capitalism – central idea – producers free to produce the goods and services that consumers want...

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Ch. 3: The American Free Enterprise System

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Ch. 3: The American Free Enterprise System

Sec. 1: Advantages of the Free Enterprise System

Capitalism – central idea – producers free to produce the

goods and services that consumers wantconsumers influenced by desire to buy goods

and services to satisfy econ. Wantsproducers influenced by desire to earn profits

Free enterprise system –

What is a Free Enterprise System?

Monica Ramirez – starts business of cosmetics for Latinascreates Zalia Cosmeticsput whole saving account into business – soon

gained backers to invest in businessoutlets in major Hispanic markets – business

growing – gives back to support Latina Entrepreneurs

Example: United States

One of 585,000 new businesses in US in 2001 – can see businesses everywhereall examples of how individuals choices are the

basis of a market economyowners choose to start the enterpriseowners choose how to use their scarce productive

resourcesmanagers and workers voluntarily exchange labor for

payconsumers choose which goods and services they will

buy

Govt. action usually limited –designed to protect or encourage competition or enforce contracts

Mexican Economy

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

Example: Emerging Markets

Singapore

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 choiceensures 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

How a Free Enterprise System Works

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 productCompetition offsets drive and forces prices downHelps producers find price that does not deter

buyer or inhibit profits

Pet rock – Gary Dahl – a pet rock easier to care for than regular petswrote a manual on pet rocks – training , tricks…Aug. 1975 – packaged and sold with manual at

gift showsmajor department store purchased 500became major story, with interviews and

articlesby end of year – sold more than 2 tons – he is

millionaire1976 – consumers lost interest – Dahl gets out

of the business

Example: Profit in Rocks

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 MarketsEconomics 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

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

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

The Roles of Producers and Consumers

Example: Producers Seek Profit

Neighborhood coffee shopowners 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 productvotes determine what will

be produced in the futureex. – low carb diets –

interests peak and fall – producers respond based on votes of the

Consumers-consumer actions cause a reallocation of resources

Example: Consumers Vote

With Their Wallets

Government in the US Economy

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

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

Most production decisions made in the marketplace through the interaction of buyers and sellers – the free enterprise sectordecisions 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 costswhen this happens – govt. sometimes provides goods or

servicePublic goods – goods and services that are provided by the

govt. and consumed by the public as a grouppublic goods are funded with taxes

Providing 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

Example: Characteristics of Public Goods

Street lighting 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.

National defense

No incentive for business to produce public goods – people will not voluntarily pay for itpeople receive the benefit of these goods

whether they pay or notFree rider – is a person who chooses not to

pay for a good or service but who benefits from it when it is providedone type of market failure

Example: Free Riders

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 ForceEveryone is

protected whether they pay or notbest way to ensure

that those who benefit pay their share is for govt. to provide the service by paying for it with taxes

Some goods provided by either sectoroften 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 useinitial funding for toll goods is provided by the

public sector, but day to day is provided by the private sector

Public and Private Sectors – Shared Responsibilities

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

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 activityex – 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 activityneighbor plants a rose garden – everyone benefits from

beauty

Managing 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: Paying For the Negative 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

Example: Spreading Positive Externalities