THE AMERICAN FREE

ENTERPRISE SYSTEM

Chapter 3

ADVANTAGES OF THE FREE ENTERPRISE SYSTEM Free Enterprise

SystemAnyone is free to

start a business or enterprise

Private ownership of factors of production

EX:U.S.Free to start upChoose where to

exchangeChoose goods

WHAT IS A FREE ENTERPRISE SYSTEM?Key Concepts System gives rights to own and

exchange private property voluntarily Open Opportunity-ability to enter,

compete in market of one’s choice Legal Equality-Everyone has the 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 DOES FREE ENTERPRISE ALLOCATE RESOURCES?

Key Concepts Example

Consumers try to get the best deal for their money

Produces try to earn the most profits

Profits-money left after production costs subtracted from sale price

Producers seek profit Neighborhood coffee

shop shows how producers help allocate resources To earn profits, charge

highest price customers will pay

Profits encourage others to open similar businesses

Result: productive resources directed toward coffee shops

GOVERNMENT IN THE US ECONOMY

Key Concepts Modified Free Enterprise

Important Limited Modified Free

Enterprise Economy-government protections, provisions, regulations that adjust capitalism

Like businesses and households, government is a 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

GOVERNMENT AND FREE ENTERPRISE

Providing Public Goods Examples

Public Sector- branches of govt. 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

2 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 Impossible to

determine price or benefit per user

PROVIDING PUBLIC GOODS

Free Riders Public and Private Sectors Share Responsibilities

No incentive for business to produce public goods- people will not pay

Free Rider-person who benefits but does not pay for a good or service

Only way to have public goods is for government to fund with taxes

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 a society to function

MANAGING EXTERNALITIESKey Concepts Market failure occurs when economic

transactions cause externalities Externality- side effect on someone

other than producer or buyerNegative Externality- people uninvolved in

the transaction pay costsPositive Externality- benefits people

uninvolved in transaction

MANAGING EXTERNALITIES

Example 1 Example 2

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 fees Offset medical costs,

reduce pollution

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

PUBLIC TRANSFER PAYMENTS

Key Concepts Redistributing Income

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

Transfer Payments move income from person or group to another Receipient does not

provide 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