative choice is not between an unhampered free-market economy
and a fully centralized command economy. It is rather the choice of which
mix of markets and government intervention best suit people’s hopes and
16.1 Basic Functions of Government
Monopoly of violence: violent acts can be conducted by the military and the
civilian police arms of government, and through its judicial system the
government can deprive people of their liberty by incarcerating them or by
o When the government’s monopoly of violence is secure and functions
with effective restrictions against its arbitrary use, citizens can safely
carry on their ordinary economic and social activities.
A related government activity is to provide security of property.
Institution building: official assistance given to developing countries in the
form of political assistance rather than economic assistance.
16.2 The Case for Free Markets
The case for free markets has been presented in two different approaches:
o “Formal defence”
Based on the concept of allocative efficiency.
In essence, if all markets were perfectly competitive, and if
governments allowed all prices to be determined by demand
and supply, then price would equal marginal cost for all
products and the economy would be allocatively efficient.
o “Informal defence”
Based on three central arguments:
Free markets provide automatic coordination of the
actions of decentralized decision makers.
o The decentralized market system is more flexible
and adjusts more quickly to changes (i.e. change
in price of oil; different consumers will reduce
their consumption in different ways)
o As conditions continue to change, prices in a
market economy will also change, and
decentralized decision makers can react
continually (government quotas, allocations etc.
are more difficult to adjust).
o A market system allows for coordination without
anyone needing to understand how the whole
system works (i.e. dairy farmer example).
The pursuit of profits in free markets provides a
stimulus to innovation and rising material living
standards. o New products and techniques will be devised to
adapt to shortages, gluts, and changes in
consumer demands and to exploit new
opportunities made available by new
o In a market economy, individuals risk their time
and money in the hope of earning profits.
o Planners in more centralized systems have to
guess which innovations will productive and
which goods will be strongly demanded.
o The biggest failure of centrally planned
economies was their inability to encourage the
experimentation and innovation that have been
proven to be the driving forces behind long-run
growth in advanced market economies.
Free markets permit a decentralization of economic
o A free-market economy tends to decentralize
power and thus requires less coercion of