Download The Basic Principles of Free Enterprise

American Free Enterprise
Section 1: Benefits of Free Enterprise
The Basic Principles of Free Enterprise
Several key characteristics make up the basic principles of free enterprise.
1. Profit Motive
The force and drive that encourages people and organizations to improve their material wellbeing.
 Business owners and managers determine how businesses will be run to maximize their
profits, not the government
 Profit motive allows for innovation and efficiency by letting creative companies grow
2. Open Opportunity
The ability for anyone to compete in the marketplace.
 No matter how much money you start out with, you can end up as wealthy or as poor as
you want to.
3. Legal Equality
Equal rights to all, thus allowing everyone to compete in the marketplace.
 Legal equality maximizes a country’s use of its human capital
4. Private Property Rights
The right to control your possessions and make your own decisions regarding your property as
you wish.
5. Free Contract
The right to decide what agreements in which you want to take part.
6. Voluntary Exchange
The right to decide what and when you want to buy and sell a product rather than forcing one to
buy or sell at particular times or at specific prices.
7. Competition
The rivalry among sellers to attract consumers.
 Competition provides consumers with the choice of a larger variety of goods, most of
which are sold at reasonable prices
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The Consumer’s Role
A fundamental purpose of the free enterprise system is to give consumers the freedom to make
their own economic choices.
 Through their economic dealings with producers, consumers make their desires known.
When buying products, they indicate to producers what to produce and how much to
make.

Consumers can also make their desires known by joining interest groups, which are
private organizations that try to persuade public officials to vote according to the interests
of the groups’ members.
The Government’s Role
 Americans expect the government to protect them from potential problems that arise from
the production of various products or the products themselves.
 We expect the government to also protect our property rights, contracts and other
business activivites
Public Disclosure Laws
Laws that require companies to provide consumers with important information about their
products, such as fuel efficiency of automobiles, side-effects of medication.
 This allows consumer to make informed decisions regarding the products they
wish to purchase and thus are protected
Public Interest
Both state and federal governments’ involvement in concerns of the public as a whole, such as
environmental protection, sanitary food production.
 Gas stations must dispose of used motor oil properly
 Gas tanks are not allowed to leak into surrounding soil
 The government has set manufacturing standards on products
SECTION 1 QUESTIONS
1. List and explain the basic principles of the U.S. free enterprise system
2. What role does the consumer play in the system of free enterprise?
3. What is the role of the government in the free enterprise system?
Section 2: Promoting Growth and Stability
Tracking Business Cycles

Macroeconomics (Large) is the study of the behavior and decision making of entire economies.
This branch examines major trends for the economy as a whole
o Microeconomics (Small) is the study of the economic behavior and decision
making of small units, such as individuals, families, households, and businesses
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
A business cycle is a period of a macroeconomic expansion followed by a period of contraction.
 Free enterprise systems are subject to business cycles because economic decisions about
factors such as prices, production, and consumption are made by individuals and businesses
acting in their own self interest.

One measure of a nation’s macroeconomy is gross domestic product (GDP). GDP is the total value of all final
goods and services produced in a particular economy.
Promoting Economic Strength
 Because the market is vulnerable to business cycles, the government creates public policies
that aim to stabilize the economy. Policymakers pursue three main outcomes as they seek to
stabilize the economy.
1 Employment

One aim of federal economic policy is to provide jobs for everyone who is able to work. In the U.S.,
many economist consider an unemployment rate of between 4% to 6% to be desirable.
2 Growth

For each generation of Americans to do better than previous ones, the economy must grow to
provide additional goods and services. GDP is a measure of such growth
3 Stability

Stability gives consumers, producers, and investors confidence in the economy and in our financial
institutions, promoting economic freedom and growth.
 One indicator of economic stability is general price levels:
o When prices rise (Inflation), consumers cut back on spending, when prices drop
(Deflation), producers and consumers feel the pain. (Stagflation) can occur which is
when prices neither rise nor fall, they stay the same. This can hurt both the consumer
and producer.

When the price of milk goes up it hurts a family with children, when it drops, it
hurts dairy farmers.
 A second indicator of economic stability is the health of the nation’s financial institutions:
o No one wants to see banks boarded up, therefore, the government regulates and monitors
banks and other financial institutions.
 The federal gov’t protects banks deposits up to $250,000 and retirees pensions
Encouraging Innovation
 The government encourages the development of new technologies in several ways. Technology
is the process used to produce a good or service.
o
Improvements in technology allow an economy to produce more output from the same or a
smaller quantity of inputs, or resources
o
Technological progress allows the US economy to operate more efficiently and
productively, increasing GDP and giving US businesses a competitive advantage around
the world.
 Federal agencies fund many research and development projects. Also, new technology often
evolves out of government research.
 A patent gives the inventor of a new product the exclusive right to produce and sell it for 20 years.
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SECTION 2 QUESTIONS
4. How does the government track and seek to influence business cycles?
5. How does the government try to promote economic strength?
6. Why and how does the government encourage innovation?
Section 3: Providing Public Goods
Public Goods
 A public good is a shared good or service for which it would be (1) impractical to make
consumers pay individually and to (2) exclude nonpayers.
 Example = Roads and Dams
 Taxes pay for the construction and up keep
 The federal government steps in to act in the public interest whenever it determines that the
benefits of a policy outweigh the drawbacks.
o Cost is critical in determining whether something gets produced as a public good. When a
good or service is public:


o
1. the benefit to each individual is less than the cost that
each would pay if it were provided privately
2. the total benefits to society are greater than the total cost
In such circumstances, the market would not provide the good; the government would
have to, or else it wouldn’t get done.
 Public goods are funded by the public sector, the part of the economy that involves transactions
of the government.
 The private sector, the part of the economy that involves transactions of individuals and
businesses, would have little incentive to produce public goods
 A free rider is someone who would not choose to pay for a certain good or service, but who
would get the benefits of it anyway if it is provided as a public good.
 Example = National defense, we benefit whether we pay or not
 Example = Firefighters, whether someone wants to pay taxes for fire protection or
not
 Example = Paying to build a new freeway in the city, but then you use it.
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Market Failures
 A market failure is a situation in which the market, on its own, does not distribute resources
efficiently.

Would the free market ensure that roads are built everywhere they are needed? Answer = NO
 If a company did build a road, it could charge a high price for tolls because it would have no
competition. Also, companies would not choose to build roads in sparsely populated areas
because profit incentives in those areas might be non-existing.
Externalities
 An externality is an economic side effect of a good or service that generates benefits or costs to
someone other than the person deciding how much to produce or consume.

The building of a new dam and creation of a lake generates:
 Positive Externalities
 A possible source of hydroelectric power, Swimming, Boating, Fishing, Lakefront Views

Negative Externalities
 Loss of wildlife habitat due to flooding, Disruption of fish migration along the river,
Overcrowding due to tourism, Noise from racing boats and other watercraft
SECTION 3 QUESTIONS
7. What are public goods?
8. What is a market failure?
9. How does government manage externalities?
Chapter 3 Vocabulary
Profit Motive
Interest Group
Open Opportunity
Public Disclosure Laws
Public Sector
Private Property Rights
Free Contract
Microeconomics
Competition
Voluntary Exchange
Market Failure
Technology
Public Good
Legal Equality
Public Interest
Macroeconomics
Private Sector
Free Rider
Gross Domestic Product (GDP)
Business Cycle
Externality
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