The Pillars of Free Enterprise

In the United States, out economic system capitalism or free enterprise, and our social and political institutions answer those questions. They have enabled our country to produce more goods and services than any other nation in history.

The free enterprise system rests on certain traditions, beliefs and practices that set it apart from other economic systems. These “pillars” of our economic system are private property, the price system and competition.

Private property. Unlike people in many other parts of the world, Americans are able to own property for business purposes and use it to produce income. Nearly 90% of the goods and services produced in this country each year come from privately earned firms.

The right to private property gives the owners of natural resources and capital the incentive to use their assets as efficiently as they can. Why? Because property owners know they will make profit if they can produce goods and services that buyers want, at a price they are willing to pay. The advantages of private property and its incentives were summarized by “the father of modern economics”, Adam Smith, in his famous book The Wealth of Nations.

1 What are the “pillars” of American economic system?

2 What does the right to private property give the owners of natural resources and capital? Why?

3 What book summarizes the advantages of private property and its incentives?

Free Enterprise: the Theory and the Reality

Adam Smith, the father of economics described a world in which the economy ran itself. Government played only the smallest role. Smith described this point of view by relating the story of a French official who asked a manufacturer what the government could do to help him. “Laissez-nous faire” (“leave us alone”) was his reply. To this day, the term “laissez faire” refers to a policy of limiting government’s ability to regulate business.

Government in America functions at three levels: federal, state and local. Despite the fact that ours is a free enterprise system, buyers and sellers must share economic power with government. This sharing of power places limits on the freedom we associate with private property, the price system, and competition. For example, governments:

- compel people to sell their property for public use through the power of eminent domain;

- decide who may sell electric power in a geographic region;

- control which machines may be sold commercially;

- license certain businesses (such as banks, barber shops, taxi cabs and restaurants);

- pay dairy farmers for not producing as much milk as they can;

- forbid export of certain machinery to specific foreign countries;

- establish the minimum wages employers must pay;

- issue permits for and inspect construction of homes and buildings.

1What is the essence of the term “laissez faire”?

2 What are the three levels of American government?

3 In what cases does the government show its power?

II

The Price System. One of the remarkable things about the American economic system is that it seems to run by itself. No central economic agency dictates responses to What, How and Who questions. Yet the questions are answered.

Prices determine what we are willing and able to buy. They influence us to continue in school or to accept a job. Prices help to determine what and where factories will be built, which businesses will succeed, which will fail, and even the color and style of the clothing that will be manufactured.

Prices, the money value of goods and services, carry so much information and so affect the behavior of buyers and sellers that economists often describe our economy as a price-directed system.

The price system provides the answers to the fundamental questions of What goods and services will be produces, How they will be produced, and Who will receive them.

1 What is the role of prices in American economic system?

2 Why is American economic system called price-directed system?

3 What are the fundamental questions that price system provides the answers to?

How the price system answers the What question. When buyers want more of a product, they are willing to pay more for it. Higher prices attract other producers. As production increases, the need for additional workers causes wages to rise within the industry. When demand for the product fails, the opposite happens. Prices fall, producers who can no longer operate profitably shut down, or switch to other products, and production falls enough to meet the reduced demand.

How the price system answers the How question. The price system encourages sellers to produce in such a way as to costs and maximize profits.

Stanly Lee owns a newspaper delivery service. Stanly used to rely on 10 to 15 kids with bicycles to deliver the newspapers before and after school. One day Stanley calculated that it would cost less to use one adult with an automobile than 15 kids on bicycles to deliver his newspapers. He laid off the school kids and hired the adult.

How the price system answers the Who question. Those who graduate from high school earn more, on the average, than those who drop out. Many professional athletes earn more than letter carriers. Physicians and attorneys earn more, on the average, than stenographers and building superintendents.

Since they earn more, professional athletes, physicians and attorneys can afford to buy more goods and services than people earning less than they do. Thus, by assigning values to the work people do, the price system answers the Who question.