Governments Role in the Economy

The Role of Government in Avoiding Market Failure

Key Terms

an illegal combination of corporations whose intent is to diminish

Cease and desist
– a ruling from the FTC that
requires a company to stop an unfair business practice that decreases
the amount of competition in a certain market.

Price discrimination– the illicit practice of charging customers different
prices for the same product.

Public disclosure– a federal requirement that forces a business to
disclose information about its products or its operations to the
general public.

Market failures, as discussed earlier, occur
when one or all of the conditions below exist:

  • When adequate competition does not exist.
  • Buyers and sellers are not well informed.
  • Resources are not free to move from one
    industry to another.

  • Prices do not reasonably reflect the costs
    of production.

The government has an obligation to protect its
citizens against market failures and thus takes steps to ensure that
the conditions outlined above do not exist. The government guards
against monopolistic business practices such as the formation of

Trust- an illegal combination of corporations
whose intent is to diminish competition.

Most students are familiar with the effect that
Trusts had on the American business landscape and the American
consumer at the turn of the nineteenth century. Their monopolization
of various industries led to increased price, lower quality and the
abuse of workers. Many laws were passed to deal with the formation
of trusts. Antitrust laws are legislation under which the United
States government acted to break up any trust. The first of these
laws was the Sherman Antitrust Act, founded upon the principle in the
Constitution that Congress could regulate interstate commerce. The
Sherman Act declared illegal every contract, combination, or
conspiracy in restraint of interstate and foreign trade. In 1914 it
was supplemented by the Clayton Antitrust Act, which prohibited
exclusive sales, contracts, inter corporate stock holdings, and price
discrimination in the cases where it may lead to a decrease in
competition. That same year, the Federal Trade Commission Act was
passed. This act established the Federal Trade Commission (FTC) and
gave it the power to issue cease and desist orders. The
Robinson-Patman Act of 1936 was designed to enhance the Clayton Act,
particularly the clause that dealt with price discrimination. Under
this act, companies were prohibited from offering special discount
prices to certain customers.

Federal Antitrust Laws,
1887 – 1950


Date Enacted


Interstate Commerce Commission



First federal law regulating the abuse
of monopoly power. Passed after “Granger” laws enacted by
rural states were declared unconstitutional.

Banned certain unfair business
practices in the railroad industry.

Sherman Antitrust Act


Made it illegal to create, or attempt

to create, a monopoly. By declaring any combinations that
were a “conspiracy in restraint of trade” illegal. This law
was used by the courts and corporate lawyers to grant
injunctions against union organization.

Clayton Antitrust Act


Sought to prevent the creation of
monopolies by defining specific illegal practices such as
trusts and interlocking directorates. Strengthened the
Sherman Act. Specifically made unions legal.

Federal Trade Commission Act


Created the Federal Trade Commission
(FTC). The FTC has the responsibility to carry out the

provisions of the Clayton Antitrust Act and to enforce
federal law in regard regulation of business.

Robinson – Patman Act


Protects small retailers from unfair
competition by chain stores and other large scale

Celler – Kefauver Act


Outlawed mergers or acquisitions that
would lessen competition or create a monopoly.

The government has the responsibility of maintaining the
proper functioning of the economy. As such it maintains a legal
system that:

  • Enforces contracts.
  • Protects property.
  • Guarantees the rights of individuals and

Another functions of the government is to
maintain the stability and the well being of our economy. In doing
so, it has to keep a sufficient level of competition in the markets
by regulating some monopolists’ prices, as well as directing the
quality of public services. The goal for the government is to
establish the same prices that might exist if there were competition.
Local and state governments regulate many of the natural monopolies
such as telephone service, and gas and electrical utilities. Usually
it is a public commission or other government agency that approves of
prices for their services. If the company wants a change in the
charged rates, then it must argue its case before the commission.
Privately owned agencies, such as the Federal Reserve system, have
certain regulatory powers including the power to regulate the money
supply (i.e. cutting interest rates), some bank operations, and even
bank mergers.

One of the benefits of living in a democracy
where a truly capitalistic society is prevented by the intervention
of the government, is the weapon of public disclosure. Our
government, in its effort protect the consumer and promote open
competition, has throughout the years required companies to reveal to
the consumer the contents of its products, and its methods of
operation and corporate organizations. An example would be how the
Food and Drug Administration (FDA) requires content labels on canned
goods and other food products. The FTC, for example, has outlawed
price discrimination and price gouging. In another move to curb
businesses and protect investors, the Securities and Exchange
Commission mandates that any corporation that sells stock to the
public lists its stock on a stock exchange must send periodic reports
to the SEC. The firms are also required to supply investors with
annual reports on the money, securities, and property the investors
own, as well as information on sales and profits.

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