Ch. 3: The American Free Enterprise System

Sec. 1: Advantages of the Free Enterprise System

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 –

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

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

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

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

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

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. 1975 – 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

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 1995-2005 – 1,200 ind. Bookseller went out of business

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

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

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

Sec. 2: How Does Free Enterprise Allocate Resources

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

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

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

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

Sec. 3: Government and Free Enterprise

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

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

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.

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

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

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

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

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

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

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

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