• Chapter 3, Lesson 1: American Free Enterprise Capitalism

    Chapter 3, Lesson 1 Presentation        Chapter 3 Summary

    Lesson 1: Vocabulary

    Content Vocabulary
    • free enterprise
    • voluntary exchange
    • private property rights
    • profit
    • profit motive
    • competition
    • biofuels
    • Great Recession
    Academic Vocabulary
    • incentive

    Characteristics of Free Enterprise Capitalism

    How does the American economy incorporate the main characteristics of a free enterprise economy?

    Capitalism is an economic system in which private citizens, like yourself or perhaps other members of your family, own and use the factors of production to make products and generate profits. If the products can be bought and sold in markets without government regulation or interference, we have a condition called free markets.

    If an economy has both capitalism and free markets, we say that the economy is based on free enterprise. Under free enterprise, resources are privately owned, and competition is allowed to flourish with a minimum of government interference. Because the terms are so similar, people often use the terms free enterprise, free market, and capitalism interchangeably to describe the economic system of the United States.  A capitalistic free enterprise economy has five important characteristics: economic freedom, voluntary exchange, private property rights, the profit motive, and competition. Many of these features may already be familiar to you, but they are so important to the success of our economy and the way we live that it’s important to review them.

    Economic Freedom

    Economic freedom means more than being able to buy the things you want. It means that you have the freedom to choose your occupation, your employer, and your job location. You can even leave your current job and move on to another job that offers greater opportunity.

    Businesses also enjoy considerable economic freedom. They are free to hire the workers of their choice, and they are free to produce the products they think will be the most profitable. Businesses can make as many items as they want, sell them wherever they please, and normally charge whatever price they choose. In short, they are generally free to risk success or failure.

    Think how much different life would be under a different economic system. There are few choices under a traditional economic system because you would be doing the same things, in the same way as your elders did. Under a command economy, you would be doing what the leaders want, not what you want. Under a system guided by socialism, you would be working for the benefit of the state, and you would be guided by the directions given to you by the state. Only a free market capitalist system would give you the type of freedom you enjoy today.

    Voluntary Exchange

    A second characteristic of capitalism is voluntary exchange—the voluntary act of buyers and sellers freely and willingly engaging in market transactions. A voluntary transaction benefits both the buyer and the seller, or the exchange would never occur.

    For example, when buyers spend their money on a product, they act on a belief that the item they purchase is of greater value than the money they give up—or they would not make the purchase. When sellers exchange their products for cash, they believe that the money they receive is more valuable than the product they sell—otherwise they would not make the sale.

    In a command or mixed socialist economy, the state would have a bigger role in deciding WHAT and FOR WHOM to produce, thus bypassing the decisions that could have been made in markets. This would result in fewer markets and fewer buyers and sellers that would benefit from voluntary exchange.

    Private Property

    Another major feature of capitalism is private property rightswhich allow people to own and control their possessions as they wish.People have the right to use or even abuse their property as long as they do not interfere with the rights of others.

    Private property gives people the incentive to work, save, and invest. When people are free to do as they wish with their property, they are not afraid to accumulate, improve, use, or lend it. They also know they can keep any rewards they might earn. The Due Process clause of the Fourteenth Amendment to the U.S. Constitution protects private property rights of the American people. That clause states that the State cannot "deprive any person of life, liberty, or property, without due process of law."

    Private property makes borrowing possible and investing attractive. If you own property, you can use the property as collateral, or security, if you need to take out a loan. Or if you want to invest in a business or in another private enterprise, there will be a record of your transaction, which will prove that you are an owner. Both of these features—borrowing and investing—are much more difficult in a command or a socialist economy, if they happen at all.

    Profit Motive

    Under free enterprise capitalism, people are free to risk any part of their wealth in a business venture. If it goes well, they will earn rewards for their efforts. If it goes poorly, they could lose their investment. Profit is the extent to which the revenue from sales exceeds the full opportunity cost of the resources involved in producing the products sold. The profit motive—the incentive to improve one's material well-being—is largely responsible for the growth of a free enterprise system.

    The freedom to seek profits helps to guarantee that there is a never-ending stream of products, new and old, being offered in markets to attract consumers' dollars. Some products are offered by firms entering industries for the first time; other firms may be leaving one industry and entering another. Not all succeed, but the lure of profits is the single most important thing that assures us of a never-ending supply of goods and services.

    In a command economy, there would be no profit motive to encourage businesses to produce, because the WHAT to produce question would be guided by the central planning authorities. These central authorities would be much more likely to keep underperforming ventures operating for political reasons rather than letting them fail so that resources could move to other activities where they could be better used.


    Capitalism thrives on competitionthe struggle among sellers to attract consumers with the best products at the lowest prices.Competition is possible because individual businesses and entrepreneurs have the freedom to produce the products they think will be the most profitable. Free enterprise capitalism allows competition to flourish, benefiting both producers and consumers alike.

    Competition benefits consumers by assuring them that unpopular products will cease to be produced if consumers do not buy them. Competition also benefits consumers by assuring them that producers are always working to bring newer, better, and less expensive products to market.

    Competition benefits the economy by ensuring that the most efficient producers of a product will survive, while the least efficient producers will be forced to shut down, or try to produce different products. In a world of scarce resources, competition helps to assure that these resources are used as efficiently as possible.

    Benefits of Free Enterprise Capitalism

    How does a free enterprise economy provide opportunities for individuals?

    Individual Freedom

    Individual freedom is almost the same as the “economic freedom” described earlier, so in some ways the two overlap—with economic freedom being both a characteristic and a benefit of capitalism. This is true of capitalism in the United States, but it is also true of other parts of the world like Singapore and northern Europe where capitalism and democracy are the strongest.

    Our individual freedom is evident in many different ways, from choices we make in the market to choices we make in the voting booth.  Strong and stable democratic traditions are also present in countries with free enterprise capitalism, both of which help reinforce the other.

    Freedom is something we should value every day, from the time we get up until the time we go to bed. Many of the choices we make—from the type of food we buy to the choices we make about our occupation, our employer, and our job location—would not be possible without an economy based on free enterprise capitalism.

    A Variety of Goods

    Market economies everywhere are renowned for producing a huge variety of goods of almost all shapes, colors, and sizes, depending on the type of product.

    Take shoes for example. Whenever you go into a store, there is an incredible variety of colors, styles, shapes, and sizes. If the store is big enough, there may be aisles and aisles of shoes—and the variety of shoes in those aisles changes from one season to the next. Go to a different store, and you can find the same thing, only this time the brands, colors, styles, and shapes may all be different. All of this comes about because of competition, but think how different things would be in a different type of economy.

    Under a command economy as in the former Soviet Union, the central planners would solve the problem of shoe production this way:  First they would get an estimate of the number of men, women, and children in the economy. Then they would decide how many pairs of shoes each would get in a year’s time. When it came to deciding how many styles and colors they would produce, the easiest thing to do would be to make a small number of styles with a limited number of colors. The result, as far as the consumer was concerned, was a handful of styles that were produced mostly in one color—black.


    Adapting to Change

    Market economies adjust daily to the forces of change. The adjustment takes place mainly through the price system, and a change in the price of one product can affect changes in other industries. Consider the way the rising cost of oil on international markets has affected our economy. One of the most visible changes has been increased gas mileage for new car models. Because there has been growing emphasis on fuel efficiency, the automakers have thought of ways to achieve this criterion. More efficient gasoline engines and lighter-weight materials for car bodies have been developed to improve efficiency. Some of the improvement is also due to extensive wind tunnel testing to reduce wind drag.

    Other changes have also taken place because of the rising price of oil. Wind farms have popped up all over the country to turn wind into electricity. Solar energy is also being harnessed, along with biofuels, fuels whose energy is derived from renewable plant and animal materials, vegetable oils, and municipal and industrial wastes. Buildings are now becoming much more energy efficient, costing less to heat and cool. All of these developments have been driven by the higher price of oil.

    These adjustments are often difficult to observe day by day, but when observed year by year or even decade by decade, the changes are significant. In the end, it is the market economy, with its emphasis on ever-changing prices, that helps us adjust to change.

    Think about how different things would be if we had a command economy in a time of rising oil prices. In a command economy, central planners might try to keep everyone happy by giving them the same amount of oil that they had been using. That might seem to work at first, but soon the government would be producing or buying oil on international markets at one price, and then distributing it to consumers at a much lower price. Government budgets would make up the difference, but none of the energy-efficient changes would take place because the quantity of oil consumed would remain relatively constant. If oil quantities did suddenly change, the central planners might dictate solutions like not driving on weekends or other short-term fixes, rather than encouraging the innovation necessary to create fuel-efficient cars.

    Promoting Progress

    In a free market capitalist economy, if business and entrepreneurs are allowed to freely enter markets and compete for the dollars that consumers are willing to spend, the result will be economic progress in the form of a continuing supply of newer and better products. For proof of this progress, consider the recent development in the markets that affect you the most.

    For example, consider the cell phone industry, which seems to have newer and better products almost monthly. Cell phones are now available from a number of different companies in a variety of sizes and shapes. The phones also have a number of different features that change almost daily—including apps that allow your phone to be used as a street map with GPS connections, an MP3 player, a game player, and a flashlight; the list goes on and on. Computer tablets have also evolved rapidly, as have many other consumer products.

    All this progress is possible because of the intense competition among firms to get the business of consumers. The competition takes the form of better products and, usually, lower prices—both of which promote progress.

    Creation of Wealth

    Economists think of wealth as the accumulation of products that are tangible, are scarce, have utility, and are transferable from one person to another. The creation of wealth is exactly what happens when more and better products are produced in a free market capitalist system.

    The Gross Domestic Product—the dollar value of all final goods, services, and structures produced within a country’s borders in a 12-month period—of the U.S. economy is the largest in the world. It is about twenty percent larger than China’s GDP, even though China’s population is more than four times larger than the population of the United States.

    There is no question that an economic system based on free market capitalism is the most efficient wealth-generating system the world has ever seen. The success of the United States has not been lost on other nations. It is one of the main reasons that so many other nations have a free market capitalist system—or are transitioning to one.

    Disadvantages of Free Enterprise Capitalism

    What are the weak points of the free enterprise economy?

    Free enterprise capitalism is not without some drawbacks. Of course they may seem relatively minor when compared to problems with other types of economies, but still, they exist.

    Uneven Economic Growth

    The growth of free enterprise capitalism is not always smooth and uninterrupted. Sometimes the growth is relatively fast, and at other times it takes a step back. Most recently, the U.S. economy went through what is now called the Great Recession, which started in December of 2007 and lasted until mid-2009. During this 18-month period, the nation’s Gross Domestic Product actually shrank about 4.5 to 5 percent!

    Periods of uneven economic growth are not pleasant, but they do remove some of the “fat” or unneeded activities in businesses and public services. Even with these painful periods, free market capitalist systems still outperform other economic systems like traditional, command, or socialist economies by a wide margin.

    Growing Gaps Between Rich and Poor

    Another disadvantage of free enterprise capitalism is that the rich seem to get richer while the poor seem to stay poor. While this will be discussed in greater detail in a later chapter, federal statistics on income support this observation.

    Some of this is due to the fact that some people—if they are able to devise a product that meets the consumer’s economic need—can grow very rich in a very short period of time. There may not be many solutions to this issue. Tax policies and social welfare programs that divert income from the wealthy to the poor are opposed by many Americans who believe them to be socialist in nature. Still, if the gap gets too wide, voters may demand that government do something about it.

    Large “Supply-Side” Tendencies

    Economists know that free enterprise economies work best when there are a large number of players—buyers and sellers—on both sides of the market.

    This is not a problem on the buyers side of the market where the number of participants seems to grow as more and more people start to search for and buy products along with millions of others. Your parents may have done most of their shopping for clothing, books, medicine, and other products in a small local market with a few thousand other buyers. You, however, may well join millions of other buyers on the Internet in purchasing the same products nationally.

    The supply side of the market is completely different because suppliers tend to combine with other suppliers in order to avoid competition—or to “become more efficient” by eliminating some overlapping operations. For example, the Carnival Corporation is a company that owns Carnival Cruise Lines, Holland America, Princess Cruises, Seabourn in North America, and also Costa Cruises in Southern Europe. You have to wonder how intense the competition between these companies really is if they are all part of the same company.

    When similar firms combine, the result is fewer participants on the supply side of the market. Meanwhile, the participants on the demand side of the market are now focused on a diminished number of suppliers. This is one of the results of capitalism, and it is one that makes competitive markets less efficient. It is one of the reasons that the government may step in if there appear to be too few firms in an industry—but the government does not often prevent the general tendency of firms to combine and reduce competition.

    Rights and Responsibilities of Business

    You may not realize it, but corporations have most of the same rights as individuals. They can sue and be sued, they can enter into contracts, and they can own property, just like you can. About the only thing that corporations can’t do that you can do is vote.

    In addition to these rights, businesses also have many responsibilities, most of which are due to government regulations that limit the scope of their activities. For example, the federal Immigration and Nationality Act (INA) requires that all employees be treated equally. This makes it illegal for businesses to have a "U.S. citizens only" hiring policy, unless citizenship is required by a federal, state, or local law, or by government contract.

    Other government regulations protect consumers against harm from products on the market, ranging from baby seats and cribs to ignition switches on automobiles. These broad-ranging regulations are required by the Consumer Product Safety Commission, which was established in 1972. Requirements like these are unique to free enterprise capitalism because they are not found in other types of economic systems like traditional, command, or socialist economies. Instead, these policies exist because consumers have the power at the ballot box to force their representatives to enact some regulations on businesses. The result is that “free enterprise” is slightly less free than the term suggests.

    Chapter 3, Lesson 3: Evaluating Economic Performance                     CH 3, L3 Presentation            

    Lesson 3: Vocabulary

    Content Vocabulary
    • minimum wage
    • Social Security
    • Medicare
    • inflation
    • fixed income
    Academic Vocabulary
    • adverse
    • accommodate

    What are the major economic and social goals of the American free enterprise system?

    We all have personal goals; even businesses and governments have goals. Living in the United States, we have goals for our free enterprise economic system. What do you think are some of the major economic and social goals most people in the United States share? Identify one of these goals and write a paragraph discussing whether you agree or disagree with that goal.

    Economic and Social Goals

    Why might our economic goals change over time?

    In the United States, people share many broad economic and social goals. While it might be difficult to find all of our goals listed in any one place, they are repeated many times in statements made by friends, relatives, community leaders, and elected officials. We can categorize those statements into seven major economic and social goals.

    Economic Freedom

    Americans traditionally place a high value on the freedom to make their own economic decisions. They like to choose their own occupations, employers, and uses for their money. Business owners like the freedom to choose when, where, and what they produce. This belief in economic freedom, like the belief in political freedom, is one of the cornerstones of American society.

    Economic Efficiency

    Most people recognize that resources are scarce and that factors of production must be used wisely. If resources are wasted, fewer goods and services can be produced, fewer wants and needs can be satisfied, and fewer resources can be left for future generations. Because economic decision making needs to be efficient, economic efficiency is also one of our major goals.

    Economic Equity

    Americans have a strong tradition of justice, impartiality, and fairness. Many people, for example, believe in equal pay for equal work. As a result, it is illegal to discriminate on the basis of age, sex, race, religion, or disability in employment. At the national and state levels, we have established the minimum wage—the lowest legal wage that can be paid to most workers. While not everyone supports it, the minimum wage does put a floor on the amount of income that some workers earn.

    In the interest of fairness, most people believe that advertisers should not be allowed to make false claims about their products. Many states even have “lemon laws,” which allow new car buyers to get their money back for a car with too many defects.

    Economic Security

    Americans desire protection from such adverse economic events as layoffs and illnesses, injuries, or disabilities that prevent them from being able to work. As a result, many states have set up unemployment compensation programs to help workers who lose their jobs through no fault of their own.

    At the national level, Congress has set up Social Security—a federal program of disability and retirement benefits that covers most working people. Today, more than 90 percent of all American workers participate in the Social Security system. Most retirees and some widows, people with disabilities, and others are also eligible for benefits. Medicare, a federal health insurance program for senior citizens, regardless of income, is another program that provides economic security to elderly Americans.

    Full Employment

    When people work, they earn income by producing goods and services for others. Without jobs, people cannot support themselves or their families, nor can they produce output for others. As a result, most people want their economic system to provide as many jobs as possible. The goal of full employment even became law when Congress passed the Employment Act of 1946 in an effort to avoid the widespread joblessness that the country faced in the Great Depression.


    Price Stability

    Another goal is to have stable prices. If inflation—a rise in the general level of prices—occurs, workers need more money to pay for food, clothing, and shelter. People who live on a fixed income—an income that does not increase over time, even though prices do—find that bills are harder to pay and planning for the future is more difficult.

    High rates of inflation can even discourage business activity. During times of high inflation, interest rates on loans tend to increase along with the price of goods and services. If interest rates get too high, they can discourage both borrowing and spending by businesses. Price stability adds a degree of certainty to the future for businesses and consumers alike.

    Economic Growth

    A major goal of most Americans is economic growth. Most people hope to have a better job, a newer car, their own home, and a number of other things in the future. Overall growth enables more people to have more goods and services. Because the nation’s population is likely to increase, economic growth is necessary to meet everyone’s needs.

    Future Goals

    The seven goals discussed so far are the ones on which most people seem to agree. As our society evolves, however, it is possible that new goals will develop. Do people feel that a cleaner environment is important enough to be added to the list of goals? Should we add the preservation of endangered species such as the California Channel Islands fox? In the end, we are the ones who decide on the goals that are most important to us, and it is entirely possible that our goals will change in the future.


    Resolving Trade-Offs Among Goals

    How are conflicts among economic goals resolved?

    There are two significant issues with goals. One is that they sometimes are in conflict; the other is that there are opportunity costs associated with achieving them. Fortunately, our democratic system can help us deal with both problems.

    For example, a policy that keeps foreign-made shoes out of the country could help achieve the goal of full employment in the domestic shoe industry, but it could work against individual freedom by restricting international trade and giving people fewer options for shoe buying. Or, as another example, supporters of an increase in the minimum wage argue that it is the equitable, or “right,” thing to do. Opponents argue that an increase in the minimum wage could cause fewer workers to be hired. They argue that the minimum wage restricts the freedom of employers to determine what wages they think are fair for their workers.

    Both of these issues also involve opportunity costs. The opportunity cost of keeping foreign-made shoes out of the country may be fewer choices and higher prices in local stores. The opportunity cost of an increase in the minimum wage may be higher unemployment and higher prices in the stores that pay workers minimum wage.

    How are the trade-offs among goals resolved? If it is a political issue, and most are, then voters can compare the opportunity costs to the benefits, and then vote for political candidates who support their position. If the majority of voters feel that foreign-made shoes provide lower prices and more selection, they would probably support policies that permit them to be imported. If the majority of voters feel that the minimum wage is too low, then they can vote for the candidates who support raising it.

    Fortunately, the economic system of the United States is flexible enough to allow choices, accommodate compromises, and still satisfy the majority of Americans. This is because a democratic government reflects the will of a majority of its people. As a result, many government functions reflect people’s desire to modify the economic system to achieve their economic goals. A program such as Social Security, as well as laws dealing with child labor and the minimum wage, reveal how Americans have modified their free enterprise economy. Attempts to achieve or modify these goals are yet another reason we have a mixed or modified free enterprise economy.