1. Ch. 3: The American Free Enterprise System

2. Sec. 1: Advantages of the Free Enterprise System

3. What is a Free Enterprise System?
Capitalism –
central idea – producers free to produce the goods and services that consumers want
consumers influenced by desire to buy goods and services to satisfy econ. Wants
producers influenced by desire to earn profits
Free enterprise system –

4. Example: United States
Monica Ramirez – starts business of cosmetics for Latinas
creates Zalia Cosmetics
put whole saving account into business – soon gained backers to invest in business
outlets in major Hispanic markets – business growing – gives back to support Latina Entrepreneurs

5. One of 585,000 new businesses in US in 2001 – can see businesses everywhere
all examples of how individuals choices are the basis of a market economy
owners choose to start the enterprise
owners choose how to use their scarce productive resources
managers and workers voluntarily exchange labor for pay
consumers choose which goods and services they will buy
Govt. action usually limited –designed to protect or encourage competition or enforce contracts

6. Example: Emerging Markets
Mexican Economy
Singapore
Govt. plays much larger role then US govt.
rules and regulations make starting business difficult
informal market has grown as a result – has driven retail stores out of business
street vendors and vendors with stalls
Govt. very closely involved with economy (Singapore Inc.)
Govt. says what benefits employers must provide employees
Workers must put certain percentage in Central Provident Fund – govt. saving scheme
fund pays pensions, and funds public projects (ed., health care, housing)
Govt. supportive of free enterprise
keeps business rents, taxes and costs low

7. How a Free Enterprise System Works
Key freedom – private property – can exchange it voluntarily – heart of free enterprise
Open opportunity – the ability of everyone to enter and compete in the marketplace of his or her own free choice
ensures market reflect wide range of interests & talents and provides incentive to be efficient and productive
Legal equality – a situation in which everyone has the same economic rights under the law
Free contract – for voluntary exchange to work, people must be able to decide for themselves

8. What motivates people to start a business?
Which legal agreement they want to enter into – business, job, or purchase commitment
What motivates people to start a business?
Profit motive – the incentive that encourages people and organizations to improve their material well-being by seeking to gain from economic activities
Producers seek highest possible price for product
Competition offsets drive and forces prices down
Helps producers find price that does not deter buyer or inhibit profits

9. Example: Profit in Rocks
Pet rock – Gary Dahl – a pet rock easier to care for than regular pets
wrote a manual on pet rocks – training , tricks…
Aug – packaged and sold with manual at gift shows
major department store purchased 500
became major story, with interviews and articles
by end of year – sold more than 2 tons – he is millionaire
1976 – consumers lost interest – Dahl gets out of the business

10. Example: Competition Over Books
Books different then pet rocks – fierce competition
before 1995 – small chain stores and neighborhood booksellers dominate market
1995 – large chain stores – Barnes & Noble Inc. and Border Group Inc. begin to compete
can buy in high volume and pass savings to consumer
warm & welcoming atmosphere in stores – reading areas, cafes, book signings
1991 – independent booksellers account for 30% on book sales in US
by 2005 – down to 15%
between – 1,200 ind. Bookseller went out of business

11. New challenge for chains – Amazon.com
huge database, quick & reliable delivery, discount prices, easy to use web site
by 2004 – sales at $134 million a week
New challenge for Amazon – Overstock.com & Buy.com
undercut Amazon’s prices and has excellent service
Consumers benefit from competition
Ind. Booksellers cannot match prices
can provide personal service and focus on local tastes or specialized topics
example of those who keep pace with the market and adjust accordingly

12. Economic Pacesetter: Milton Friedman: Promoter of Free Markets
Economics professor – b. July 31, 1912 – d. Nov. 16, 2006
career teaching at U. of Chicago – free market ideas – “Chicago School of Economics”
Market should be free to operate in all fields – even law & medicine
lowering licensing standards would bring more dr. and lawyers into market
would bring down costs of services

13. Advisor for 2 presidents and head of state for several other countries
Govt. most important role is to control the amount of money in circulation
with no control, economy would experience inflation
Advisor for 2 presidents and head of state for several other countries
1976 – won Nobel prize for Economics
1980 – wrote Free to Choose – best seller nonfiction
1977 – 2006 – served as scholar at Hoover Institution, conservative public policy research center at Stanford University

14. Sec. 2: How Does Free Enterprise Allocate Resources

15. The Roles of Producers and Consumers
Profit – the money left over after the costs of producing a product are subtracted from the revenue gained by selling that product
Seeking profit is one way producers help allocate scarce resources in the economy

16. Example: Producers Seek Profit
Example: Consumers Vote With Their Wallets
Neighborhood coffee shop
owners charge highest price consumers are willing to pay
possibility for good profit encourages other to open shops
productive resources got to the coffee shops instead of other businesses
profit seeking helps in allocation of resources
When consumers buy a product, they vote for it vs. another product
votes determine what will be produced in the future
ex. – low carb diets – interests peak and fall – producers respond based on votes of the
Consumers-consumer actions cause a reallocation of resources

17. Government in the US Economy
Modified free enterprise economy – includes some govt. protections, provisions, and regulations to adjust the free enterprise system

18. Modified Free Enterprise
Figure 2.4 showed flow of resources and products moving in a circular flow between businesses and households
Figure 3.4 shows how govt. fits in
Govt. exacts costs and gives benefits
green arrows show flow of money
blue arrows show flow of products and resources
govt. is both consumers and producer
consumer in the resource market – spending to buy factors of prod.
consumer in product market – spending money in exchange for products
a producer – providing goods & services to households & businesses
collects money from businesses & households in form of taxes
covers costs of what is produced with this money
uses money to make purchases in the resource and product market
Figures 3.5 & 3.6 – show govt. a major consumer of resources and products
govt. employs about 22 million workers – 16% of labor force
govt. consumption is over 2 trillion
Modified Free Enterprise

19. Sec. 3: Government and Free Enterprise

20. Providing Public Goods
Most production decisions made in the marketplace through the interaction of buyers and sellers – the free enterprise sector
decisions made by different levels of govt. – the public sector
which sector produces a good or service?
if all costs borne by and benefits go to the buyer and seller, the free enterprise sector
Market failure – people who are not part of the marketplace interaction benefit from it or pay part of the costs
when this happens – govt. sometimes provides goods or service
Public goods – goods and services that are provided by the govt. and consumed by the public as a group
public goods are funded with taxes

21. Example: Characteristics of Public Goods
Public goods have 2 characteristics:
1. people cannot be excluded from the benefits of the product even if they do not pay for it
2. one person’s use of the product does not reduce its usefulness to others

22. Street lighting National defense
Impossible to exclude people from using it
the benefit is not diminished because other people use it
no way for private business to establish a realistic price and collect
local govt. provides and collects taxes to cover cost
Everyone benefits from it
the benefit is not diminished because other people feel secure
Given the benefit – you would readily pay for sense of security
Everyone pays through taxes to national govt.

23. Example: Free Riders
No incentive for business to produce public goods – people will not voluntarily pay for it
people receive the benefit of these goods whether they pay or not
Free rider – is a person who chooses not to pay for a good or service but who benefits from it when it is provided
one type of market failure

24. Fireworks Shows
Shows are very expensive – no way to charge people for watching the show
can charge for a very good spot, but others will still be able to see it
those who do not pay – free riders
Little interest in providing fireworks displays as a business opportunity
to address problem – govt. to provide certain goods and services
city govt. puts on the show and pays for it with taxes
costs and benefits shared throughout the community

25. Police Force Everyone is protected whether they pay or not
best way to ensure that those who benefit pay their share is for govt. to provide the service by paying for it with taxes

26. Public and Private Sectors – Shared Responsibilities
Some goods provided by either sector
often toll goods – goods consumed by the public as a group, but people can be excluded from using them
open for all to use, but have to pay a toll to use
initial funding for toll goods is provided by the public sector, but day to day is provided by the private sector

27. Public and private share responsibility for the nation’s infrastructure
Ex. – highways, mass transit, power, water, sewer systems, education, health care systems, fire and police services
if not have these things – economy would come to a halt
lose ability to move troops in case of attack and evacuate in emergency
Infrastructure – essential to economic health

28. Managing Externalities
Externality – a side effect of a transaction that affects someone other than the producer or the buyer
Negative externality – is an externality that is a negative effect or cost for the people who are not involved in the original economic activity
ex – manufacturing company discharges pollution into a river – cost of pollution is borne by those who live near the river – even if no connection to company
Positive externality – is an externality that is a positive effect or benefit for people who were not involved in the original economic activity
neighbor plants a rose garden – everyone benefits from beauty

29. Example: Paying For the Negative Externalities
Industrial pollution
Company has little incentive to pay extra to reduce pollution
those living around it are going to suffer from it, bear the cost of clean-up and bear the medical costs if ill
Limiting negative externalities is important role of the govt.
govt. taxes or fines polluters
money raised can offset higher medical costs
Tax or fine provides incentive for owner to reduce pollution

30. Example: Spreading Positive Externalities
New college built
Local business benefit from student purchases
Workers benefit as businesses expand
Community benefits – taxes collected form students, more skilled and knowledgeable population
local govt. can spend more to provide public goods
govt. tries to increase positive externalities
Subsidy – is a govt. payment that helps cover the cost of an economic activity that is considered to be in the public interest
comes from taxes , so everyone shares the cost
ex. – given to drug companies to develop new vaccine
will benefit the whole community once it is in effect