The states role in capitalist and socialist economies

Definition of capitalism
Capitalism is defined as an economic system in which the means of
production and industry are owned and controlled by the private
individuals or corporations for profit also know as free market economy
or laisser-faire economy.
Under this political system, there is minimal government interference in
the financial affairs, the key elements of a capitalistic economy are
private property, the salient features of capitalism are as under:
• Factors of production are under private ownership. They can use it in a
manner they think fit, although the government can put some
restrictions for public welfare
• There is freedom of enterprise, i.e. every individual is free to engage in
the economic activity of his choice
• The gaps between haves and have-nots are wider due unequal
distribution of income
• Consumer sovereignty exists in the economy, i.e. producers produce
only goods that are wanted by the customers
• Extreme competition exists in the market between firms which uses
tools like advertisement and discounts to call customers attention
• The profit motive is the key component; that encourage people to
work hard and earn wealth
Definitions of Socialism
Socialist economy is defined as an economy in which the resources are
owned, managed and regulated by the state, the central idea of this
kind of economy is that all the people have similar rights and in this
way each and every person can reap the fruits of planned production
As the resources are allocated, in the direction of the centralized
authority that is why it is also termed as command economy or
centrally planned economy..
Under this system, the role of the market forces is negligible in deciding
the allocation of factors of production and the price f the product.
Public welfare is the fundamental objective of production and
distribution of products and services.
The following are the salient features of socialism:
• In socialist economy, collective ownership exists in the means of
production that is why the resources are aimed to utilize for attaining
socioeconomic goals
• Central planning authority exists for setting the socioeconomic
objectives in the economy, moreover the decisions belonging to the
objectives are also taken by the authority only
• There is an equal distribution of income to bridge the gap between
the rich and poor,
• People have right to work, they cannot go for the occupation of their
choice as the occupation is determined only by the authority
• As there is planned production, consumer sovereignty has no place
• The market forces do not determine the price of commodities due to
the lack of competition and absence of profit motive
Key differences between Capitalism and socialism
the following are the major differences between socialism and capitalist
• The basis of capitalism is the principle of individual rights. Whereas
socialism is based on the principle of equality
• Capitalism encourages innovation and individual rights whereas
socialism promotes equality and fairness
• in the socialist economy, the resources are state-owned.but in the case
of capitalist economy the means of production are privately owned
• in capitalism, the prices are determined by the market forces and
therefore the firms can exercise monopoly power by charging higher
prices conversely in socialism government decides the rates of any
product which leads to shortages
• In capitalism, the competition between firms is very close, whereas in
socialism there is no competition because the government controls the
market
• In capitalism there is a large gap between rich classes and poor
classes because of unequal distribution of wealth. As opposed to
socialism where there is no such a gap
• in capitalism, every individual works for own capital accumulation,
but in socialism the wealth is shared by all people equally
• In capitalism, the efficiency is higher as compared to socialism
because of the profit incentive that encourages the firm to produce
such products that are highly demanded by the customers, whereas
in socialism, there is lack of motivation to earn money which leads to
inefficiency.
Capitalism and socialism differ in terms of
• Ownership
• Equity
• Efficiency and
• employment
Classical perspectives on capitalism
Smith and Ricardo
One of the key authors who wrote about capitalism is Adam Smith, though
he did not use word capitalism per se, smith devised set of concept that
remains strongly associated with the capitalism today
The invisible hand
• The core of smith’s thesis was that human’s natural tendency towards
self interest results in prosperity
• Smith argued that by giving everyone freedom to produce and exchange
goods as they pleased (free trade) and opening the market up for
domestic and foreign competition, people’s natural self interest would
promote greater prosperity than with strict government regulations
• Smith believed that humans ultimately promote public interest through
their every day economic choices. The free market economy become
known as invisible hand, but it need support to bring about its magic
Elements of prosperity according to Smith
• Smith believed that nations needed the following
three elements to bring about universal prosperity
1. Enlightened self-interest
Smith wanted people to practice thrift (quality of using money and
other resources carefully), hard work, and enlightened self-interest.
He thought the practice of enlightened self-interest was natural for
majority of the people
He gave an example: a butcher does not supply meat based on good
heartened intentions, but because he profits by selling meat, if the
meat he sells is poor he will not have repeat customers and thus not
profit. Therefore it is in the butchers self-interest to sell good meat at
a price that customers are willing to pay so that parties benefit in
every day transaction.
2. Limited Government
Smith saw the responsibilities of the government being
limited to the defence of the union, universal education,
public works (infrastructure such as roads and bridges), the
enforcement of legal rights (property rights and contracts)
and the punishment of crime. the government would step
in when people acted on their short-term interests, and
would make and enforce laws against robbery fraud and
other similar crimes
3. Solid currency and free market: The third element smith
proposed was solid currency twinned with free market
principles. By backing currency with hard metals smith hoped
would curtail the governments ability depreciate currency by
circulating more of it to pay for war or other wasteful
expenditure,
• with hard currency acting as a check to spending, smith wanted the
government to follow free market principles by keeping taxes low and
allowing free trade across borders by eliminating tarrifs. He pointed
out that tariffs and other taxes only succeeded in making life more
expensive for the people while also stifling industry and trade
abroad.
Ricardo Perspective on capitalism
• He developed the law of comparative advantage, which aimed to
explain why it is profitable to parties to trade even if one of the two
partners is more efficient in every type of economic production
• He argued that a country boosts its economic growth by focusing on the
industry in which it has the largest comparative advantage.
• For example, Somalia was able to manufacture cheap milk, and Ethiopia
can produce cheap coffee, Somalia would stop producing coffee and
Ethiopia would stop producing milk.
• the theory of comparative advantage become the bases of free trade,
he argued that specialization and free benefit all partners
Absolute advantage and Comparative advantage
A country has an absolute advantage in producing goods over another
country if it uses a fewer resources to produce that good. Absolute
advantage can be the result of country’s natural endowment. For
example, extracting oil in Saudi Arabia is pretty much just a matter of
drilling a hole while USA has one of the largest farmland around the
world, they can produce easily corn or wheat
• Comparative advantage when a good can be produced at lower cost
in terms of other goods
• An example: imagine a world where there are only two countries
Saudi Arabia and United States, and two products OIL and corn,
assume that consumers of both countries desire both goods
• there are available resources to both countries: labour hours. Suadi
Arabia can produce oil with fewer resources and US can produce with
fewer resources
COUNTRY OIL (hours per barrel) Corn (hours per bushel)
Saudi Arabia 1 4
USA 2 1
Production possibilities before trade

Saudi Arabia has an absolute advantage in the production of oil because

it only takes an hour to produce barrel of oil compared to two hours
in the united states. The united states has an absolute advantage in
the production of corn
• To simplify lets say Saudi Arabia and the united states each have 100
worker hours see table 2 we illustrate that each country is capable of
producing it is own using production possibility frontier graph

Country Oil Production using 100 Corn Production using

worker hours (barrel) 100 worker hours
Saudi Arabia 100 25
United State 50 100
Production possibilities before table
Production possibility frontier, (a) Saudi Arabia can produce 100 barrels
of oil and zero corn or 25 bushels of corn and zero it can also produce
the combinations of oil and corn. The same is true for United states.
Overview of the financial system

• The financial system is the network of banks, stock and bond

markets, and other financial markets and institutions that make it
possible for money to flow from lenders to borrowers.
• The financial system consists of financial markets and financial
intermediaries
• An asset is anything of value owned by a person or a firm.
• A financial asset is a financial claim, which means that if you have a
financial asset, you have a claim on someone else to pay you money.
For instance, a bank checking account
• Financial securities are tradable financial assets, which means they
can be bought and sold in financial markets
• Financial market is A place or channel for buying or selling stocks,
bonds, or other financial securities
• Stocks are financial securities that represent partial ownership of a
firm. If you buy one share of stock in Golis Telecom you become
one of dozens/hundreds of owners of that firm, and you have a
legal claim to your portion of anything GE owns and to its profits.
• Bonds are financial securities that represent promises to repay a
fixed amount of funds. When GE sells a bond, the firm promises to
pay the purchaser of the bond an interest payment each year for
the term of the bond, as well as a final payment equal to the face
value of the bond
• A financial intermediary is an institution that borrows funds from
savers and lends them to borrowers. The most important financial
intermediaries are commercial banks.
•
Services provided by financial system
• They allows households and firms to borrow the money they want
• Risk sharing: Financial systems allow us to diversify our investment in
order to avoid the risk of losing every thing
• Liquidity is the ease with which an asset can be exchanged for cash.
The financial system provides the service of liquidity through markets
in which savers can sell their holdings of financial securities.
• Information: The financial system also provides savers with a third
service by collecting and communicating information.
The role of the central bank in the financial system
• regulating money supply
• acts as lender of the last resort
• acts as the government’s bank
• facilitate the payment system
Money

• money is any items that are regularly used in economic

transactions or exchanges and accepted by buyers and sellers.
• Modern economy cannot work with money, the expansion of
the economy and the division of labour led the need for
exchange of money
• Before the invention of money. exchanges used to take place
in the form of barter trade,
• barter is the direct exchange of goods for goods. Barter is a
system of trading without the use of money.
• Barter trade had many challenges that the invention of money
solved.
Difficulties of barter:
Barter trade presents many difficulties such as
• The absence of double coincidence of wants: barter requires a
double coincidence of wants that is, one must have what the other
man wants and vice versa.
• Not standard of measurement: barter provides no standard of
measurement, this means that there is no standard over which
someone measures his goods
• Absence of sub division: sometimes it will be difficult to split up
commodities into parts. They will lose their value, if they are
subdivided.
• Difficult of storage: money serves as store value. In the absence of
money a person has to store his commodities in the form of
commodities and they cannot be stored for a long period, some
commodities are perishable and some will lose their value
Functions of money
Money performs many functions in modern economy, the following are the major
functions:
1.Medium of exchange: the most important function of money is that it acts as a medium
of exchange.
• Medium of exchange is any item that buyers give to sellers when they purchase goods
and services.
2. Measure of value: money acts as a common measure of value, it is a unit of account
and standard of measurement. Whenever, we buy a good in the market, we pay a price
for it in money.
• A unit of account is a standard unit in which we
can state prices and compare the value of goods and services.
3. Store of value: The property of money that holds that
money preserves value until it is used in an exchange. Money acts as a store of value,
someone who wants to store his wealth cannot store in the form of goats or cars etc
4. Standard of differed payments money is used to pay future transactions since
modern business is based on credits, it is inevitable to find out something that shall
have the same standard and value in the future
Qualities of Good Money
1. General acceptability: a good money material must be
generally acceptable. People should not hesitate to exchange
their goods for the material.
2. Portability: a good money is one that can be carried out from
one place to another without difficult
3. Cognoscibility: the material used as money should be easily
recognisable
4. Durability: the material used as money should not deteriorate,
the early form of money such corn fish and skin were unsuitable
in this regard
5. Divisibility: the material must be capable of division without
difficult and without loss of value on account of division metals
have this advantage
6. Homogeneity: all coins of the material should be of the same
quality. One coin should not be superior to another
7. Stability of value: this is another important quality of a good money
material. Commodities which are subject to violent changes in supply
and demand are unfit for money. For the value of money like any
other thing is determined by its supply and demand, if there is violent
change in its supply and demand its value is not likely to be stable.
Components of money
• Currency: Currency is defined as coins and paper money
held outside the banking system.
• Checking deposits: The other component ofM1 is bank
money. This consists of funds, deposited in banks and other
financial institutions, on which you can write checks and
withdraw your money on demand.
• Are credit cards money? The answer is no the reason is that
a credit card is actually an easy (but not cheap!) way
tomorrow money. When paying with a credit card, you are
promising to pay the credit card company—with money—at
a later date.
Quantity theory of market
• The Quantity Theory of Money is the proposition that in the long run,
an increase in the quantity of money brings an equal percentage
increase in the price level. The quantity theory of money is used to
determine the interest rate in an economy
• Before we discuss the theory, let us see another term which relates
to the theory which is the velocity theory of money. Fisher defined
the velocity of money—or, simply, velocity—as the average number
of times each dollar in the money supply is used to purchase a good
or service that is included in GDP
V = PY/M meaning velocity of money = GDP/money supply
• For example if the nominal GDP of Somalia is 10.000.000 and the
money supply is 4.000.000, then the velocity of money wills
10.000.000/2.000.000 which means that each dollar circulates 5
times in exchange of goods and services.
• The quantity theory of money assumes that the velocity of money is
always constant.
• The quantity equation gives us a way of showing the relationship
between changes in the money supply and the inflation rate.
• The equation is (money growth rate + rate of velocity change =
inflation rate + real GDP growth rate). Thus

Inflation rate = Money Growth rate + rate of velocity + GDP growth

rate
Government role in Money markets

Introduction
Governments control the money supply to ensure the stability
of money markets, The money market is the market for
money where the amount supplied and the amount
demanded meet to determine the nominal interest rate.
Governments has several ways to control money supply,
broadly they can be divided into two
1. Monetary policy
2. fiscal policy
Definition: monetary policy is the macroeconomic policy laid
down by the central bank. It involves management of
money supply and interest rate and is demand side
Goals of Monetary policy
Central banks have a number of goals when setting the monetary policy of
the country, the following five goals are main aim of monetary policy.
1. Price stability: inflation or rising prices erode the value of money, if prices
rise it will make households to decide how much to spend and save, firms
acing uncertain future will hesitate to enter into long term contracts.
Thus central banks attempt to lower prices
2. High employment
3. Economic growth: With high employment, businesses are likely to be
more confident that demand for their products will remain strong, and so
will be willing to engage in the long-term investment necessary for
growth.
4. Financial market stability: When financial markets and institutions
are not efficient in matching savers and borrowers, the economy
loses resources. Firms with the potential to produce high-quality
products and services cannot obtain the financing they need to
design, develop, and market these products and services.
5. Foreign exchange market stability
Tools of monetary policy
There are number of tools that central banks use to control supply of
money. These include
1. Open market operations: are the buying and selling the central bank
treasury bills and bonds. The Fed can decrease the federal funds rate by
increasing the supply of bank reserves, and it can increase the federal
funds rate by decreasing the supply of bank reserves. When the bank
want to decrease bank reserves it engages open market sale, when it
wants to increase bank reserves it engages an open market purchase.
It the central bank want to increase the money supply in the market, it
will sell its securities to public or other banks, if want s to reduce the
money in the market it can purchase government bills and bonds
2. discount rate (The interest rate the Fed charges on discount loans)
The discount rate is the interest rate paid by member banks when they
borrow at the Federal Reserve District Bank. If the central bank want to
increase money supply, it will reduce interest rates allowing banks to
barrow more money, thus increasing the money in the market.
If the central bank want to reduce money supply, it engages in increasing
interest rate, thus making difficult for commercial banks to barrow money
form central banks.
3. Federal reserve requirement: The Federal Reserve requires that banks hold a
certain percentage of their checking account deposits as either vault cash—
currency held in the bank—or as deposits with the
Fed.
• Banks that have reserves above the required levels are free to loan them to
households and firms or invest them in Treasury bills or other securities
• Reserve requirements provide the Fed with a monetary policy tool because
raising the required reserve ratio, or the percentage of checking account
deposits that must be held as reserves, reduces the ability of banks to make
loans and other investments. Lowering the required reserve ratio increases
the ability of banks to make loans and other investments
The limitations of monetary policy
1. Policy lags: In practice, the Fed is not instantly aware that a demand
shock or supply shock has occurred that is large enough to cause a
recession or to cause inflation to accelerate. Even after the Fed
becomes aware that a demand shock or supply shock has occurred, it
takes time to decide on an appropriate change in policy. Then it takes
time for the new policy to actually affect real GDP, employment, and
inflation
2. economic forecasts are not reliable: economists use economic
models to predict the performance of the economy but it is proved
these models cannot be relied
3. Moral Hazards: Moral hazard The risk that people will take actions
after they have entered into a transaction that will make the other
party worse off. The central bank is likely to intervene a collapsing
firm if that firm is Too-big-to-fail policy; A policy in which the federal
government does not allow large financial firms to fail for fear of
damaging the financial system. Monetary policy cannot moral hazard
Fiscal Policy: Fiscal policy refers to changes the federal
government makes in taxes, purchases of goods and
services, and transfer payments that are intended to
achieve macroeconomic policy objectives.
Tools of fiscal policy:
The two main tools of fiscal policy are taxes and spending.
Taxes influence the economy by determining how much
money the government has to spend in certain areas and
how much money individuals has to spend for
Spending is used as a tool for fiscal policy to drive government
money to certain sectors that need an economic boost.
Whoever receives those dollars will have extra money to
spend on goods and services
Example of three fiscal effecting the real GDP
1. Government Purchases: government purchases goods, such as
computers for government offices, aircraft carriers, and services.
Holding everything else constant, an increase in government
purchases (G), will increase aggregate expenditure(AE). The increase
in aggregate expenditure means that firms sell more goods and
services, which leads them to expand production, increasing real
GDP.
• An increase in government purchases : an increase in aggregate
expenditure : an increase in real GDP and employment
2. taxes: Governments obtain tax revenue from many different sources.
Such as personal income tax, VAT, sales tax, corporate tax etc Changes
in taxes affect the consumption and investment components of
aggregate expenditure.
Taxes affect the GDP in many ways
• Consumption side: taxes on consumption such as sales taxes or a VAT
affect consumption. An increase in these taxes makes goods and
services more expensive by raising prices, so households reduce their
consumption. Thus
• An increase in consumption taxes : an increase in prices of
consumption goods : a decrease in consumption : a decrease in
aggregate expenditure : a decrease in real GDP and employment.
• Income side: taxes on personal income tax increases or
decreases disposable income. Households can do one of two
things with their disposable income: They can either spend it on
goods and services, such as clothes and vacations, or they can
save it.
• A decrease in the tax rate on personal income: an increase in
disposable income : an increase in consumption : an increase in
aggregate expenditure : an increase in real GDP and
employment.
• Investment: An increase in corporate income taxes: a decrease in the
after-tax profitability of investment projects : a decrease in
investment : a decrease in aggregate expenditure : a decrease in real
GDP and employment.
3. Transfer payment: A transfer payment is a payment to one person
that is funded by taxing others. Food stamps, welfare benefits, and
unemployment benefits are all government transfer payments thus
An increase in transfer payments : an increase in disposable income : an
increase in consumption : an increase in aggregate expenditure : an
increase in real GDP and employment.
Types of fiscal policy
They are two types of fiscal policy: expansionary and contractionary
Expansionary is used at times of recession, high unemployment, it means
the government spending more money or lower taxes or both, the aim
is to put more money into the hands of customers as they spend goods
and services
Contractionary fiscal policy is used to slow down economic growth, such
as when inflation is growing too rapidly, it raises taxes and cut
spending.
Four major functions of fiscal policy
1. Allocation function: fiscal policy plays the role of allocation function,
the government should determine how funds will be allocated to the
provision of social goods, this relates the collection of taxes and
spending.
2. distribution: adjustment of the distribution of income and wealth to
assure conformance with what society considers a fair or just society
state of distribution of income. Taxes play an important role in
reducing inequality
Stabilization: Fiscal policy is needed for stabilization since full
employment and price stability does not come
automatically, the overall level of employment and prices
depend upon the level of aggregate demand, government
expenditure add to the total demand while taxes reduce.
Economic growth: fiscal policy may affect the rate of saving
and the willingness to invest and therefore may influence
the rate of capital accumulation.
Government and Re-distribution

• Redistribution is the transfer of income and wealth from

some individuals to others by means of social mechanism
such as taxation, charity, welfare services, confiscation etc.
• In economics, it is how countries redistribute total GDP
among its citizens.
• Redistribution of income does also mean taking money
from haves and giving to the have-nots.
• re-distribution of income is different from pre-distribution
policy which means the state should prevent in-equalities
to happen in the first place.
• For example, the state may require employers to pay a
living wage to their employees.
Role in economic systems
Economic systems have varying degrees of intervention when
it comes to income and wealth redistribution.
• Free market economy have the highest income inequality
because the income gap among the population is so wide
hence it tends to have high degrees of income
redistribution
• In command economies, there is low income redistribution
because socialism does not allow people to own capital or
land which are major derivers of inequality.
Stages of redistribution
Cash benefits: are designed to help low income or zero
original income persons. It can be contributory or non-
contributory
• Contributory benefits are given to those contribute to the
national insurance fund, e.g. employment allowances,
pensions.
• Non-contributory benefits does not require previous
contribution to have been made, but they are designed to
help the needy person in the country. Examples are child
benefits, housing benefits, income support etc.
Direct tax: a direct tax is paid directly by an individual to the
government, for example income tax, property tax,
personal property tax.
Indirect taxes: indirect taxes such as VAT, is regressive
meaning that the burden increases on the poor,
lower income groups pay a greater proportion of
their income than higher income groups pay.
Benefits in kind: are services such as education that
government provides for free or discounted rate,
they are important tool for redistribution of income.
Criticism on taxes and benefits
1. It may create disincentive effect
2. it may create moral hazards where individuals may
not work to improve their lives.
Unemployment

Unemployment refers to a situation where individuals that are

supposed to be used in production are willing and able to be
employed at the existing wage rates, but are unutilized or
underutilized. To compute unemployment
Total number of workforce ×100
Number unemployed
Types of unemployment
1. Cyclical unemployment: Cyclical unemployment exists when
individuals lose their jobs as a result of downturn in
aggregate demand (AD)
2. Structural unemployment occurs when certain industries
decline because of long term changes in market conditions.
Eg motor vehicle industry in england
Regional unemployment: When structural unemployment affects local areas
of an economy, it is called regional unemployment for example
unemployed coal miners and ship.
Classical unemployment: Classical unemployment is caused when wages are
too high
Seasonal unemployment: seasonal unemployment exists because certain
industries only produce or distribute their products at certain times of the
year
Frictional unemployment: Short term unemployment that
arises from the process of matching the job skills of
workers to the requirements of jobs. It is also called search unemployment
occurs when workers lose their current jobs and are in the process of
finding another one
Voluntary unemployment is defined as a situation when workers choose not
to work at the current equilibrium wage rate. For one reason or another
workers may elect not to participate in the labour market.
There are can be several reasons that compel this type of unemployment
including generous welfare, higher tax, benefits etc
• Disguised unemployment happens when a job
which is aught to be done by small worker is
handled by large number of people.
Causes of unemployment
1. Rapid population growth
2. Inappropriate technology
3. Relative factor price distortions
4. The education system
5. Rural urban migration
6. Seasonal nature of production
Class Assignment
Question : Discuss the role of the state in economic
growth?
Policies for curbing unemployment
1. Wages subsides: lowering wages will allow firms to employ
additional workers
2. restructuring the education sector
3. Increasing the number institutions to train agricultural
labour.
4. increasing incentives for changing product prices
5. import substitution
6. export promotion
The role that government can play in unemployment reduction.
7. Government sponsored job creation schemes
8. a monetary or fiscal stimulus to the aggregate demand
9. active labour market policies.
10. welfare to work schemes
 Inflation
Inflation refers to persistent increase in the general price level
over time. It is the opposite of deflation; the persistent
downward movement in the general price level overtime
for an aggregate of goods and services.
Forms of inflation
• Creeping inflation: this is sharp increase in the price level
per year. Less than 3% per annum.
• Hyperinflation: is when prices skyrocket more than 50
percent per month, hyperinflation occurs when
governments print money to finance deficit.
• Trotting inflation: when prices rise moderately and the
annual inflation rate is between 3-10%.
Types of inflation
• Open inflation: occurs when the government takes no steps to
control the rise in the price level
• suppressed inflation occurs when government intervenes the
economy to check the rise in price level.
• Stagflation: Occurs when price increases are accompanied by
declining output producing unemployment.
Measures of inflation
Inflation is measured by
The consumer price index (CPI) – measures the relative changes in the
prices of a specified set of market basket of consumer goods, which
are bought by a typical urban household regularly.
The producer price index (PPI) – measures relative changes in the prices
of raw materials, intermediate and finished goods i.e. at all stages of
the productive process rather than at the stage of the ultimate user
Causes of inflation
• demand-pull inflation: the inflation is caused by when
aggregate demand exceeds aggregate supply. Demand pull
inflation is caused by;
 Increase in the level of demand for goods and services in
the near employment
 A general shortage of goods and service at times of
disasters
 Export surplus leading to inflow of foreign currency
 Expansion of government spending from borrowed money.
• cost-push inflation: this is caused by the demand of
workers to earn high salary when the GDP is below its
potential level, firms increase prices to give the demanded
salary and this causes high cost of living
Causes of cost-pull inflation
• Labour unions asking for higher wages
• Manufacturers fixing higher profit margins, this is called make-up
inflation
• An increase in import prices eg oil
• Government imposing new taxes
• Structural rigidities in production that leads to increasing average
price
Effects of inflation
Internal disadvantages
• Income and wealth is redistributed arbitrarily i.e. those hold money
have to take the burden while those holding real asset do not feel,
thus it reduces the standard of living of those dependent on fixed
income i.e. pensioners
• Interest rates rise
• Invest is dis-encouraged by government anti-inflationary policies
• Inflation generates industrial and social unrest since there is
competition for higher incomes.
• Higher administrative costs eg negotiating contracts, revising prices
and labels, work to rule disruptions
• Wage settlements rise prices which exacerbate the situation
External effects
• Exports tend to decline
• Imports tend to increase
• An outward movement of capital
Remedies of inflation
Governments can use measures to curb the rising inflation, the most
common tools are fiscal and monetary policy
Fiscal measures
• Reduction in unnecessary expenditure/spending
• Increase in taxes/ or new taxes
• Surplus budgets and lowering barrowing
• Increase in savings
Monetary measures
• Credit control
• Rising interest rates
• Increasing the cost of overnight borrowing by commercial banks.
Price and income policies
• Government exhortations to firms to avoid unjustified price rises and
to unions to avoid unjustified wage claims.
• The setting up of a prices and incomes board to examine proposed
price increases and to contribute to collective bargaining between
employers and unions.
• Rational wage policy: Bringing together of employers’ and unions’
organizations in an attempt to obtain some voluntary agreement from
both parties to keep prices and incomes down.
• Price control: The impositions of legislation to regulate or even freeze
wages and prices
• increase production
Political economy
• Political economy is the study of the relationship between
citizens and the state.
• it concerns with the allocation of resources in a world of
infinite want and needs
• It studies philosophy and ideology about the evolution of
political and economic ideas.
• Political economy is a mixture of politics, economics,
sociology, philosophy, and history, which all bring together
evidence to the study of how humans exist within societies.
• Political economy can be split into two; classical and
modern political economy
The classical approach
This approach studies the Greek city state and classical philosophers
such as Aristotle Plato, Adam smith
Characteristics of the political approach
• States were city-states
• Governments/political institutions were polity
• The major social institution was household, the household was an
institution of production, distribution and consumption
• Polities had their roles limited to providing an enabling environment
to enable the activities of the household to go on like production e.g.
roads (transport) and schools (education/skilling) etc.
• The relationship between the polity and the household was a two
way relation .
• Development in this approach implied welfare of the society
• development was participatory as all elderly members of 18 years
and above were supposed to engage in decision making
The modern approach
• It studies modern states holistically as entities that are composed of
heterogeneous people with varying interests, needs and wants but all
living within the same boundary
• The major political institution of analysis today is the government
• the family that is the major social unit carrying out functions as those
of the household during the classical approach. The family is an
institution of consumption today
• The functions of government is now by providing the basic services to
the people as well as giving them equal opportunity in accessing
services
• All people do not participate in development decision and policy
making processes.
Why study political economy
• The allocation of scarce resources when there is wants are limitless
• It studies the relationship between citizens and the state
• It studies philosophy and ideologies that study the evolution of
economic ideas
• It explains why particular structures are best and reasons behind it
• It enables us to understand the economies of states.
Roles of the state and markets in development.
• A clearly defined system of property rights.
• They provide us regulatory structure
• Cohesive society exhibiting trust and social cooperation
• Social and political institutions that mitigate and manage risks
• Ensure economic freedom
• Ensure that institutional structures and rules are necessary activity
for economic development.
• The provide the incentive to invest.
• Ensure high employment
• Provide education and training
Developmental state
• It refers to a phenomenon of state led macroeconomic planning,
where the state had autonomous political power as well as control
over the economy.
• A developmental state is characterized by having strong state
intervention, as well as extensive regulation and planning
• There are two orientation towards a private economic activities;
regulatory and developmental.
• A regulatory state governs the economy mainly through regulatory
agencies that are empowered to enforce a variety of standards of
behaviour to protect the public against market failures of various sorts
• a developmental state intervenes more directly in the economy
through a variety of means to promote the growth of new industries
and to reduce the dislocations caused by shifts in investment and
profits from old to new industries
Characteristics of a developmental state
• Economic nationalism
• Emphasise of market share over profits
• Protection of fledging domestic industries
• Focus on foreign technology transfer
• Large government bureaucracy
• Alliance between the state, lab or and industry called corporatism
• Scepticism of neo-liberalism and the Washington Consensus
• Prioritization of economic growth over political reform
• Legitimacy and Performance
• Emphasis on technical education
Developmental states are found in east and southeast Asia; China,
Singapore, Taiwan, Malaysia, South Korea, Indonesia etc