Role of government in the economy


Consumers, households, firms, and the government are the four basic entities of an economy because they perform the basic economic activities of production and consumption in an economy. In this article, we have discussed the role of government in the economy.

Role of Government

The role of the government is essential to stimulate or discourage economic activity. This role can be divided into the direct role and indirect role.

Direct Role of Government in the Economy

  • Development of infrastructure: The state’s role is essential for the development of infrastructure. In the initial phase, investments will have to be made towards creating economic and social heads such as education, health, power and transport. The private sector does not undertake such activities as there is more risk with low profit.
  • Removal of inequalities of income and wealth: In a free capitalist economy, income equality cannot be achieved to a large extent because ownership of private property is allowed. Hence, the government can adopt measures such as the progressive tax system, expenditure policy and nationalisation of industries to reduce inequalities of income and wealth.
  • To direct the market forces: The market forces of demand and supply do not meet the economic needs of all sections of people. These market forces are favourable only to those who can spend more, i.e. luxury goods for rich people will be produced more in the economy at the cost of necessities of life.
  • Industrial development: The private sector is basically engaged in the manufacture of a few consumer goods for domestic consumption which provides profit. Hence, the state can directly participate by setting up essential industries such as iron and steel and heavy electricals.
  • Agricultural development: The state can play a positive role in improving the productivity and production of the agricultural sector.
  • Organisational changes: The private sector is neither capable nor interested in undertaking certain organisational changes in the process of economic development of a country. The government can develop the means of transport for the expansion of market size and organise labour by reorganising labour unions.

Indirect Role of Government in the Economy

The government can also participate indirectly in the process of growth and development of an economy. It can adopt the following measures for rapid economic development:

  • Monetary policy: Monetary policy is the policy of the government regarding controlling and regulating the supply of money and credit in the economy. The government formulates a specific monetary policy to maintain equilibrium between the demand and the supply of money.
  • Fiscal policy: Fiscal policy refers to the revenue, expenditure and public debt policy of the government. Inequalities of income and wealth are corrected through the fiscal policy of the government.
  • Foreign trade policy: Adverse balance of payments and shortage of foreign exchange can be solved by the government through measures such as export promotion and import substitution.
  • Price policy: Through price policy, the government can maintain stable prices within a narrow range.

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