In free market economy, it is assumed that there will be no Government involvement.

Invisible hand as
described by the Adam smith is going to correct any market failure. In real life market forces are not as efficient
as are assumed in theory and it provide a justification of government intervention. Basic objective of
Government is to maximize social welfare and to reduce disparity between different segment s of the society.
Private sector allocates resources to maximize its private benefit and ignores the benefit of the whole society.
Government produces and provides many important goods and services which are not produced by the private
sector or produced inefficiently. Government provides national defense, transportation, education and legal
system. Government is responsible to provide basic necessities to every member of the society. In every society,
resources are not equally distributed; some people are born rich and some born poor. Government tries to reduce
gap by providing equal opportunities to everyone.
Private sector is interested in producing private goods so that these can be sold and profit can be earned. Private
goods are rival, excludable and exhaustible. There is competition for the ownership of the private goods.
Government provided public goods to maximize social welfare. National defense, legal system and education
are the examples of public goods. Public goods are non-excludable (no one can be excluded from taking the
benefit of these goods), non rival (there is o competition for these goods as everyone can enjoy the benefit).
Government also produces near public goods or merit goods because these goods are produced in less than the
desired quantity by the private sector. Government provides parks, museums, health and television broadcasting
at subsidized rates so that all the members can enjoy the benefits. These goods are easy to exclude but there is
no rivalry involved. For some goods it is hard to exclude but consumption is highly rival, these are known as
common property goods. Lakes, rivers, oceans, forest are examples of these goods.
Government needs funds to finance public and merit goods. Normally Government does not have any direct
source of earning money so Government imposes taxes on the members of society. Direct taxes are imposed on
the income of individuals and firms. Direct tax is visible and normally disliked by the society so Government
mostly depends on indirect taxes. Indirect taxes are imposed on consumption and collected by the retailers and
producers, on the behalf of the govt. Indirect tax is not easy to avoid and normally government imposes these
taxes on the goods and services with inelastic demand. Consumers have to pay even if they do not like these
taxes as these goods are habit forming and consumers have to pay even a higher price. Government can use
taxes to redistribute income and can use it to reduce inequality. A tax is said to be creating vertical equity if it is
progressive and rate of tax increases along with the income. Horizontal equity involves charging the same tax to
all the people with same ability of paying tax. Tax charged by the government must be fair, just and helpful to
reducing disparity.
Failure of the market forces is main justification of government intervention now it is established that
government roll is essential in any economy. It is important to note that it is not necessary that government is
going to achieve all its targets or what is expected from it. Government may also fail to achieve economic
efficiency and equity. Main causes of government failure are lack of information, short term decision making,
electoral pressure, making popular but not economic decisions and procedural hurdles due to inefficient
bureaucracy.
It is easy to criticize the performance of the government as it is not possible to make decisions that can make
happy every segment of the society. Government can be imperfect and can allocate resources inefficiently but
there is always a room for improvement. Government can provide more information to voters, can make its
operations and decision making process more transparent. Government should not involve it in any economic
activity which can be performed better by the producers and consumers.