1. Chapter 2: Free enterprise & other economic systems

2. Three basic Economic Questions
What should be produced?
How should these good & services be produced?
Who consumes these goods & services?
Interactive Chart
Three basic Economic Questions

3. Three Basic Economic Questions
This illustration shows two different approaches to the question of how to combine the factors of production. Analyze Information Which approach is most efficient? Explain your answer.

4. Based on how society answers the 3 economic questions
Structure of methods and principles a society uses to produce and distribute goods and services
Based on how society answers the 3 economic questions
Economic System

5. Economic Goals of Society
Efficiency
Freedom
Security
Equity
Growth
Conflicting Economic Goals

6. Little room for change/innovation Revolves around family unit
Relies on habit, custom, or ritual to answer the three basic economic questions
Little room for change/innovation
Revolves around family unit
Work divided by gender
Small, close communities
Agricultural and hunting/gathering societies
May not have money economy
Low standard of living
Traditional Economy

7. Market: arrangement that allows buyers and sellers to exchange things
Can’t be self-sufficient
Specialization: concentration of the productive efforts of individuals and businesses on a limited number of activities
Interactive Chart
Free Markets

8. Characteristics of a free market:
Answer 3 economic questions by the voluntary exchanges in the market
Individuals decide what is made, how much is made, and how people get it
Businesses decide what to buy and sell
Also called capitalist economy because capital of businesses is vital
Free Markets

9. Households: person or group living in a home Provide labor for firms
Free Markets
Households: person or group living in a home
Provide labor for firms
Provide capital by investing
Consume goods and services
Firms: businesses or organizations that use resources to produce services
Use factors of production to produce goods and services
Pay households for labor
Factor Market: where firms buy land, hire workers, pay them in paychecks, borrow money in the form of investment, pay households returns on investments
Product Market: When households buy stuff from firms
3D model

10. Elements of a Free Market Economy
The circular flow model shows the interaction between households and firms in a free market. Analyze Charts What is the primary item that changes hands in the monetary flow?

11. How Markets Self Regulate:
Adam Smith: “The Wealth of Nations”
Economy made up of many transactions
In the exchanges, buyers & sellers worry about their own self-interest (personal gain)
Consumers have incentive (hope of reward or fear of penalty) to find the lowest price
Firms have incentive to sell for the highest profit
Firms have incentive to compete (struggle among producers for dollars of consumers) for business
Invisible hand that regulates the marketplace is made of self interest and competition
Benefits:
Better prices
Better product
More variety
Innovation
Interactive Gallery
Free Markets

12. How Markets Self-Regulate
In a free market, incentives of all sorts influence individuals to act in their own self-interest. Identify Central Ideas Use one of the examples from this diagram to explain how the incentive given leads to the response indicated.

13. Advantages of Free Markets
Economic Efficiency
Self regulating
Responds quickly
Economic Freedom
Work where we want
Make what we want
Consume what we want
Economic Growth
Competition encourages innovation
Additional Goals
Wide variety of goods & services
Consumer sovereignty: consumers have power to decide what gets produced
Advantages of Free Markets

14. Government bureaucracy Also called command economies
Centrally Planned Economy: The government, not the consumers and producers, answer the three basic economic questions
Government bureaucracy
Also called command economies
Oppose private property, free market prices, compeition, consumer choice
Centrally Planned

15. Communism: central government owns and controls all resources & means of production and makes all economic decisions
Socialism: range of economic & political systems based on the belief that wealth should be evenly distributed through society

16. Centrally Planned Economies comparing chart
Disadvantages:
Economic Efficiency
Workers lack incentive to work faster/produce more b/c government controls pay
Bureaucracy takes a long time to adjust to demands and conditions
Economic freedom:
Sacrifice individual freedom for societies goals
Discourages competition
Takes choices from producers/consumers
Economic growth:
No reward fro innovation
Discourage change
Economic equity:
Government still play favorites
Some with higher income have more access to high quality goods
Ordinary people suffer shortages or poor quality products
Additional Goals
Guarantees jobs & income
Good for jump starting certain industries
Centrally Planned Economies comparing chart
A woman shops in a mostly empty Soviet food store in 1990.

17. Degree to which government is involved varies from nation to nation
Mixed Economy: some market based elements and some government involvement
Degree to which government is involved varies from nation to nation
Laissez Faire: doctrine that says government GENERALLY should not get involved in the economy
Defense, highways, public education
Private Property: property can be owned by individuals or companies and not the government or people as a whole
Eminent Domain limits
Intellectual Property: books, songs, movies that have been created
Mixed Economies

18. How much are you willing to pay in taxes?
Mixed Economies
Find the balance:
What will you give up?
How much are you willing to pay in taxes?
What would you be willing to pay for?
Unemployment
Military
Education
Roads & bridges
New stadiums

19. Mixed economies Interactive Chart
Government in the Factor Market:
Act like firms by buying land, labor and capital
US 3 million employees over $150 billion a year in labor
Government in Product Market:
Act like households in that they buy stuff from firms
Also act like firm b/c people buy goods and services from the government
Mixed economies Interactive Chart

20. Transfer payment: transferring money it collects to people and businesses as part of the factor market
Mixed Economies

21. Mixed Economies Interactive Chart
Mixed Economies today:
Continuum of government involvement
Some a lot of government, little free
Others little government, very free
Some transitioning: moving from one system to another (China)
Must privatize: selling enterprises operated by governments to individuals and allowing them to compete
Difficult
Mixed Economies Interactive Chart

22. Mixed economy founded in free enterprise system
Individual & corporate ownership
Private investments
Government Roles:
Keep order
Provide vital services
Promote general welfare
Protect private property
Minimal regulation
Overall Freedom:
Very high
Few limits
Chose our work, where to live
Chose to enter business
Chose what business to enter
Chose how to operate
Open to foreign investment
The US Economy

24. Benefits of Free Enterprise
Opportunity
27 million businesses
6 million by minorities
“land of opportunity”
Incentives
Profit
Low prices, high wages
Personal satisfaction
Avoiding penalties (taxes)
Profit Motive
Drives individuals and businesses to make decisions that improve their material well being
Competition:
Better price
Technology/innovation
Better product
Better variety
Open opportunity: principle that anyone can compete in marketplace
Legal Equality:
everyone has the same legal rights
Private Property Rights:
control your own possessions & use as wish
Economic Freedom:
Free contract: decide what agreements they want to enter into
Voluntary Exchange: allows consumers and producers to decide what, when and how they buy & sell
Benefits of Free Enterprise

25. Benefits of Free Enterprise
Role of Consumer in Free Enterprise System:
Can tell firms what they want and how much to produce based on what they do and don’t buy
Can communicate with interest groups
Private organization that tries to persuade public officials to act in ways that benefit its members
Role of the Entrepreneur:
Fuel growth by combining factors of production in new ways
Benefits of Free Enterprise

26. Benefits of Free Enterprise
Limited role of the Government:
Information
Public disclosure laws: give consumers important info about the products or services they offer
Protect the health, safety, and well being
Negative effect of regulation is higher taxes, more money to comply, can lead to less competition
Benefits of Free Enterprise

27. Supporting Economic Growth
Macroeconomics: study of economic behavior and decision making in a nation’s whole economy
Large scale
Microeconomics: study of economic behavior and decision making in a smaller units, such as households and firms
Small scale
Supporting Economic Growth

28. Supporting Economic Growth Interactive Graph
GDP Measures Business Cycles:
GDP: Gross Domestic Product
The measure of a nations wealth
The total value of all final goods and services produced in a country in a given year
Business Cycle: alternating pattern of expansion and contraction
Expansion
Peak
Contraction
Trough
GDP higher in expansion
GDP lower in contraction
Supporting Economic Growth Interactive Graph

29. Supporting Economic Growth
Encouraging Economic Strength
Maximum Employment
Healthy unemployment rate 4-6%
Governments may encourage job growth if unemployment rises too fast
A Growing Economy
Higher standard of living
Increasing GDP
May see governments cut taxes or increase spending
Stability
Confidence for investors
Price levels fairly fixed
Secure Financial Markets
Banks & stock market functioning well
Government regulations to protect people
Economic Citizenship
Voting for people with economic policies in mind
More say at state & local level with referendums
Laws submitted directly to people on ballots
Supporting Economic Growth

31. Supporting Economic Growth
Productivity & the Role of Technology
Technological Progress
Improved technology = higher productivity
Helps economy function efficiently
Increases GDP
Gives US businesses an advantage over other countries
Side effect:
Obsolescence: older products & processes become out of date
Encouraging Innovation
Morrill Acts 1862 & 1890 created land grant colleges
Texas A&M, MIT, long history of innovation
Government research institutions like NASA
Patents: inventors have exclusive rights to produce & sell new product for 20 years
Copyrights: author, musician, etc. exclusive rights to public and sell his/her creative works
American Work Ethic
Commitment to the value of hard work
Work hard & care about the quality of the work you do
Supporting Economic Growth

32. Public Goods & externalities
Shared good or service for which it would be impractical or inefficient to make consumers pay for individually or to exclude those who don’t pay
NASA, public parks, defense, roads & bridges, dams or flood services
Many people can use them without reducing the benefits to any single consumer
Financed by the public sector
Public sector is transactions of the government
Private sector is transactions with businesses
Private sector has little incentive to produce public goods
Public Goods & externalities

33. Cost & benefits:
Infrastructure: basic facilities that are necessary for a society and economy to function efficiently and grow
Transportation, electricity, internet, bridges, canals, dams, clean water, gas
Should it be a public good?
1. Benefit to each individual is less than the cost that each would have to pay if they were to provide it privately.
2. Total benefits to society are greater than the total cost.
Boils down to efficiency in producing goods & services

34. Public Goods & Externalities
Free Riders
Problem with public goods
Someone who would not be willing to pay for a certain good or service, but would get the benefit of it anyway if it were provided as a public good
Consume what they don’t pay for
If the government relied on voluntary contributions to fund public services, many would refuse, and many services would be eliminated

35. Public goods & externalities
Market Failures:
Describes a specific situation in which the free market, operating on its own, does not distribute resources efficiently
No profit for private sector
That’s why it becomes a public good

36. Public goods & externalities interactive before and after
Unintended economic side effect of a good or service
Could be good and give people unintended benefits (positive externality)
Could be bad and have unforeseen costs to a person (negative externality)
Government goals: sign of market failure because the costs or benefits are not assigned properly
Government may take action to create positive externalities
Government should limit negative externalities
Economists want the government to allow market driven solutions to some problems (environmental) because many think the private sector can better reduce negative externalities
Public goods & externalities interactive before and after

37. Public goods & externalities
Poverty Problem
15% of Americans live in poverty
Higher for children
Government programs take money from some and redistribute it to others
Many say it violates principle of limited government intervention
Free market is good at generating wealth, but it is unevenly spread
Poverty threshold: income level below that which is needed to support families
2012 single adult with 1 child is $15, 825
2012 family of four, 2 adults, 2 kids, $23, 283
Government helps old, sick, poor and disabled with safety net programs
Raise people’s standards of living to purchase needed goods and services
Welfare system: a general term for government programs that help the poor
Since 1930’s but revised under Johnson
Attacked since 1980’s
Unwilling & unable to get off of it
Argues that it discourages productivity and actually increases or enables poverty
1996 changes in number of people and how long could recieve
Public goods & externalities