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