Economics
Chapter 3
The American Free Enterprise System
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Economics
Chapter 3
Chapter 3: The American Free Enterprise System
KEY CONCEPT
• 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
• 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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Economics
Chapter 3
Section-1
Advantages of the Free Enterprise System
What is a Free Enterprise System?
KEY CONCEPTS
• 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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Economics
Chapter 3
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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Economics
Chapter 3
What is a Free Enterprise System?
Emerging Markets
• 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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Economics
Chapter 3
What is a Free Enterprise System?
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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Economics
Chapter 3
How a Free Enterprise System Works
EXAMPLE: Profit in Rocks
• 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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Economics
Chapter 3
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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Economics
Chapter 3
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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Economics
Chapter 3
Reviewing Key Concepts
Explain the differences among the following terms:
• open opportunity
• legal equality
• free contract
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Economics
Chapter 3
Section-2
How Does Free Enterprise Allocate Resources?
The Roles of Producers and Consumers
KEY CONCEPTS
• 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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Economics
Chapter 3
The Roles of Producers and Consumers
EXAMPLE: Producers Seek Profit
• 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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Economics
Chapter 3
The Roles of Producers and Consumers
EXAMPLE: Consumers Vote with Their Wallets
• 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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Economics
Chapter 3
Government in the U.S. Economy
KEY CONCEPTS
• Government important but with limited role in U.S. economy
• Modified free enterprise economy:
— government protections, provisions, regulations adjust capitalism
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Economics
Chapter 3
Government in the U.S. Economy
Modified Free Enterprise
• 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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Economics
Chapter 3
Reviewing Key Concepts
Answer the following question:
• Why is the U.S. economy sometimes referred to as a modified free enterprise system?
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Economics
Chapter 3
Section-3
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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Economics
Chapter 3
Providing Public Goods
EXAMPLE: Characteristics of Public Goods
• 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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Economics
Chapter 3
Providing Public Goods
EXAMPLE: Free Riders
• 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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Economics
Chapter 3
Providing Public Goods
Public and Private Sectors—Shared Responsibilities
• 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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Economics
Chapter 3
Managing Externalities
KEY CONCEPTS
• 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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Economics
Chapter 3
Managing Externalities
EXAMPLE: Paying for Negative Externalities
• 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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Economics
Chapter 3
Managing Externalities
EXAMPLE: Spreading Positive Externalities
• 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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Economics
Chapter 3
Public Transfer Payments
KEY CONCEPTS
• 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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Economics
Chapter 3
Public Transfer Payments
Redistributing Income
• 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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Economics
Chapter 3
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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Economics
Chapter 3
Case Study: The United States: Land of Entrepreneurs
Background
• 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
• What are some of the options for opening your own business?
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Economics
Chapter 3
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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Economics
Chapter 3
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