CHAPTER 3: SECTION 1 Characteristics of Free Enterprise

2. CHAPTER 3: SECTION 1Characteristics of Free Enterprise How Does Free Enterprise Answer the Three Economic Questions? • In a free enterprise economy, business firms will produce the goods that consumers want to buy. For example, General Motors and Ford Motor Company decide what style and make of cars they will produce based on what they think the car-buying public wants to buy. • The individuals who own and manage the business firms decide how goods will be produced.

3. In a free enterprise economy, goods are produced for people who are both willing and able to buy them. For example, a person may have $1,000 to spend on a new computer, but be unwilling to replace his or her old computer. In this case, the potential buyer is able, but not willing, and a sale will not take place.

4. Five Features of Free Enterprise • Free enterprise has five major characteristics: private property, choice, voluntary exchange, competition, and economic incentives. (See Transparency 3-1.) • Private property can be described as any good that is owned by an individual or a business, such as a car, a house, or a piece of machinery. Any good that is owned by the government is referred to as public property.

5. TRANSPARENCY 3-1: Free Enterprise In a free enterprise system, individuals own most, if not all, of the resources.

6. Sometimes the government may have a need for private property. Under the right of eminent domain, the government can take ownership of private property even without the consent of the owner. In such cases, the government will compensate owners for their loss. Eminent domain has been used to obtain private land for such uses as building new schools, highways, and government buildings. • Another key element of free enterprise is freedom of choice. Workers have the right to choose what work they want to do and whom they will work for. Businesses have the right to choose the products they will produce and offer for sale. Likewise, buyers have the right to choose the products they will buy.

7. In free enterprise, individuals have the right to make exchanges or trades that they believe will make them better off. Trading $10 cash for a book is an example of a voluntary exchange. • Free enterprise also gives way to competition. Consumers are likely to benefit from competition between sellers. Workers can also benefit from competition. The competition between employers for labor services will often result in higher wages. • Under free enterprise, money acts as an incentive to produce. If you produce goods and services that people are willing and able to buy, you receive money in return.

8. Laws, Institutions, and Regulations • Free enterprise takes place in many countries, and the economic climate may vary from country to country. Legal systems and institutions can either help or hinder free enterprise.

9. The Circular Flow • Much of what characterizes a free enterprise economy has to do with how the key economic sectors—government, businesses, and households—deal with each other. • A household is defined as an economic unit of one person or more that sells resources and buys goods and services.

10. A picture of what an economy can look like in action may help us better understand how the key economic sectors interact. (See Transparency 3-2.) This circular flow of economic activity shows the relationship between different economic groups. As you can see, the economy is composed of businesses, government, and households. There is a relationship between businesses and households. In addition, both businesses and households have an economic relationship with the government.

11. The Circular Flow of Economic Activity • Households buy goods from businesses and sell resources to businesses. • Both businesses and households pay taxes to the government. • Both businesses and households receive benefits from the government.

12. Examples of goods and services received by households are roads, schools, and national defense. • The circular diagram is useful because it helps us see how a change in one economic activity (such as paying taxes) will lead to a change somewhere else in the economy (such as the amount households spend on goods and services produced by businesses).

13. CHAPTER 3: SECTION 2Profit and Loss in Free Enterprise Profits and Losses • Profit is the amount of money left over after all the costs of production have been paid. Profit exists whenever total revenue is greater than total cost. • A loss occurs when the total cost exceeds total revenue.

14. For example, suppose you sell 10 CD players at $100 each, for a total revenue of $1,000. If it costs you an average of $70 each to produce those CD players, your total cost to produce 10 CD players is $700. Do you have a profit or a loss on your sale of 10 CD players? • (Answer: You show a profit because your total revenue of $1,000 is greater than your total cost of $700.)

15. Profit and Loss as “Signals” • In a free enterprise economy, some businesses are earning profits and some are taking losses. Profits and losses are • signals to the firms actually earning the profits or taking the losses, and • signals to firms standing on the sidelines

16. A firm on the sidelines will see what product is profitable and possibly enter that market. • A firm may discontinue a product that is producing losses, and reallocate its resources to a profitable product. • Resources flow toward profit and away from losses.

17. Practice Price = $10 Number sold = 50 TR = ? $10 x 50 = $500 Average cost = $5 Number sold = 20 TC = ? $5 x 20 = $100

18. CHAPTER 3: SECTION 3The Ethics of the Free Enterprise System Ethics and Free Enterprise Ethics consists of principles of conduct, such as right and wrong, morality and immorality, and good and bad.

19. Free enterprise is considered an ethical system because individuals are allowed to choose their own occupations or professions. • Free enterprise allows for production of goods and services preferred by both the minority and majority

20. An ethical economic system will reward producers for responding to the buying public. Sellers that do not respond to the public end up taking losses and going out of business. • Proponents of free enterprise argue, no economic system can be ethical if it limits people’s freedom.

21. Economic Principles in Key Documents • The Bill of Rights notes that “private property [shall not] be taken for public use, without just compensation.” • The Declaration of Independence lists complaints against Great Britain. One complaint is the king prevented the colonies from “trading with all parts of the world.”

22. The U.S. Constitution states “no tax or duty shall be laid on articles exported from any State.” Important to allow the free trade of goods across state lines.

23. Economic Rights and Responsibilities in a Free Enterprise Economy • People in a free enterprise economy usually share three sets of rights and responsibilities: 1. Open disclosure. The right to sell an item comes with the responsibility to disclose any relevant facts about the item in question.

24. 2. Obeying the law. One has the right to use private property as one wishes, within the limits of the law. 3. Being truthful. The responsibility attached to the right to compete is that one must compete in a truthful, legitimate manner.

25. CHAPTER 3: SECTION 4Entrepreneurs Imagine Being an Entrepreneur An entrepreneur is a person who has a special talent for searching out and taking advantage of new business opportunities. Entrepreneurs play an important role in society by taking risks to develop new products or new ways of doing things that benefit the public.

26. Most people are not entrepreneurs; entrepreneurs are a tiny minority of the population. • What new product can you think of developing? How about a new way of doing something?

27. Entrepreneurs, Profit, and Risk • People will not risk their time and money to develop new products unless they can potentially earn a profit. Not all entrepreneurs are successful. However, a few end up as millionaires and even billionaires, and it is the prospect of such success that motivates entrepreneurs.

28. CHAPTER 3: SECTION 5The Role of Government in a Free Enterprise Economy Government as Enforcer of Contracts • A contract is an agreement between two or more people to do something. • Could the free enterprise system function without a government to enforce contracts? Probably not as well, because the risks of going into business would be too great.

29. Government as Provider of Non-excludable Public Goods • Goods are categorized as two major types: private goods and public goods. • A private good is a good in which one person’s consumption takes away from another person’s consumption. Examples include food and gas. • A public good is a good in which one person’s consumption does not take away from another person’s consumption. An example would be a movie in a movie theater.

30. A public good can be excludable or non-excludable. • An excludable public good is a public good that individuals can be excluded (physically prohibited) from consuming. An example would be a college lecture, which is available only to enrolled students of the college. • A non-excludable public good is a public good that individuals cannot be excluded from consuming.

31. Who will want to produce a nonexcludable public good? Economists say that in a free enterprise system, no one will want to. After all, people will not pay for something they get anyway. However, even in a free enterprise economy, people want non-excludable public goods, such as national defense or flood protection (dams). Who will produce these goods? The government will provide non-excludable public goods and pay for them with taxes.

32. If the government is producing these goods, then how does the public have a say in what goods are produced? U.S. citizens have the right to vote, and they can influence what government does by exercising that right.

33. Externalities • There are two kinds of externalities: negative and positive externalities. • A negative externality is an adverse side effect of an act that is felt by others. • A positive externality is a beneficial side effect of an action that is felt by others.

34. Some people argue that education generates positive externalities. What you learn at school will not only help you earn a living, but also help you become a better citizen and a more informed voter. • Following that argument, if the public benefits from your education and the education of others, then the public should pay for that education. Some people argue that government should pay for all activities that generate positive externalities for society.

35. When it comes to negative externalities, some might say that the role of government is to reduce the negative externalities. Government can reduce the negative externalities through the following: the court system, regulation, and taxation. • If you have a complaint against a negative externality, the courts are available to hear your case and find a resolution. • The government creates regulations, such as speed limits and pollution standards, to deal with negative externalities.