IIn the United States, economic opportunity is abundantly

evident, from corporate headquarters in gleaming cities

like Miami, shown here, to neighborhood mom-

and-pop businesses, to drive-through franchises in

suburban strip malls. This chapter examines the

benefits of American free enterprise and the factors

that make it so prosperous, adaptive, and enduring.

American Free Enterprise

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In what ways do the benefits of free

enterprise affect your daily life? List

as many examples as you can.

Consider neighborhood businesses,

jobs you have held, and other ways

in which you benefit from our

nation’s prosperity.

Economics JournalEconomics Journal

SSome of the most famous Americanshave not been politicians, sports

figures, or actors. Do you recognize nameslike John D. Rockefeller, founder ofStandard Oil of New Jersey, or AndrewCarnegie, who started Carnegie SteelCompany, or Bill Gates, the founder ofMicrosoft? Each of these people startedwith an idea and through persistence,vision, and effort built that idea into a hugebusiness success. They made themselvesinto the richest people of their time, helpedfuel the economy, and contributed vastsums of money to programs and charitiesfor the public good.

A Tradition of Free Enterprise Today there are over 18 million unincorpo-rated businesses in America, includingabout 3 million minority-owned busi-nesses. Many of these were started by asingle entrepreneur or a small group offriends or family members hoping to earn aliving and, perhaps, become successful oreven wealthy.

For centuries, people have consideredAmerica to be a “land of opportunity”—aplace where anyone from any backgroundcould achieve success through hard work.

Although immigrants no longer expect tofind streets paved with gold, this countrydoes offer special opportunities that haveallowed business people to be sosuccessful and have contributed to ouroverall economic prosperity.

Why has America been such an economicsuccess? Certainly the open land, naturalresources, and uninterrupted flow of immi-grants with different backgrounds andexperiences all contribute. But a key factorhas also been the American tradition of freeenterprise—the social and politicalcommitment to giving people the freedom

Benefits of Free Enterprise

Preview

ObjectivesAfter studying this section you will be able to:

1. Describe the tradition of free enterprise in

the United States and the constitutional

protections that underlie it.

2. Explain the basic principles of the U.S. free

enterprise system.

3. Identify the role of the consumer in the U.S.

free enterprise system.

4. Describe the role of the government in the

U.S. free enterprise system.

Chapter 3 n Section 1 51

Section FocusAmerican free enterprise is based on

the principles of profit motive,

voluntary exchange, private property

rights, competition, and freedom for

producers and consumers. The U.S.

Constitution supports the free

enterprise system by guaranteeing

private property rights, the right to

make contracts, and freedom from

unfair taxation.

Key Termsprofit motive

open opportunity

private property rights

free contract

voluntary exchange

competition

interest group

public disclosure laws

public interest

. How does thisphoto represent theAmerican freeenterprise system?

52 American Free Enterprise

and flexibility to try out their business ideasand compete in the marketplace.

Constitutional ProtectionsThe Bill of Rights to the United StatesConstitution guarantees certain individualfreedoms, such as freedom of speech andfreedom of religion. The Constitution alsoguarantees important rights that allowpeople to engage in business activities.

Property RightsThe most important of these is the constitu-tional recognition of property rights. Inmany other countries, even in moderntimes, the king or other ruler has had thepower to take people’s property for his ownuse. Early American statesmen wanted toprotect against this, so they includedproperty as a protected right under the FifthAmendment. It is a right just as importantas the other individual rights. The FifthAmendment states that no person shall

“be deprived of life, liberty, or property,without due process of law; nor shallprivate property be taken for public use,without just compensation.”

Since the Fifth Amendment applies onlyto actions by the federal government, theFourteenth Amendment, ratified in 1868,also includes a due process clause extendingthe same limitation to the state govern-ments. These due process clauses preventthe government from taking property awayfrom an individual except when there is apublic reason—and even then the govern-ment must pay the person the fair value ofthe property that has been taken. Theserights apply to corporations as well, sobusinesses get the same protection fromgovernment seizure that individuals enjoy.

TaxationThe Constitution also contains the basicrules for the ways in which the governmentcan tax individuals and businesses. Congresscan only tax in the ways the Constitutionallows. Article I gives Congress the power tolevy taxes, but Sections 2 and 9 require that

Figure 3.1 Features of American Free EnterpriseFigure 3.1 Features of American Free Enterprise

Private Property Individuals and

businesses have the right to buy

and sell as much property as they

want. Property owners may prohibit

others from using their property.

Contracts Individuals and

businesses have the right to make

agreements to buy and sell goods.

Such contracts may be written or

oral. They are legally binding.

Economic Freedom In the United States,

individuals have the right to choose their

occupations and to work wherever they

can find jobs. Businesses can make their

own decisions on whom to hire, what to

produce, how much to produce, and how

much to charge for their products and

services. The government generally does

not interfere in these decisions.

Self-Interest Consumers and

producers may make decisions on

the basis of their own benefit. Their

decisions do not have to benefit or

please the government or other

consumers and producers.

Profit Motive American free enterprise

is driven by the desire for profit, the

gain that occurs during financial

dealings. Profit is a powerful incentive

that leads entrepreneurs and

businesses to accept the risk of

business failure.

Voluntary Exchange Consumers

and producers may freely buy

and sell goods when the

opportunity costs of such

exchanges are worthwhile. In a

voluntary exchange, both parties

expect to gain from the

transaction.

Free enterprise in America is founded on ideas so basic toour culture that we tend to take them for granted.Government Choose one of these features and give anexample from your own daily life.

Competition Producers have the

right to engage in rivalries to gain

business. Competing producers

have an incentive to create new

and better products. This gives

consumers more economic choices.

direct taxes be apportioned according topopulation so that everyone will pay thesame amount. The Sixteenth Amendment,ratified in 1913, first gave Congress the clearright to set taxes based on income.

Finally, the Constitution guaranteespeople and businesses the right to makebinding contracts. Article I, Section 10prohibits the states from passing any “Lawimpairing the Obligation of Contracts.”This means that individuals or businessescannot use the political process to getexcused from their contracts. No legisla-ture can pass a law changing the terms ofsomeone’s business agreement.

Basic Principles of

Free Enterprise Our free enterprise economy has severalkey characteristics. These include profitmotive, open opportunity, legal equality,private property rights, free contract,voluntary exchange, and competition.

Profit Motive The American economy rests on a recogni-tion of the importance of the profit motive—the force that encourages people and orga-nizations to improve their materialwell-being. Under other economic systems,the government may control business activ-ities, deciding what companies will beformed and how they will be run. In a freeenterprise system, business owners andmanagers make these choices themselves,operating in ways they believe willmaximize their profits. This approachforces management to exercise financialdiscipline because it makes people economi-cally responsible for their own success orfailure. It rewards innovation by lettingcreative companies grow, and it improvesproductivity by allowing more efficientcompanies to make more money.

Open Opportunity The United States economy also benefitsfrom a strong tradition of open opportunity,

the concept that everyone can compete in

the marketplace. We acceptthat different people anddifferent companies will havedifferent economic outcomes,depending on their success inthe marketplace. This allowseconomic mobility up ordown: no matter how muchmoney you start out with, youcan end up wealthier orpoorer depending on howwell your business performs.

Economic RightsWe also have a commitmentto legal equality—by givingeveryone the same legal rights,we allow everyone to compete in theeconomic marketplace. Countries thatrestrict the legal rights of women or minori-ties lose the productive potential of a largeportion of their society. Legal equality maxi-mizes a country’s use of its human capital.

Another essential component of theAmerican free enterprise system are private

property rights, the concept that people havethe right and privilege to control theirpossessions as they wish. The free enterprisesystem allows people to make their owndecisions about their own property.

The right of free contract allows people todecide what agreements they want to enterinto. The right of voluntary exchange allowspeople to decide what and when they wantto buy and sell, rather than forcing them tobuy or sell at particular times or at specificprices. Because of all these rights, we haveextensive competition, the rivalry amongsellers to attract customers while loweringcosts. Competition provides consumers withthe choice of a larger variety of goods, mostof which are sold at reasonable prices.

The Role of the ConsumerA fundamental purpose of the free enter-prise system is to give consumers thefreedom to make their own economicchoices. Consumers make their desiresknown through their economic dealingswith producers. When consumers buy

profit motive the force

that encourages people

and organizations to

improve their material

well-being

open opportunity the

concept that everyone

can compete in the

marketplace

legal equality the

concept of giving

everyone the same

legal rights

private property rights

the concept that people

have the right and

privilege to control

their possessions as

they wish

free contract the

concept that people

may decide what

agreements they want

to enter into

voluntary exchange the

concept that people

may decide what and

when they want to buy

and sell

competition the rivalry

among sellers to attract

customers while

lowering costs

Chapter 3 n Section 1 53

In the News Read more about basic

principles in free enterprise in

“Expanding First Amendment,” an

article in The Wall Street Journal

Classroom Edition.

The Wall Street Journal

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products, they signal to producers what toproduce and how much to make.

Consumers can also make their wishesknown by joining an interest group, which isa private organization that tries topersuade public officials to act or voteaccording to the interests of the group’smembers. Interest groups have formedaround many economic issues, such astaxation, aid for farmers, and land use.

The Role of the Government We expect the government to carry out itsconstitutional responsibilities to protectproperty rights, contracts, and other businessactivities in our free enterprise system. Eventhough such protections are not spelled outin the Constitution, many Americans expectprotection from problems that affect us all,such as pollution or unsafe foods.

Information and Free Enterprise In a free market system, consumer buyinghabits determine what goods get produced.But consumers will not be able to makeinformed choices if they cannot get basicinformation about the products they arebuying. In other words, educated consumerswill make the free market system work moreefficiently. Because of this, one of the govern-ment’s important roles in the economy is tomake sure that producers provide consumerswith information.

Consumers use government informa-tion to protect themselves from dangerousproducts and fraudulent claims. Public

disclosure laws require companies to giveconsumers important information abouttheir products. Often this informationwill be attached to the product when it isoffered for sale in stores. You may haveseen fuel efficiency labels on new cars, orenergy efficiency tags on refrigerators orair conditioners. Using this information,consumers can evaluate some importantaspects of the products they are consid-ering buying.

Protecting Health, Safety, and Well-Being Federal and state agencies regulate indus-tries whose goods and services affect thewell-being of the public. (See Figure 3.2.)Although the government does not getdirectly involved in running private busi-nesses, it does impose various restrictions.

Businesses must follow certain environ-mental protection rules. Gas stations, forexample, must dispose of used motor oilproperly and ensure that gas tanks cannotleak into surrounding soil. Both individualsand businesses are subject to local zoninglaws. These laws may forbid homeownersfrom running businesses out of their homes.

In addition, until the mid-1900s, manu-facturers of cars, food, medicine, and otherproducts affecting people’s health and well-being were largely unregulated. Starting inthe 1960s, however, the federal governmentand many states became actively involved ineconomic matters of public interest, theconcerns of the public as a whole.

interest group a private

organization that tries

to persuade public

officials to act or vote

according to group

members’ interests

public disclosure laws

laws requiring

companies to provide

full information about

their products

public interest the

concerns of the public

as a whole

New Business in Russia Starting a new business in Russia is no

easy task. The average new business applicant has to deal with 20 to 30

agencies and needs from 50 to as many as 90 approved registration forms. In

addition, many businesses have to pay bribes to government officials for start-

up licenses. Because the Russian economy is unreliable, banks are reluctant to

lend to new businesses. Taxes are often unpredictable and can be very high.

There are a vast number of different taxes that apply to almost every aspect of

business life, and filling out the tax forms can be time consuming and expensive.

As a final roadblock, a few large companies often control virtually an entire

industry, making it difficult for new businesses to break in.

Global Connections

m From whataspects of the freeenterprise systemare these studentsbenefiting?

54 American Free Enterprise

Chapter 3 n Section 1 55

A key part of this new governmentactivity was consumer protection. To thisend the government sets manufacturingstandards, requires that drugs be safe andeffective, and supervises the sanitary condi-tions in which foods are produced. Labelson consumer packages must include infor-mation about safe operation of equipmentor expiration dates for perishables.

Negative Effects of Regulation Government regulation, however, can havenegative effects on both businesses andconsumers. During the 1960s and 1970s,popular demand for government protectionof consumers and of the environmentresulted in the creation of new govern-mental agencies and regulations. Businessespointed out that the rules were costly toimplement, cutting into profits, slowinggrowth, and forcing them to charge unnec-essarily high prices. Highly regulated indus-tries, such as the airlines and telephonecompanies, pointed out that governmentrules and regulations stifled competition,resulting in prices that were arbitrarily high.The growth in government oversight ofindustry also raised government spending.

In the 1980s and 1990s, public pressurefor leaner, less costly government resulted inbudget cuts that curtailed some governmentregulation of industry. President George W.

Bush’s administration worked to be moresensitive to the economic considerationsraised by businesses.

Section 1 Assessment

Key Terms and Main Ideas1. Explain the importance of the following terms in the U.S.

free enterprise system: (a) profit motive, (b) voluntaryexchange, (c) private property rights, and (d) competi-tion.

2. What constitutional guarantees underlie the American

free enterprise system?

3. Explain at least three benefits of the free enterprise

system.

Applying Economic Concepts

4. Critical Thinking What are some opportunity costs of a

greater government role in the economy?

5. Decision Making Explain how the decisions you make

as a consumer influence the economy.

6. Critical Thinking What is the impact of economic

concepts in the U.S. Constitution on contemporary

economic issues and policies? Use specific examples

from the chapter to support your conclusions.

This table shows a few of the many federal regulatoryagencies. Government Might the free market fulfill themission of any of these agencies? Give an example.

Agency and Date Created Role

1906 Food and DrugAdministration (FDA)

Sets and enforces standards for food, drugs,and cosmetic products

1914 Federal TradeCommission (FTC)

Enacts and enforces antitrust laws to protect consumers

1934 Federal CommunicationsCommission (FCC)

Regulates interstate and international communicationsby radio, television, wire, satellite, and cable

1958 Federal AviationAdministration (FAA)

Regulates civil aviation, air-traffic and pilotingstandards, and air commerce

1964 Equal EmploymentOpportunity Commission (EEOC)

Promotes equal job opportunity through enforcementof civil rights laws, education, and other programs

1970 Environmental ProtectionAgency (EPA)

Enacts policies to protect human health and thenatural environment

1970 Occupational Safety andHealth Administration (OSHA)

Enacts policies to save lives, prevent injuries, andprotect the health of workers

1972 Enacts policies for reducing risks of harm fromconsumer products

1974 Nuclear RegulatoryCommission (NRC)

Regulates civilian use of nuclear products

Consumer ProductSafety Commission (CPSC)

Figure 3.2 Major Federal Regulatory AgenciesFigure 3.2 Major Federal Regulatory Agencies

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