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The American Free Enterprise System. 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

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Chapter 3: The American Free Enterprise System


  • Free enterprise system is another name for capitalism. This name is used because anyone is free to start a business or enterprise.


  • 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.


Advantages of the Free Enterprise System

What is a Free Enterprise System?


  • Capitalist system also known as free enterprise system

— anyone is free to start a business or enterprise

— private ownership of factors of production


What is a Free Enterprise System?

EXAMPLE: United States

  • 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

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


What is a Free Enterprise System?


  • 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

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


How a Free Enterprise System Works

EXAMPLE: Competition over Books

  • 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

Milton Friedman: Promoter of Free Markets

Free to Choose

  • 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

Reviewing Key Concepts

Explain the differences among the following terms:

  • open opportunity
  • legal equality
  • free contract


How Does Free Enterprise Allocate Resources?

The Roles of Producers and Consumers


  • 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

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


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


Government in the U.S. Economy


  • Government important but with limited role in U.S. economy
  • Modified free enterprise economy:

— government protections, provisions, regulations adjust capitalism


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


Reviewing Key Concepts

Answer the following question:

  • Why is the U.S. economy sometimes referred to as a modified free enterprise system?


Government and Free Enterprise

Providing Public Goods


  • 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

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


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


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


Managing Externalities


  • 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


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


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


Public Transfer Payments


  • 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

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


Reviewing Key Concepts

Explain the relationship between the terms in each of these pairs:

  • market failure and free rider
  • negative externality and positive externality
  • subsidy and positive externality
  • safety net and public transfer payment

Case Study: The United States: Land of Entrepreneurs


  • 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?

Case Study: The United States: Land of Entrepreneurs {continued}

Thinking Economically

  • How do the legal rights built into the free enterprise system affect the businesses in A and C?
  • Which of these two businesses do you feel would provide more stability for its owner? Why?
  • Do you think entrepreneurs make up a large percentage of the work force? Why are entrepreneurs important to the economy?

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