THE FREE ENTERPRISE SYSTEM

Chapter 2

THE 6 PILLARS OF FREE ENTERPRISE

1. Private Property - the right to own property (capital & other resources owned by individuals or businesses rather than governments) is guaranteed by the U.S. Constitution (5th Amendment)2. Specialization – is a process in which businesses & people focus on producing one or a few parts of an entire product

3. Voluntary Exchange – specialization leads to voluntary exchange; people must buy & sell products to acquire all the things they want

THE 6 PILLARS OF FREE ENTERPRISE

4. The Price System- uses monetary prices as a message system (or “signals”) to facilitate exchanges between buyers & sellers 5. Market Competition- the rivalry among buyers & sellers in the purchase and sale of resources & products

a. Competition in markets for resources

b. Competition in markets for products6. Entrepreneurship – is the motivation that drives business leaders to compete & react to changing conditions in the market

THREE ECONOMIC QUESTIONS

• What goods and services will be produced?

• What do we have?

• How will they be produced?

• Hand > machine > elsewhere

• Who gets what is produced?

3 ECONOMIC SYSTEMS

• Economic system (economy) – an organized way of providing for the wants and needs of people.

1). Command

2). Market

3). Traditional

COMMAND ECONOMIES

• Economic activity is planned out by the government, with people having little influence.

• Examples:• Cuba• North Korea• China • Former Soviet Union

COMMAND ECONOMIES - PROS

• Allows an economy to change direction very quickly.

• After Stalin’s first two Five Year Plans, Russia moved from a rural agricultural economy to an industrial economy.

COMMAND ECONOMIES - PROS

• Little uncertainty as to who will do what.

• No unemployment because the government gives everyone a job (whether it is needed or not).

• Ayn Rand - Anthem

COMMAND ECONOMIES - CONS

• Not designed to meet the wants of consumers.

• Stalin’s Five Year Plan directed resources away from both agriculture and consumer goods.

• Provides strange incentives• Do just enough to meet quotas.

COMMAND ECONOMIES – MORE CONS

• No rewards for individual performance.• Tetris

• No flexibility to handle problems. • Great Depression disrupted the USSR’s First Five Year

Plan

• Requires a large decision making agency.• Stalin’s Five Year Plans governed all economic activity in

Russia…that’s a lot of paperwork!

MARKET ECONOMIES

• People and businesses act in their own best interests to answer the three basic economic questions.

MARKET ECONOMIES – HOW THEY WORK

• Lure of personal and financial gain leads consumers and businesses to interact in various markets.

• Each person acts as they see fit in order to advance their own interests.

THE FIRST ECONOMIST – ADAM SMITH

• “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest.” – Wealth of Nations, 1776

MARKET ECONOMIES - PROS

• Economy can adjust to change over time• Businesses can adapt to changing consumer

tastes by creating new/different products.

• High degree of individual freedom• Businesses and individuals are free to do what

they want.

MARKET ECONOMIES – MORE PROS

• Small degree of government interference (Mixed Economy)

• Economic decisions are made by all, not limited to government officials.

• Seemingly unlimited variety of goods and services available to consumers.

MARKET ECONOMIES - CONS• Does not provide for the basic needs of

everyone.• Elderly, disabled and other groups would be

unable to survive in a market economy without governmental assistance.

MARKET ECONOMIES – MORE CONS

• Does not provide certain services that people value.

• National Defense & Education.

• High degree of uncertainty

• Tommy Boy• Jobs going overseas• Market Failures

TRADITIONAL ECONOMIES

• Economic activity is based on tradition with roles determined by previous generations.

• Examples:• Medieval Europe• Various hunting tribes in

Africa and northern Canada (Inuit)

• Amish• Aborigines

TRADITIONAL ECONOMIES – PROS

• Everyone knows what their role is.

• Life is generally predictable and stable.

TRADITIONAL ECONOMIES - CONS

• Discourages new ideas and new ways of doing things.

• Lack of progress leads to a lower standard of living.

THE US ECONOMIC SYSTEM

• Mixed Economy

• Free enterprise or Capitalism

• Based on 4 important principles• Private Property• Freedom of choice• Profit• Competition

THE CIRCULAR FLOW

Households - includes everyone living in the U.S., play 2 important roles:1. Consumers - use the goods & services that businesses produce2. Resource Owners - owners of all the economy’s resources labor & other productive resources)

THE CIRCULAR FLOW

• Goods & Services (or Products) Market- when households exchange money for the goods & services businesses produce

• Resource Market- when households exchange their labor & other resources in the resource markets for money to spend in the goods & services (products) markets

THE CIRCULAR FLOW

• How does money earned from one business (from the resource market) become income for another business (in the goods & services market)?

• People earn money for their labor from one business which they spend on goods & services from other businesses. (The money is income for other the business.)

BARTER

Exchanging goods & services without using money• We have not always used “money,”

because people traded other items• Wampum (shells), animals, produce, crops

(tobacco), metals, rocks, salt (“salary”)• Barter is not an easy way to trade• Both sides have to be willing to accept

what is traded or you have to find what they want

THREE FUNCTIONS OF MONEY

1. Medium of Exchange- accepted (or exchanged) in return for most goods & services

2. Store of Value- can be saved for future buying power

3. Measure of Value (or prices)- money indicates the relative value of products and resources

ECONOMIC GOALS

• Full employment – almost all people in the labor force are able to find work

• Economic growth – an increase in output of goods & services in the U. S. economy during a year

• Price stability – prices of goods, services & resources do not fluctuate significantly in short periods of time.

ECONOMIC GOALS

• Economic freedom – freedom of choice in employment, buying, selling, use of our time, & other decisions related to our economy

• Economic security – the basic needs of every person should be met

• Economic Equity – fairness & impartiality• Efficiency – Getting the maximum output from the resources used to produce goods & services

ECONOMIC FREEDOM

• Individuals have freedom to choose their own occupations, employers, and spending habits.

• Businesses have freedom to choose how and where to produce goods/services.

• Are we meeting this goal?

ECONOMIC EQUITY

• People should receive equal pay for equal work.

• People should receive adequate pay for the work they perform.

• People should all have the same opportunities to get ahead.

• Are we meeting this goal?

ECONOMIC SECURITY

• We should have protection from negative economic events such as layoffs and injuries.

• Social Security – federal program that provides disability and retirement benefits.

• Everyone should have their basic needs met.

• Are we meeting this goal?

PRICE STABILITY

• We should have stable prices that protect against inflation.

• Inflation – a rise in the general level of prices.

• Are we meeting this goal?

WHEN ECONOMIC GOALS ARE NOT MET…

…People get mad!!!!!!!

JOHN MELLENCAMP - SCARECROW

As you listen, think about the goals of:

• Economic Equity?

• Economic Security?