The American Free Enterprise System
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Chapter 3: The American Free Enterprise
System
KEY CONCEPT
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Free enterprise system is another name for capitalism. This name is
used because anyone is free to start a business or enterprise.
WHY THE CONCEPT MATTERS
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Free enterprise affects your day-to-day life. It is all around you, from
huge suburban shopping malls to industrial developments to office
buildings to neighborhood corner stores. Where you work, where you
shop, and what you buy are all influenced by the free enterprise
system.
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Advantages of the Free Enterprise
System
What is a Free Enterprise System?
KEY CONCEPTS
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Capitalist system also known as free enterprise system
– anyone is free to start a business or enterprise
– private ownership of factors of production
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What is a Free Enterprise System?
EXAMPLE: United States
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Businesspeople free to start business, choose how to use resources
Managers and workers choose where to exchange labor for pay
Consumers choose which goods and services to buy
Zalia Cosmetics—2001 startup aimed at underserved Latina market
Government protects or encourages competition, enforces contracts
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What is a Free Enterprise System?
Emerging Markets
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Most countries—own mix of tradition, free enterprise, government
involvement
Mexican government regulations make starting a business difficult
– street vendors get around rules; have driven out some retail stores
Singapore government keeps business costs low but is very involved
– requires employers pay benefits; workers pay into national fund
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How a Free Enterprise System Works
KEY CONCEPTS
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System gives right to own and exchange private property voluntarily
Open opportunity—ability to enter, compete in market of one’s choice
Legal equality—everyone has same economic rights under the law
Free contract—right to decide which legal agreements to enter into
Profit motive—incentive to gain from economic activities
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How a Free Enterprise System Works
EXAMPLE: Profit in Rocks
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1975 pet rock fad; packaged with care manual
– highly popular and profitable gag gift during holiday season
In early 1976, consumers stopped buying
– owner quit the business
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How a Free Enterprise System Works
EXAMPLE: Competition over Books
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Demand for books high; competition driving out small booksellers
Before 1995, small chain stores and independents dominant
1995, large chains offered discounted prices, appealing atmosphere
1995, online booksellers open with huge number of titles, low prices
small stores now offer personal service, local or specialized topics
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Milton Friedman: Promoter of Free Markets
Free to Choose
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Professor—thinks market should be free to operate in all fields
Thinks government’s key role is to control money supply, thus
inflation
Served as advisor to two U.S. presidents, foreign heads of state
Won 1976 Nobel Prize for Economics
Recent years, scholar, has foundation promoting educational freedom
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Reviewing Key Concepts
Explain the differences among the following terms:
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open opportunity
legal equality
free contract
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How Does Free Enterprise
Allocate Resources?
The Roles of Producers and Consumers
KEY CONCEPTS
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Consumers try to get the best deal for their money
Producers try to earn the most profits
Profit—money left after production costs subtracted from sale price
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The Roles of Producers and Consumers
EXAMPLE: Producers Seek Profit
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Neighborhood coffee shop shows how producers help allocate
resources
– to earn profits, charge highest price consumers will pay
– profits encourage others to open similar businesses
– result: productive resources directed toward coffee shops
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The Roles of Producers and Consumers
EXAMPLE: Consumers Vote with Their Wallets
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Consumers help allocate resources through their choice of products
– their choices guide producers to provide what consumers will buy
Early 2000s, low-carbohydrate diets became popular
– food producers moved some resources into low-carb market
– In 2004, producers cut back when consumer interest faded
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Government in the U.S. Economy
KEY CONCEPTS
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Government important but with limited role in U.S. economy
Modified free enterprise economy:
– government protections, provisions, regulations adjust capitalism
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Government in the U.S. Economy
Modified Free Enterprise
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Like businesses and households, government is producer and
consumer
– as consumer, buys factors of production in resource market
– as consumer, buys products in product market
– as producer, provides goods and services to businesses,
households
– collects taxes in payment, uses these to pay for resources,
products
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Reviewing Key Concepts
Answer the following question:
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Why is the U.S. economy sometimes referred to as a modified free
enterprise system?
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Government and Free Enterprise
Providing Public Goods
KEY CONCEPTS
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Public sector—branches of government that make production
decisions
Market failure—outsiders benefit from or pay for marketplace
interaction
Public goods—products provided by government, consumed by
public
Public goods funded with taxes
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Providing Public Goods
EXAMPLE: Characteristics of Public Goods
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Two characteristics of public goods
– people who do not pay cannot be excluded
– one person’s use does not make product less useful to others
Street lighting, national defense examples of public goods
– impossible to determine price or benefit per user
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Providing Public Goods
EXAMPLE: Free Riders
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No incentive for business to produce public goods—people will not
pay
Free rider—person who benefits but does not pay for good or service
Only way to have public goods is for government to fund with taxes
– examples: July 4 fireworks, law enforcement
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Providing Public Goods
Public and Private Sectors—Shared Responsibilities
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Some goods provided by either public or private sector
– toll goods—consumed by public but people can be excluded
– often initial funding public, daily operations private
Infrastructure—goods and services needed for society to function
– examples: highways, mass transit, water, sewer, health care, fire
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Managing Externalities
KEY CONCEPTS
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Market failure occurs when economic transactions cause externalities
Externality—side effect on someone other than producer or buyer
– negative externality—people uninvolved in the transaction pay
costs
– positive externality benefits people uninvolved in transaction
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Managing Externalities
EXAMPLE: Paying for Negative Externalities
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Factory owners—little incentive to pay to cut industrial pollution
People of region pay cleanup cost, have illnesses and medical bills
Government limits negative externalities through taxes and fines
– offset medical costs, provide incentives to reduce pollution
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Managing Externalities
EXAMPLE: Spreading Positive Externalities
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A new college benefits local businesses, community as whole
Government tries to increase positive externalities
Subsidy—government payment to help cover cost of economic
activity
– subsidy to drug company to make flu vaccine yields fewer sick
people
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Public Transfer Payments
KEY CONCEPTS
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A limitation of free enterprise:
– people unable to contribute cannot access all economic
opportunities
Safety net—government programs designed to protect people from
economic hardship
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Public Transfer Payments
Redistributing Income
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Transfer payments move income from person or group to another
– recipient does not provide product in return
Public transfer payment—made by government with tax money
Most public transfer payments in area of social spending
– usually go to poor, aged, disabled, or people who lose their jobs
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Reviewing Key Concepts
Explain the relationship between the terms in each of
these pairs:
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market failure and free rider
negative externality and positive externality
subsidy and positive externality
safety net and public transfer payment
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Case Study: The United States: Land of
Entrepreneurs
Background
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The free enterprise system and the belief that everyone has the right
to pursue economic success is the backbone of American society
Although many people achieve success by working for an employer,
an increasing number are working for themselves
What’s the Issue?
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What are some of the options for opening your own business?
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Case Study: The United States: Land of
Entrepreneurs {continued}
Thinking Economically
1. How do the legal rights built into the free enterprise system affect the
businesses in A and C?
2. Which of these two businesses do you feel would provide more
stability for its owner? Why?
3. Do you think entrepreneurs make up a large percentage of the work
force? Why are entrepreneurs important to the economy?
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