Question

We often hear politicians discussing taxing firms that earn “excessive” profits. Other times, such as in the wake of the 2008 financial crisis, we observe firms requesting “bailouts” from the government to compensate for losses. In the context of this section’s material on the role of economic profits and loss, discuss the implications of policyaimed at reducing profits or mitigating losses.

Answer 1

Policies are planned in such a way that it will increase the total surplus and welfare in the economy. It is the reason that politicians plan taxation for the firms who generate excessive profit. The taxes will be used for the welfare programs. On a similar note, when firms are in trouble, then are given financial bailouts as it affects huge number of families. So, government tries to prevent creation of chaos in the society. But, there are implication of policy aimed at reducing profit or reducing the losses and firms can take it differently.

When policy is aimed at reducing the profits, then it discourages the firms to deliver their best performance and do not produce enough. It creates inefficiency so that they do not want to give taxes. At the same time, when government makes policies to help in troubled times, then management of the firm shows moral hazard in the their decision making process that increases the scope of loss and failure. Hence, the nature of the policies mentioned here, create a scope of market failure. Hence, these policies should be balanced and focused to increase welfare, rather giving management the chance to take erratic decisions.