¶ … Economic Policy for an Imperfect World" by Karen I. Vaughn published in "Southern Economic Journal," Vol. 62, Issue 4, 1996 After the collapse of the Soviet Union it has become evident that market economies are necessary for producing wealth. However, the case for "free markets" is far from settled as those looking for an alternative to central planning usually consider "regulated market economy" as the solution. Hence the debate about how much "free market" or government regulation is appropriate, still rages. The ways in which contemporary economic theory contributes to the debate about the right mix of free market and government regulation is the theme of this article.

In the 1980s, a notable economist opined that government guidance was necessary for the 'invisible hand' to succeed. Some time later, another pointed out the lack of scientific evidence about the success of free markets. Other economists have even challenged some of the key assumptions of apparently settled economic theories.

It is clear that while enhancing efficiency is the goal of all economic policies, the "perfect' market models used by economists to predict the behavior of markets cannot explain the behavior of the markets in the real world.

Theories for Economic Policy Formation:

The related models of "perfect competition" and "general equilibrium" dominated economic theory in the 20th century. According to the perfect competition model,...

The theory of General Equilibrium also assumes similar equilibrium conditions in which no further improvement is possible. Some economists present these two models as argument for free markets but they actually give more support for regulated markets since perfect competition and full equilibrium conditions cannot be achieved by free markets. Furthermore, economists often assume market failure as a defect in the economy that can be corrected by government regulation; both these assumptions are not necessarily correct. The most oft-used theories for economic policy formation thus stand on shaky grounds.
Public Choice View:

There are a number of pitfalls in economic policy formation and governmental regulation such as influence of interest groups and conflicting agendas. The costs of market imperfections must, therefore, be weighed against the costs of implementing a policy. Unfortunately, the current economic models based on 'perfect' conditions do not provide adequate tools for weighing the alternatives since they do not replicate real life conditions.

Perfect Models, imperfect Reality:

The use of simplistic 'perfect' models to complicated real life world often leads to wrong conclusions. While it is true that these models help us to understand the complexities of the real world, it would be wrong to fall…