EXERCISE 4. Prepare short reports on the following topics. The reports are to be translated in the class

· What does economics study?

· The first modern economists.

· Types of economic systems.

2. THE AMERICAN ECONOMIC SYSTEM

The Pillars Of Free Enterprise

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 areprivate property,theprice system andcompetition.

Private Property. Americans are able to own property for business purposes and use it to produce income. Nearly 90 percent of the goods and services produced in this country each year come from privately owned 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 a 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 work, The Wealth of Nations.

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 the 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 when 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 produced, How they will be produced, and Who will receive them.

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 falls, 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 minimize costs and maximize profits.

Stanley Lee owns a newspaper delivery service. Stanley 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 10 to 15 school kids on bicycles to deliver his papers. 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 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.

Competition refers to the rivalry among buyers and among sellers. Sellers compete by trying to produce the goods and services buyers want at the lowest possible price. Those unable or unwilling to sell at a price low enough to attract buyers will be unable to dispose of their goods or services. This rivalry benefits us all.

· It benefits us by giving us the goods and services we want, when and where we want them. Producers know that if they don't satisfy consumer demand, their compe­titors will.

· It benefits us because producers must constantly strive to operate more efficiently. The quest for greater efficiency conserves scarce resources, increases output and raises living standards by reducing costs.

Buyers compete with one another because there is never enough of everything to go around. Those willing to pay the price can buy steak. Those unwilling or unable to pay will substitute a less costly product like chopped meat, chicken or hot dogs. In other words, in the rivalry among buyers of steak, those unable to pay the price will lose to those who are able to pay.

The History of Economic Thought

Adam Smith And The Wealth Of Nations

Engraving:

The Bettmann Archive.

Seventeen seventy-six, the year that we associate with the signing of the Declaration of Independence, also marked the publication in England of one of the most influential books of our time, The Wealth of Nations. Written by Adam Smith, it earned the author the title "The father of economics."

Smith objected to the principal economic beliefs of his day. He differed with the physiocrats who argued that land was the only source of wealth. He also disagreed with the mercantilists who measured the wealth of a nation by its money supply, and who called for government regulation of the economy in order to promote a "favorable balance of trade."

In Smith's view, a nation's wealth was dependent upon production, not agriculture alone. How much it produced, he believed, depended upon how well it combined labor and the other factors of production. The more efficient the combination, the greater the output, and the greater the nation's wealth.

The heart of Smith's economic philosophy was his belief that the economy would work best if left to function on its own without government regulation. In those circumstances, self-interest would lead business firms to produce only those products that consumers wanted, and to produce them at the lowest possible cost. They would do this, not as a means of benefiting society, but in an effort to outperform their competitors and gain the greatest profit. But all this self-interest would benefit society as a whole by providing it with more and better goods and services, at the lowest prices.

To explain why all society benefits when the economy is free of regulation, Smith used the metaphor of the "invisible hand":

"Every individual is continually exerting himself to find the most advantageous employment for whatever capital he can command. It is his own advantage, and not that of society, which he has in mind, … but he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his inten­tion, for the pursuit of his own advantage necessarily leads him to prefer that employment which is most advantageous to society."

The "invisible hand" was Smith's name for the economic forces that we today would call supply and demand, or the marketplace. He sharply disagreed with the mercantilists who, in their quest for a "favorable balance of trade," called for regulation of the economy.

Instead, Smith agreed with the physiocrats and their policy of "laissez faire," letting individuals and businesses func­tion without interference from government regulation or private monopolies. In that way, the "invisible hand" would be free to guide the economy and maximize production.

The Wealth of Nations goes on to describe the principal elements of the economic system. In a famous section, Smith turned to the pin industry to demonstrate how the division of labor and the use of machinery increased output.

"One man draws out the wire, another straightens it, a third cuts it, a fourth points it, a fifth grinds it at the top for receiving the head; to make the head requires two or three distinct operations. ..."

Although modern technology has improved the methods by which pins are produced, the principles pertaining to the division of labor remain unchanged.

Similarly, other sections dealing with the factors of produc­tion, money and international trade are as meaningful today as when they were first written.

You can see, therefore, that Thomas Jefferson's Declaration of Independence and Adam Smith's The Wealth of Nations have more in common than a birthday. More importantly, both contain some of the best descriptions of the principles upon which our political and economic systems are based.

The Role Of Government In The American Economy

What ought to be the role of government in the economy? This question has been debated since the founding of our republic. Today's economists are divided over government's role. Some, like Adam Smith, would argue for the return of laissez faire, reducing the government's role in economic affairs. Others favor more active participation. Despite their differences, however, almost all would agree that the following economic responsi­bilities are best fulfilled by government:

· Safeguarding the market system;

· Providing public goods and services;

· Dealing withexternalities;

· Assisting those in need;

· Helping specific groups;

· Stabilizing the economy.

Let's take a closer look at government's economic responsibilities.

Safeguarding the Market System. In the world that Adam Smith described, many small business firms competed for the consumer's dollar. Competition forced sellers to produce the things consumers wanted, at the lowest possible prices. Sellers whose products did not measure up in price or quality lost sales and faced the chance of failure. Meanwhile, the ongoing efforts to reduce costs and improve quality resulted in a more efficient use of the economy's limited resources.

Quite the opposite is true where there is little or no competi­tion. Consumers cannot take their business elsewhere, nor is the need to reduce costs and eliminate waste as urgent. Prices in these circumstances are determined by the producers them­selves rather than in the marketplace. For these reasons, a lack of competition is likely to lead to higher prices, wasted resources, and lower living standards since the public would be able to afford fewer goods.

To protect the market system, Congress and the state legisla­tures have enactedantitrust legislation. These laws prohibit practices that reduce competition and increase the power of monopolies. Monopolies are firms that have so much control over a market that they can set the price at which their goods are sold.

The federal government has also taken steps to encourage competition. In recent years, rules and regulations affecting the airline, trucking, and banking industries have been adjusted to allow more competition.

Providing Public Goods and Services. Every business day commuters slowly make their way through traffic to and from their jobs. Along the way, they see many reminders of govern­ment's role in the economy. The roads they travel, the traffic lights and signs, the police and highway maintenance crews are furnished by government.

Government provides these goods and services because private enterprise is unable, or unwilling, to do so. Items that cannot be provided by the market system and so must be furnished by government are known aspublic goods and services.National defense, street lighting, parks, airports and mosquito control are examples of public goods and services.

There are two reasons the market system does not provide public goods and services:

1. There is no easy way to charge individual users or to exclude them from the benefits of the service.

· Street lamps light the way for all in a downtown neighborhood. There is no way that those who did not pay for this service could be excluded from benefiting from the lights.

· The benefits of a national highway system and the protection provided by a country's armed forces, for example, extend to all citizens.

2. Anticipated profits from the product or service do not justify a private firm's investment.

· Local, state, and national parks are so expensive to build and maintain that private companies could not charge high enough entry fees to make a profit.

· The expense of designing and perfecting rockets for space exploration was too great for individual firms to take. Now that our technology has improved, private businesses are launching their own satellites.

Dealing with Externalities. Certain costs fall outside (are external to) the market system. The cost of promoting or correcting these "externalities" falls to government.

A New England mill manufactures paper that it sells to printers, packaging firms, and other large-scale users. A town 50 miles downstream can no longer draw its drinking water from the river because of pollution from the mill. Cleaning up the river will require a major effort, and considerable expense.

Assuming that there are no laws against polluting rivers, the price that the mill charges for its paper will depend upon its production costs and the price other firms are charging for similar products. The mill will not have to include the cost of cleaning up the river in its calculations because it will not have to pay it. Nothing in the market system would require the mill or its customers to assume the cost of restoring the river to its former state.

Economists refer to the effects of economic activities that fall outside the market system asexternalities. Obviously, the water pollution caused by our hypothetical paper mill is an example of a harmful externality. But externalities can be beneficial as wellas harmful.

Now suppose the company that owns the paper mill built a new office building. Included in the construction is a public plaza containing gardens and benches which people from nearby office buildings use during their lunch breaks.

The building's landscaping is an example of another externality. That is, those who enjoy it are not charged the cost of its construction or maintenance. Like all externalities, their effects fall outside the market. But in this instance the externality is a beneficial one.

Since externalities take place outside the market, society has traditionally turned to government to discourage those that are harmful and encourage those that are beneficial.

Correcting harmful externalities. Government can correct harmful externalities either by regulating them or taxing them. Regulation involves passing laws banning or restricting the activity. For example, the state in which the paper mill is located could pass legislation banning the pumping of wastes into rivers. Or it could require that paper factories install equipment that would eliminate harmful wastes.

Government can also use its power to tax to correct harmful externalities. Suppose, for example, that a state levied a tax on the discharge of toxic wastes. The tax would encourage paper mills to clean up their discharges, or it would generate the funds needed to pay someone else to do it.

Encouraging beneficial externalities. In instances like the landscaped public space, government can encourage the development of beneficial externalities by offering subsidies to builders who include them in their plans. Asubsidy is a payment by government to producers or consumers.

Programs to Assist Those in Need. Since the 1930's, govern­ment has undertaken a number of programs to increase the income of disadvantaged groups and to provide everyone with equal economic opportunity. The poor, the elderly, victims of discrimination and others in need have been the intended beneficiaries of these efforts.

Programs to help those with special needs fall into two categories.

Programs to help people in need by increasing their income. Welfare payments, food stamps and Social Secu­rity benefits are examples of these efforts.

Programs to eliminate the causes of poverty and economic disadvantage. This goal has led government to outlaw discrimination and provide for educational programs designed to equip people with certain essen­tial skills.

Programs to Help Specific Groups. Ever since the days of George Washington, government has used its powers to help business, farmers, labor and other special interest groups. Tariff laws have protected industries threatened by foreign competi­tion. Patent and copyright laws have protected inventors, writers and the firms that employ them. Government subsidies and loans have enabled thousands of farmers who may have been forced into bankruptcy to continue farming their land. A number of laws favorable to labor unions in the 1930's led to the greatest growth in union membership in history.

Programs to Stabilize the Economy. Experience has shown that government can do much to stabilize (smooth out the ups and downs of) the economy. Government may seek to minimize unemployment, stabilize prices, and promote the growth of economic activity. Full employment, stable prices and economic growth are three of the most important goals of government economic policy.

Summary

We described how the pillars of free enterprise — private property, the price system and competition — support American capitalism. We also noted the special role played by profits and other economic incentives in our capitalist system.

We learned about the functions of government in our system and what economists mean when they describe ours as a mixed economy.