Capitalism & Free Enterprise Economics 101 Capitalism & Free Enterprise

The economic systems

In a Command economy, the government answers the three basic questions …(1) What to produce (2) How to produce (3) For Whom to produce

The government directs economic decision-making

Top-down decision making

Little individual choice

Little competition

the government controls factors of production, sets wages and prices, and makes all major economic decisions

In command economies, there is a central planning agency (Gosplan in the former Soviet Union)

The central planning agency sets production goals and quotas (“Five Year Plans” under Stalin)

Command economies have proven to be less productive than market economies

This is largely because there is little incentive for businesses and workers to perform at high levels

Examples of command economies would be communist countries, such as China (although they have started implementing more capitalist features)

Another type of economic system is a Traditional economy

Traditional Economy – economic decisions based on customs passed down from generation to generation

People supply what they need by hunting, farming, and making things by hand

Everyone has a well-defined role

People share resources

There is little change

There is little innovation, and, as a result, little progress (and little economic growth)

Traditional economies are stagnant compared to market economies

Examples: Native Americans, Eskimos in Alaska, “Developing countries” (non-industrialized “Third World”)

However, most economic systems are mixed economies … combining elements of each!

Mixed Economy – combines basic elements of a pure market economy and a command economy

In a “Socialist” economy, The government controls the major industries (mail, railways, power & other utilities, oil & steel production, health care, education, etc.)

Whereas socialist economies would be considered “command” economies, there is still widespread small-scale private ownership of businesses by private citizens (like in a market economy) There is high, “progressive” taxation that pays for many government programs that benefit its citizens

Wealth is more equally distributed

In the U.S., which is a market economy, the government regulates part of the economy

Why does the government regulate part of our economy Why does the government regulate part of our economy? 1) protect consumers 2) protect workers 3) protect the environment 4) protect businesses (maintain competition)

We’re going to talk more about how the government regulates our economy a wee bit later!

Our government also provides public goods that the private sector does not provide (We’ll talk about that later, too!)

You can even argue that our economy has aspects of socialism (Medicare, The post office, Social Security, Amtrak, etc)

The point being … most economies are mixed economies

Let’s get back to our market economy that we have here in the United States

Market Economy – The three basic economic questions are answered by individual citizens based on the market forces of supply and demand

The U.S. economy is built on capitalism and free enterprise

Capitalism – An economic system in which private citizens own and use the factors of production to seek a profit

Before we examine the Factors of Production, let’s first understand the results (or outputs) of production

Economic outputs can be divided into two categories: GOODS & SERVICES

Goods – A tangible, physical product (Examples: stapler, computer, soda, clothes)

Services – work performed for someone else Services – work performed for someone else. (Ex: getting a haircut, babysitting, teaching)

Factors of Production are needed to produce goods and services IN CAPITALIST ECONOMIES, THE FACTORS OF PRODUCTION ARE PRIVATELY OWNED!

CELL There are 4 Factors of Production To help you learn them, remember this acronym: CELL

The “C” stands for CAPITAL You cannot have Capitalism without Capital So, what is capital?

CAPITAL – man-made materials used to produce goods & services (Ex: tools, machinery, factory, etc.)

Capital is also financial It’s the money necessary to start and run a business

We also have human capital … these are your personal talents, abilities, smarts, education (skill level), motivations, initiatives, etc. that are essential for being successful in business

This is one reason for you to be in school… you are investing in your human capital!

Do you know the difference between a capital good and a consumer good?

An oven in a bakery used to produce pastries is a capital good An oven in your home used to cook your meals is a consumer good Both are ovens, but one is a capital good and the other is a consumer good

The “E” in CELL stands for ENTREPRENEUR

ENTREPRENEURS – The individuals who start new businesses; Entrepreneurs introduce new products; They improve management techniques; Entrepreneurs are innovative risk-takers

Entrepreneurs are driven by the “invisible hand” (self-interest)

Entrepreneurs take a risk in hopes of earning a profit

Entrepreneurs drive the economy because they use factors of production to produce new products

The first “L” in CELL stands for LAND

LAND (Land is shorthand for Natural Resources) – Naturally occurring materials that make production possible Ex: land, trees, minerals,

Another way to look at LAND would be this: Mother Nature’s gifts Another way to look at LAND would be this: Mother Nature’s gifts! What we get from the planet Earth

The 2nd “L” (and 4th Factor of Production) in CELL stands for LABOR

LABOR – The nation’s workforce Labor is also referred to as human resources Labor includes both physical and mental work

White-collar labor Works with the mind; it’s mental labor White-collar labor Works with the mind; it’s mental labor! (Ex: manager, accountant, lawyer, etc)

Blue-collar labor Works with muscles; it’s physical labor Blue-collar labor Works with muscles; it’s physical labor! (Ex: construction worker, mechanic, plumber, etc)

Which does a market economy value more? How do you know? Why?

In a capitalist economy, the factors of production are privately owned by individual citizens. They organize these factors of production to produce goods and services They do this to make a profit!

A capitalist system is a market economy that operates under the laws of supply & demand And, in a true capitalist, market economy … there is free enterprise

Free enterprise – economy in which competition is allowed to flourish with a minimum of government interference

These ideas about free enterprise and competition were first introduced by the Scottish economist, Adam Smith

Adam Smith

Adam Smith – You could call adam smith the founder of modern economics Adam Smith – You could call adam smith the founder of modern economics! His famous book in which he laid out the principles of capitalism and free enterprise is called… The Wealth of Nations (1776) (shortened title)

Adam Smith developed the “Invisible hand” concept

The invisible hand guides the behavior of the buying and seller in the market. So what drives their behavior? Self-interest! The drive for profit! Adam smith wrote all about that in the Wealth of Nations.

Adam smith also coined the phrase, Laissez-Faire – “to be left alone;” the idea that government should not interfere in the marketplace (In other words, Free Enterprise)

Adam smith believed in Free Trade – no trade barriers between countries. He was opposed to tariffs (taxes on imports) and quotas (setting limits on what can be imported)

So, what are the basic principles of capitalism that Adam Smith wrote about?

Capitalism has SIX features (McVepp) Markets Competition Voluntary Exchange Economic Freedom Private Property Profit Motive

MARKETS

MARKETS Where buyers & sellers meet for exchanges Guided by the laws of supply and demand Markets set prices Markets connect different sectors of the economy Free enterprise is limited government control Consumer Sovereignty

Consumer Sovereignty

A consumer is a buyer of a good or service Consumption is buying a good or service for your own personal use The consumer has the power in the marketplace!

The consumer is king (or queen) of the market!

Don’t forget, the consumer is always right!

COMPETITION Competition between sellers Competition between buyers Competition between buyers and sellers Competition increases the quality of products, but lowers the price Competition gives consumers more choice Competition – rewards the most efficient producers and forces the least efficient out of business

VOLUNTARY EXCHANGE Voluntary Exchange – the act of buyers and sellers freely and willingly engaging in market transactions WILLINGNESS & ABILITY are the key concepts. BOTH must be present before a transaction can take place BOTH buyer and seller must feel that they benefit from their exchange, or the transaction will not take place

ECONOMIC FREEDOM Choice is the key element We choose our job/profession We choose what products we buy Businesses choose who they hire Businesses choose what they pay and set working conditions

PRIVATE PROPERTY The private ownership of the factors of production Individuals own businesses in capitalism We are free to own and use our property as we choose as long as we do not interfere with the rights of others These rights give us the incentive to work, save, and invest Also, these rights give incentive to take better care of things

PROFIT MOTIVE Profit – the money left over after all costs of production have been paid People are better off at the end of a period than at the beginning Profit Motive – the driving force behind capitalism (again, Adam Smith called this the “invisible hand”) “Self-interest is good”; “Greed is good” Entrepreneurs are willing to invest in a business venture and risk losing their investment for the chance to earn a profit