Freedom in American society is not limited to our nation’s form of government. Our nation’s economy, or business system, is based on freedom, too. We are free to choose the products and services we buy, the jobs we seek, and the businesses we start, and to decide where and when we sell our products and the price we sell them for. There is nobody, in our free economy, who decides how many cars, houses, shirts, shoes, or comic books will be produced. Every business firm is free to make its own decisions about what to produce and what price to charge for its products.
In our free economy goods of all kinds are produced to satisfy the needs of the people. It is also possible for a business to produce a product, and then “sell” people the idea that they need their product. Our system works because each person is free to make nearly all of his own economic decisions. Citizens’ needs will be met by companies that enjoy four basic freedoms.
1.
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Our economy is based on a
free market
. In a free market people may buy any product from any seller. In our economy there is usually more than one producer or service. This permits the consumer, one who buys or uses products and services, to look for the best price or even purchase a substitute article. Because we have this freedom our choices determine what will be produced and in what quantity. Indirectly, we also help decide a product’s price. How do we do this?
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2.
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We do this by the force of
competition
. In the United States, businesses are free to compete with one another for customers. Each business tries to convince us that its product or service will best satisfy our wants or needs. The force of competition leads businesses to find ways of operating more efficiently and effectively. Free competition enables the consumer to show which product s/he favors every time s/he makes a purchase. It can also be a means of keeping the price of products from rising too high. As you can see, the buyer is free to decide what price s/he will pay for any product.
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Free competition also exists for jobs and for workers. A worker may work anywhere s/he can get a job. Once employed s/he is free to stay or look for another one. Business firms also compete to hire the best workers. For this reason skilled workers who meet a business’ needs are paid often good wages. So important is competition to the American economic system the government often acts to promote it.
3.
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In our economic system we are free to own
private property
. Every American is free to buy land, machines, tools, and other equipment to produce goods or services. All Americans are also free to sell their private property as they wish. Land, property, machines, or money used to provide services or produce goods is called “capital.” The American system is sometimes called “capitalism,” or a “capitalistic system,” because capital is private property and owned by individuals. A plumber’s tools are capital; they cost money and are used to produce things people want. The machines used by the auto makers to produce cars are also capital. Both the auto manufacturer and the plumber are capitalists. A capitalist is for our purposes any person who has money invested in a business firm which produces goods or services. Anyone can be a capitalist.
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4.
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One key to our free enterprise system is the freedom to earn a
profit.
The hope of a profit motivates people to invest and businesses to take risks. Profits are realized when income from sales are greater than the total cost of producing the goods or services.
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Any realistic view of our free enterprise system must take into account the role of government. It is a role that has grown greatly in recent times. Today few businesses are completely free in their operations. To some degree their activities are regulated by the government. Many of the goods and services we enjoy are provided directly by the government.
America has a mixed economy. In it owners of private business and government workers try to satisfy our economic desires. Both private people and government play important roles.
One important role is that of a regulator of business. The government fills this role to protect all Americans. In 1906, for example, Congress passed the Federal Food and Drug Act. This law prohibited the use of harmful chemicals or drugs in medicine or food. To prevent monopolies Congress has passed the Sherman Antitrust Act (1890), and the Clayton Act (1914), and created the Federal Trade Commission (1914), thereby preventing such activities as price fixing and regulating deceptive practices. A complete monopoly exists if there is only one seller, who therefore may set his own price. The combined action of several companies who control the supply of a product also results in a monopoly when no competitor can enter the field. The exceptions are called “legal” monopolies. These legal monopolies, such as the telephone company, bus system, and gas and electric companies, are regulated by our government to make certain they provide good service at reasonable rates. In the years since 1914, Congress has set up agencies to regulate the sale of stocks and bonds (SEC), airline traffic (CAB), and a number of other economic activities.
State and local governments also engage in business regulation. Banks are inspected by state banking commissions. Restaurants are inspected by local health officers. There are local building codes that set standards for home and building construction. Labor laws regulate age, kinds of work, hours, safety regulations, and so on.
The government does not just regulate business; it is a business. The government employs thousands of workers. It also produces goods and services.
The national government produces electricity. It does this at government-built projects such as the Tennessee Valley Authority and the Hoover Dam on the Colorado River. The national government is also in the banking business. The Small Business Administration loans money to small businesses, while the Export-Import Bank lends money to foreign countries. The government is in the insurance business. It offers an insurance service through the Federal Deposit Insurance Corporation (FDIC). The FDIC insures bank accounts against bank failure. The national government also runs a park system, schools (West Point, the Coast Guard Academy, etc.), and veterans’ hospitals.
On the state and local levels, governments run public schools, colleges, and universities. These governments also run parks, bus lines, and hospitals.
Still another governmental role is found in aid given to business. This is done in two ways, through taxes and government spending, and through regulation of our money supply.
The government receives money in the form of taxes. It spends money on a seemingly endless variety of things. It pays us for work being done now (salaries), for past work (pensions), and for work to be done in the future (grants).
Most American businesses fall into one of three general forms of organization: single proprietorship, partnership, and corporation.
A large number of small businesses and farms are controlled by a single owner or family. Here the owner is his or her own boss. S/he makes all the decisions, raises the finances, and gets all the profits. A single proprietorship is easy to set up and run. Its growth, however, is limited to the assets and credits of the owner. The owner is responsible for all losses and business debts. This is known as “unlimited liability.” Any property or income of the owner, not just the business, may be legally seized by the firm’s creditors if the owner fails to pay them.
Individual proprietorships may turn into partnerships. A person may wish to expand but lack the capital or the “know-how” to make the business a success. In this case the single proprietor may have to form a partnership. A partnership is an agreement between two or more persons to share the profits and responsibilities of a business. Each partner owns a share of the business, but not always in equal parts. The profits are divided according to the agreement made when the partnership was formed. Each partner is responsible for all financial obligations of the business. That is, each partner has unlimited liability. Partnership is a form of business often used by such professions as law, medicine, and architecture.
The corporation is by far the most important form of business organization in America today. A corporation is a business concern which may be large or small and may have many owners, but is operated as an individual firm. It is considered to be legally distinct from its owner; in the eyes of the law a corporation is a “person.” Business is transacted in the name of the corporation, which can sue and be sued in court. As a legal institution, the corporation receives its right to operate from the state government. The state issues the certificate or charter to do business, which describes the nature of the business that may be carried on.
Corporations raise money by selling “stock,” or shares of ownership. Each share represents a part ownership in the corporation. The corporation’s profits are divided to pay stockholders and are called “dividends.” It is important to know that many corporations issue two kinds of stock, preferred and common. Both kinds of stock usually can be bought and sold by anyone who wants to invest in the corporation.
Owners of preferred stock take less risk. As long as the company makes a profit they will receive a fixed dividend. They are paid their dividends before common stockholders receive their dividends. Preferred stockholders do not usually have a vote in the corporation.
Common stockholders take a greater risk. They get no guarantee of a dividend. They are paid dividends only after both preferred stockholders and bond owners are paid. There are, however, three main advantages in owning common stock. If the company’s profits are high, the owner may receive dividends greater than those given to owners of preferred stock. If profits are high, the price of the stock usually will increase. The owner may then sell for a profit. Finally, common stockholders have a vote in electing the board of directors who run the company, and also vote on some company policies. Each stockholder gets as many votes as s/he has shares of stock.
Even after selling preferred and common stock some corporations need to raise more money. The most common method of borrowing money is to issue bonds. A bond is a promise by the firm to repay at the end of a stated number of years the full amount of money loaned to the firm. Interest, at a fixed rate, will be paid to the owner whether or not the corporation is making a profit. The company must pay this interest before it pays dividends to shareholders. If the corporation is not able to pay back the full amount of the bond on the due date, or if the interest is not paid when due, the bondholders may take over the business. The corporation’s assets may be sold to meet these payments. Bond holders do not share in profits or have any voting rights in the corporation. They do have the safest investment.
The corporation has several advantages over individual proprietorships or partnerships. The corporation provides the means of raising adequate funds. Each stockholder has limited liability; s/he can lose no more than s/he has invested. Stockholders do not have to become involved in managing the firm. This is done by professional directors and managers. Shares of stocks are transferable, and may be sold or given away without changing the status of the firm. The actual selling is done by professional brokers. Corporations also have a perpetual life. They do not have to close or reorganize when one of the owners dies or withdraws. The major disadvantage of the corporation is that it must pay high federal income taxes on profits. When the remaining profits are paid to stockholders as dividends, those receiving the dividends then must pay tax on them. This is a case of double taxation.
Is big business a blessing or a curse? The answer is of course both. In manufacturing, large businesses can use specialized machinery economically. Large firms are able to use by-products to a greater extent than small firms. They may have workers who have specialized skill or training. Research is carried on by large firms. Large firms buy materials at lower rates and can pass the savings on to the consumers. They also have an advantage in advertising their products. All these factors help to increase sales. However, big business does have some disadvantages. Big business is impersonal. Workers may feel that their work is not appreciated or that they are not needed. They may lose their sense of accomplishment or pride of workmanship. Mass production and automation have greatly improved our lives but they also create uncertainties. Automation is seen by many workers as a threat to their job security. In some industries, size is not necessarily an advantage. If a few firms get too large they may get a disproportionate control of output. Critics of big business and monopoly say that when a few firms gain control of the supply of a product, artificially high prices will result.
At this point it might be fruitful briefly to compare our economic system with that of the Soviet Union.
The Soviet Union has established a command economy. In this type of system, the government completely controls, or commands, the entire economy. The Communist government owns all businesses, and almost all of the capital, tools and equipment, and land used for production. The government dictates what jobs people must take, where they work, their wages, and the prices of goods. The government, not the market, decides what goods and services are to be provided. The Soviet Union is rich in natural resources. The way these resources are used is also determined by the government. Almost all farmland is owned and managed by the government, and organized into farms called “collectives.” Farm workers are not permitted the same job mobility as Americans. On the collectives bonuses are awarded to squads who exceed their quota. Small plots of land may be given to individuals, but they must work the plots themselves.
Americans enjoy a much higher standard of living. The average Soviet worker earns about 1/7 of what his American counterpart earns. Americans can own a great variety of goods including land, capital, businesses, and tools of production.
There are “rich” men in this classless society. They are always high-ranking members of the Communist party. Artists, performers, scientists, and business managers also fare better than the average worker.
The basic difference between the two systems lies in the orientation of their goals. The American system is designed to serve and meet the needs of the consumers. By contrast, the Soviet economy is established to serve the needs of the government, not the people.