American Free Enterprise Chapter 3

Happy Constitution Day! Constitutions are economic documents as well as political documents. Constitutions are economic documents as well as political documents. Our nation’s founders believed that economic freedom as well as political freedom are essential for national prosperity and growth. Our nation’s founders believed that economic freedom as well as political freedom are essential for national prosperity and growth. They included numerous provisions in the Constitution that support and encourage the operation of a market economy. They included numerous provisions in the Constitution that support and encourage the operation of a market economy.

American Free Enterprise We can shop for a t.v. 24 hrs. a day from the comfort of our own homes In 1971, a 25” color t.v. cost an avg. worker 174 hrs. of wages. Today, a 25” color t.v., that is much more dependable, gets better reception and more channels, costs the avg. worker 23 hrs. of pay. Life expectancy has gone from 47 yrs to 77 yrs. Infant mortality plunged by 93% We’ve wiped out/controlled polio, TB, typhoid, and whooping cough Our (mixed) market economy deserves a lot of credit for this progress!

U.S. is a capitalist economic system U.S. is a capitalist economic system “Land of Opportunity” “Land of Opportunity” This is all based on private ownership of the 3 F of P This is all based on private ownership of the 3 F of P Consumers are free to choose Consumers are free to choose what they buy, producers are what they buy, producers are free to make what they like, free to make what they like, and make as much profit and make as much profit as possible. as possible.

How Free Enterprise Works (Free Enterprise is just another name for capitalism) (Free Enterprise is just another name for capitalism) You are free to start a business that provides usefulness to consumers (open opportunity) You are free to start a business that provides usefulness to consumers (open opportunity) Business is free to use scarce resources as they please (private property rights) Business is free to use scarce resources as they please (private property rights) Managers and workers operate these businesses in exchange for pay (profit motive) Managers and workers operate these businesses in exchange for pay (profit motive) Consumers decide what they want to buy (voluntary exchange) Consumers decide what they want to buy (voluntary exchange) They look for goods and services to fulfill wants for the best possible value (competition) They look for goods and services to fulfill wants for the best possible value (competition)

Limits to Free Enterprise Gov’t only limits free enterprise in small ways Gov’t only limits free enterprise in small ways Gov’t promotes the “public interest” Gov’t promotes the “public interest” ex. Can’t take advantage of consumers with unsafe products ex. Can’t take advantage of consumers with unsafe products ex. Public Disclosure Laws ex. Public Disclosure Laws Happy Fun Ball Commercial Happy Fun Ball Commercial Happy Fun Ball Commercial Happy Fun Ball Commercial

Five Freedoms of Free Enterprise 1. Right to Private Property- ability to own your own land, thoughts, and material items. (why invest time/energy/money if no guarantee you will reap what you sow?) Ex. patents and copyrights Ex. patents and copyrights Ex. Fish Activity and Tragedy of the Commons Ex. Fish Activity and Tragedy of the Commons 2. Open Opportunity- Anyone can take part in the market by free choice. Ex. No one can tell you that you can’t open a deli or a bowling alley. Ex. No one can tell you that you can’t open a deli or a bowling alley. This creates a wide range of goods and services to choose from. Forces all businesses to be productive and efficient. This creates a wide range of goods and services to choose from. Forces all businesses to be productive and efficient.

3. Legal Equality- Everyone in the economy is protected by same economic rights under law. Everyone has the right to succeed or fail. 4. Free Contract- People choose which agreements to enter into in the market place ex. Buying a house and agreeing to pay a mortgage ex. Buying a house and agreeing to pay a mortgage Five Freedoms of Free Enterprise

5. Profit Motive- force that encourages people to improve their wealth through economic activity Ex. You decide to open a Starbucks on Newburgh to become wealthier Ex. You decide to open a Starbucks on Newburgh to become wealthier Five Freedoms of Free Enterprise

Competition in Free Enterprise “Profit is the motivator, competition is the regulator” Drives prices down to offset peoples true ambitions to make as much money as they can Drives prices down to offset peoples true ambitions to make as much money as they can It creates reasonable prices for the consumer, but still leads to profit It creates reasonable prices for the consumer, but still leads to profit Ex. Gas Station Wars Ex. Gas Station Wars

Ex. Seeking Profit Convenience Stores They charge a reasonable yet higher price on their products They charge a reasonable yet higher price on their products Because convenience stores make a profit, it will motivate Timmy to open his own store Because convenience stores make a profit, it will motivate Timmy to open his own store People allocate resources to places they know they will make money People allocate resources to places they know they will make money

Resources are now being allocated (set aside) for convenience stores instead of another area Resources are now being allocated (set aside) for convenience stores instead of another area This creates competition and variety in the economy This creates competition and variety in the economy

Consumers Also Allocate Resources When you buy a product you are choosing it over another When you buy a product you are choosing it over another This helps to influence what producers will make and provide (consumer sovereignty) This helps to influence what producers will make and provide (consumer sovereignty)

Ex. Popularity of Energy Drinks Ten years ago they were not in demand Ten years ago they were not in demand Now all the largest soft drink companies are making them due to popularity Now all the largest soft drink companies are making them due to popularity Coke and Pepsi allocated their resources and put more money into making energy drinks. Coke and Pepsi allocated their resources and put more money into making energy drinks.

Questions What other trends have taken place in society where a new product causes companies to reallocate their resources into a new product? What other trends have taken place in society where a new product causes companies to reallocate their resources into a new product? How does a free enterprise system avoid the problem of having too many convenience or drug stores in a market? How does a free enterprise system avoid the problem of having too many convenience or drug stores in a market?

Role of Gov’t In Our Economy (Nobody likes the umpire, but you can’t play the World Series without one.) Good government makes a market economy possible (Bad gov’t. kills capitalism). They define the “rules of the game.” Good government makes a market economy possible (Bad gov’t. kills capitalism). They define the “rules of the game.” Our gov’t plays a limited, but important, role in regulating our economy Our gov’t plays a limited, but important, role in regulating our economy

Gov’t provides public goods Public good: a shared g&s for which it would be inefficient or impractical to make consumers pay individually and to exclude those who do not pay Makes us better off but wouldn’t otherwise be provided by the private sector

Private vs. Public Who pays? Will sharing diminish your enjoyment? Does your consumption exclude others from also consuming the same product? Can people pick and choose whether or not they pay for this product?

Gov’t provides public goods 2 basic characteristics: 1) cost of offering the good to more users is very low or zero (shared consumption) ex. missile defense, radio signal, park, traffic lights 2) very hard, if not impossible, to exclude people who haven’t paid for the good from using it (nonexclusion) Ex. lighthouse, fireworks

Costs and Benefits of Public Goods The benefit to each individual is less than the cost that each individual would have to pay if it were provided privately. The total benefits to society are greater than the total cost. The gov’t pays for public goods through taxes Thus, the financial burden on each individual is significantly less than if a few people decided to fund a project privately. Ex. anti-missile defense shield

Taxes Taxes are used to make sure all people contribute towards public goods in some way Taxes are used to make sure all people contribute towards public goods in some way It would be impossible to charge individually for all of these public services It would be impossible to charge individually for all of these public services

Free Rider Problem Free riders public good Free riders are people who are not willing to pay for a particular good or service but would benefit from it if it were offered as a public good. Gov’t collects taxes to prevent free riders from taking advantage of public goods and services without paying Gov’t collects taxes to prevent free riders from taking advantage of public goods and services without paying Ex. Fireworks display Ex. Fireworks display It would be impossible to charge everyone who could see them to pay for them. So city takes the money out of tax dollars It would be impossible to charge everyone who could see them to pay for them. So city takes the money out of tax dollars Ex. Lighthouses, Living on a hippie commune, NPR Ex. Lighthouses, Living on a hippie commune, NPR

Free Riders Any system of voluntary payment falls victim to free riders—they can cripple a business Any system of voluntary payment falls victim to free riders—they can cripple a business Ex. Stephen King’s novel experiment on the internet. Wanted everyone to pay $1 for each chapter every month. Shut down when he found < 50% of readers paid their buck. Ex. Stephen King’s novel experiment on the internet. Wanted everyone to pay $1 for each chapter every month. Shut down when he found < 50% of readers paid their buck.

Market Failures Public goods are an example of a market failure. Market failure: situation where the free market does not distribute resources efficiently. Ex. building roads, street lighting systems

Managing Externalities Externality: side effect that affects someone other than buyer or seller Externality: side effect that affects someone other than buyer or seller Negative Externality- imposes costs on people who were not involved in the econ’ic transaction Negative Externality- imposes costs on people who were not involved in the econ’ic transaction Ex. air and water pollution from factories Ex. air and water pollution from factories

Managing Externalities Positives externalities: create benefits for people who were not involved with economic activity Positives externalities: create benefits for people who were not involved with economic activity Ex. I build a tire factory in Livonia. It will create jobs, bring in other businesses, and increase home values Ex. I build a tire factory in Livonia. It will create jobs, bring in other businesses, and increase home values Gov’t works to increase these positive externalities and limit negative externalities Gov’t works to increase these positive externalities and limit negative externalities Ex. provides free public education to students Ex. provides free public education to students Ex. all cars req’d. to have catalytic converters Ex. all cars req’d. to have catalytic converters Axe commercial Axe commercialAxe commercialAxe commercial

The Gov’t. lowers the cost of doing business in many ways: Provides uniform rules and regulations Ex. contract law Roots out fraud Circulates a sound currency Builds and maintains infrastructure Ex. roads, bridges, locks, and dams Ensures effective regulation and oversight making markets more credible Overall, our gov’t enforces the “rules of the game” in a reasonably fair and efficient way (NOT perfect, but better than many—ex. India)

Government and Technology Gov’t promotes innovation and invention to help maintain the country’s technological advantage by: Gov’t promotes innovation and invention to help maintain the country’s technological advantage by: Funding research and development projects at universities Funding research and development projects at universities Establishing their own research institutions Establishing their own research institutions NASA, NIH NASA, NIH Granting patents and copyright, which are an incentive to innovation (defining and protecting property rights) Granting patents and copyright, which are an incentive to innovation (defining and protecting property rights)

Our gov’t also helps the poor Remember, econ’ic equity is not a goal in a free market econ’y, so wealth is spread unevenly throughout society, which leaves some people below the poverty threshold. As a society, we recognize some responsibility to the very young, the very old, the sick the poor, and the disabled. Gov’t tries to provide a safety net through various programs

Poverty in America A family of four making less than $22,000 a year live below poverty level 12% of U.S. pop A family of four making less than $22,000 a year live below poverty level 12% of U.S. pop Some families are poor for along time, but most move in and out of poverty over the years Some families are poor for along time, but most move in and out of poverty over the years

Redistribution Programs Cash transfers Cash transfers Temporary Assistance for Needy Families (TANF) Temporary Assistance for Needy Families (TANF) Social Security Social Security Collects $ from current workers and redistributes funds to retired and disabled persons Collects $ from current workers and redistributes funds to retired and disabled persons Unemployment insurance Unemployment insurance Provides $ to workers who have lost their jobs as long as recipients offer proof that they are looking for work. Help is only temporary. Provides $ to workers who have lost their jobs as long as recipients offer proof that they are looking for work. Help is only temporary. Worker’s compensation Worker’s compensation Provides state funds to workers injured on the job Provides state funds to workers injured on the job

In-Kind Benefits In-kind benefits are g&s provided for free or at a greatly reduced price Ex. Food stamps, subsidized housing, legal aid Other Gov’t Programs Medical Benefits Medicare, Medicaid, SCHIP Education Numerous programs from pre-K through college

Encouraging Private Action Tax laws allow individuals and corporations to take tax deductions for charitable donations Provide grants and other assistance to organizations that provide social services FYI, contrary to popular opinion, most gov’t benefits do not go to the poor, they go to the middle class in the form of Medicare and s.s.

Sooooo, good gov’t matters! Individuals can’t gather the intelligence, track down terrorists in other countries, do research on bioterrorism, or protect planes and airports Yes, the gov’t takes $ out of your paycheck and therefore takes away the happiness you would’ve had from spending it. But… There are things that make you better off that you can’t buy for yourself. Missile defense system, traffic lights, lower trade barriers with China, regulations on the NYSE, etc.

Mixed Market Circular Flow Federal, State, and Local gov’t take tax dollars from individuals, businesses, and provide services Federal, State, and Local gov’t take tax dollars from individuals, businesses, and provide services ex. Military, Social Security, Print Money, Maintain Roads ex. Military, Social Security, Print Money, Maintain Roads Product and Factor Markets provide resources for gov’t to use to operate Product and Factor Markets provide resources for gov’t to use to operate Ex. Gov’t workers, computers, land Ex. Gov’t workers, computers, land