Classical economists believed in the concept of free market mechanism.
According to them, in the free market mechanism, the intervention of government in economic development is fully restricted. In addition, they had a view that the free market mechanism itself is efficient to provide solutions for various major problems of an economy.
These problems include poverty, illiteracy, unemployment, economic instability, and unequal distribution of income. Apart from this, classical economists also advocated that economy is self-regulating and capable of achieving an optimal level of output.
However, this statement did not prove true in solving the economic problems of various developed and underdeveloped nations. This resulted in the failure of the free market mechanism. Consequently, the need for government intervention arose for performing various economic activities and attaining economic growth. The government of any nation plays an indispensible part in the economy. The main objectives of government intervention are to prevent the failure of markets, achieve equitable distribution of income and wealth, and improve the performance of the economy.
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However, deciding the extent to which a government can intervene in the economy of a country has always been a controversial matter. The role of government in an economy can be broadly classified on the basis of economic systems currently prevalent in the world. These economic systems are capitalist economy, socialist economy, and mixed economy. In capitalist economic system, the role of government is confined to maintain law and order and monitor the supply of money in the economy. On the other hand in socialist economy, the government plays a comprehensive role in all the economic activities.
Lastly, a mixed economy is characterized by the combination of both, capitalist economic system and socialist economic system. In this system, the private sector functions on the principles of the free market mechanism under the policy framework decided by the government. The economic structure of India is based on mixed economic system. After independence, India has adopted a centrally planned economy to make effective and equitable allocation of national resources and achieve balanced economic growth.
Therefore, the Indian government has implemented several regulatory measures and enacted certain laws to control the activities of the private sector and reduce economic concentration. Some of these measures are Open Market Operations, Bank Rate Policy, Monopolies and Restrictive Trade Practices (MRTP) Act, Industrial Relation and Disputes Act, and Foreign Exchange Regulation Act (FERA).