american free enterprise€¦ · free enterprise preview objectives after studying this section you...

IIn the United States, economic opportunity is abundantlyevident, from corporate headquarters in gleaming cities

like Miami, shown here, to neighborhood mom-and-pop businesses, to drive-through franchises insuburban strip malls. This chapter examines thebenefits of American free enterprise and the factorsthat make it so prosperous, adaptive, and enduring.

American Free Enterprise

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In what ways do the benefits of freeenterprise affect your daily life? Listas many examples as you can.Consider neighborhood businesses,jobs you have held, and other waysin which you benefit from ournation’s prosperity.

Economics JournalEconomics Journal

ECON_07NA_se_CH03_CO 8/3/05 9:25 AM Page 50

SS ome 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

PreviewObjectivesAfter studying this section you will be able to:1. Describe the tradition of free enterprise in

the United States and the constitutionalprotections that underlie it.

2. Explain the basic principles of the U.S. freeenterprise system.

3. Identify the role of the consumer in the U.S.free enterprise system.

4. Describe the role of the government in theU.S. free enterprise system.

Chapter 3 ■ Section 1 51

Section FocusAmerican free enterprise is based onthe principles of profit motive,voluntary exchange, private propertyrights, competition, and freedom forproducers and consumers. The U.S.Constitution supports the freeenterprise system by guaranteeingprivate property rights, the right tomake contracts, and freedom fromunfair taxation.

Key Termsprofit motiveopen opportunityprivate property rightsfree contractvoluntary exchangecompetitioninterest grouppublic disclosure lawspublic interest

� How does thisphoto represent theAmerican freeenterprise system?

ECON_07NA_se_CH03_S1 8/3/05 9:27 AM Page 51

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 andbusinesses have the right to buyand sell as much property as theywant. Property owners may prohibitothers from using their property.

Contracts Individuals andbusinesses have the right to makeagreements to buy and sell goods.Such contracts may be written ororal. They are legally binding.

Economic Freedom In the United States,individuals have the right to choose theiroccupations and to work wherever theycan find jobs. Businesses can make theirown decisions on whom to hire, what toproduce, how much to produce, and howmuch to charge for their products andservices. The government generally doesnot interfere in these decisions.

Self-Interest Consumers andproducers may make decisions onthe basis of their own benefit. Theirdecisions do not have to benefit orplease the government or otherconsumers and producers.

Profit Motive American free enterpriseis driven by the desire for profit, thegain that occurs during financialdealings. Profit is a powerful incentivethat leads entrepreneurs andbusinesses to accept the risk ofbusiness failure.

Voluntary Exchange Consumersand producers may freely buyand sell goods when theopportunity costs of suchexchanges are worthwhile. In avoluntary exchange, both partiesexpect to gain from thetransaction.

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 theright to engage in rivalries to gainbusiness. Competing producershave an incentive to create new and better products. This givesconsumers 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 privateproperty 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 forcethat encourages peopleand organizations toimprove their materialwell-being

open opportunity theconcept that everyonecan compete in themarketplace

legal equality theconcept of givingeveryone the samelegal rights

private property rightsthe concept that peoplehave the right andprivilege to controltheir possessions asthey wish

free contract theconcept that peoplemay decide whatagreements they wantto enter into

voluntary exchange theconcept that peoplemay decide what andwhen they want to buyand sell

competition the rivalryamong sellers to attractcustomers whilelowering costs


In the News Read more about basicprinciples in free enterprise in“Expanding First Amendment,” an article in The Wall Street Journal Classroom Edition.

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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. Publicdisclosure 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 privateorganization that triesto persuade publicofficials to act or voteaccording to groupmembers’ interests

public disclosure lawslaws requiringcompanies to providefull information abouttheir products

public interest theconcerns of the publicas a whole

New Business in Russia Starting a new business in Russia is noeasy task. The average new business applicant has to deal with 20 to 30agencies and needs from 50 to as many as 90 approved registration forms. Inaddition, many businesses have to pay bribes to government officials for start-up licenses. Because the Russian economy is unreliable, banks are reluctant tolend 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 ofbusiness 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 entireindustry, making it difficult for new businesses to break in.

Global Connections

� From whataspects of the freeenterprise systemare these studentsbenefiting?


ECON_07NA_se_CH03_S1 8/3/05 9:27 AM 4


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 Americanfree enterprise system?

3. Explain at least three benefits of the free enterprisesystem.

Applying Economic Concepts4. Critical Thinking What are some opportunity costs of a

greater government role in the economy?

5. Decision Making Explain how the decisions you makeas a consumer influence the economy.

6. Critical Thinking What is the impact of economicconcepts in the U.S. Constitution on contemporaryeconomic issues and policies? Use specific examplesfrom 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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Alice RivlinAlice Rivlin (b. 1931)(b. 1931)

During the 1994 congressional election campaign, debate raged abouthow to reduce government spending. Clinton-appointed economistAlice Rivlin recommended controversial cuts in government programs.When the Republicans, who had called for tax cuts instead, gainedmany seats in the election, the president’s political advisors urged thatRivlin be fired.

Principles and PoliticsSuch controversy was nothing new forAlice Rivlin, who by 1994 had alreadybuilt a long and distinguished career inWashington. Rivlin’s opinions about therole of government in the nation’s economyhad gained her a reputation as a tough,nonpolitical economic analyst. “I am afanatical, card-carrying middle-of-the-roader,” Rivlin has stated. A formerdirector of the Congressional Budget Officeagreed. “She is someone who’s called theshots straight,” he said.

A Career in Public ServiceAs a teenager, Alice Rivlin wanted to be adiplomat. After taking an economics coursein college, however, she decided on thatfield instead. Rivlin’s talent for analyzinggovernment policy emerged in 1957, whenshe worked at the Brookings Institution, aWashington “think tank” that researchessocial issues. In the 1960s, she helped planPresident Johnson’s “Great Society,” aseries of government programs aimed atreducing poverty.

In 1975, Rivlin became the first head ofthe Congressional Budget Office, a federal

agency created to help Congress betterunderstand government spending issues.When Bill Clinton became president in1993, he called Rivlin to serve as Directorof the Office of Management and Budget(OMB). In 1996, Clinton appointed her tothe Federal Reserve Board, where sheserved until 1999. Today, Rivlin is chair ofthe Center on Urban and MetropolitanPolicy at the Brookings Institution.

Rethinking Government’s RoleRivlin shuns both direct federal spendingand tax policy as ways to stimulate econ-omic growth. Instead, she prefers programsthat increase overall productivity. Rivlinalso argues that spending on technology,transportation, communications, andeducation is a better approach to growththan cutting taxes.

Rivlin also questions, in general, thefederal government’s role in the businesssector. She argues that programs to aidbusiness should be at the state level, wherea better grasp of specific needs exists.Rivlin favors federal involvement only inareas such as environmental protection,whose effects can be felt across state lines.

56

ECONOMICEconomist

Entrepreneur

1. Source Reading In her call for program cuts to reduce governmentspending, Alice Rivlin wrote: “Everyonelooks for ways of accomplishing ambi-tious goals without effort—lose weightwithout dieting, learn French while yousleep.” Explain what she meant.

2. Critical Thinking Would AliceRivlin be more likely to favor tax breaksto encourage companies to hire unem-ployed workers or creating a new gov-ernment-funded training program toteach workers useful job skills? Explain your answer.

3. Decision Making Do you agree ordisagree with Rivlin’s opinion that lowering taxes does not effectivelyraise living standards?

CHECK FOR UNDERSTANDING

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AAmerica’s economy is big—very big. Itconsists of roughly 108 million house-

holds of about 288 million people whowork at some 137 million jobs and earnmore than $8 trillion a year. They makesavings deposits of $28 billion or so in about71,000 banks. They buy close to 6.5 millionhomes and 17 million automobiles a year.

In Washington, armies of economists usethe latest computer and other technologiesto try to predict whether this massiveeconomy will grow or shrink. Economicpolicymakers pull in the reins when theeconomy bolts at breakneck speed, andattempt to kick start it when it gets slowand unproductive.

Tracking Business CyclesIn this section we’ll examine how theUnited States government affects macro-economic trends. Macroeconomics is thestudy of the behavior and decision makingof entire economies. This branch ofeconomics examines major trends for theeconomy as a whole. Microeconomics, incontrast, is the study of the economicbehavior and decision making of smallunits, such as individuals, families, house-holds, and businesses. (Macro means“large,” while micro means “small.”)

One way economists measure economicwell-being is by calculating the nation’s

gross domestic product (GDP), the total valueof all final goods and services produced inan economy. Economists follow thecountry’s GDP and other key statistics topredict business cycles. A business cycle isa period of macroeconomic expansionfollowed by a period of contraction, ordecline. These economic cycles are majorfluctuations, unlike the day-to-day ups anddowns of the stock market. We are alwaysat some point in the business cycle. Cyclesmay last less than a year or continue formany years.

Free enterprise systems are subject tobusiness cycles because economic decisionsabout factors such as prices, production,and consumption are made by individualsand businesses acting in their own self-interest. In America’s free enterprisesystem, the government plays a role inattempting to prevent wild swings ineconomic behavior.

Where we are in a given business cycleaffects our lives every day. If the economydoesn’t create enough jobs, high schoolgraduates have trouble finding work. Ifprices rise, but incomes don’t, our ability tobuy what we need declines.

Promoting Economic StrengthBecause the market is vulnerable tobusiness cycles, the government creates

macroeconomics thestudy of the behaviorand decision making of entire economies

microeconomics thestudy of the economicbehavior and decisionmaking of small units,such as individuals,families, andbusinesses

gross domestic product(GDP) the total value of all final goods andservices produced in a particular economy

business cycle aperiod of macro-economic expansionfollowed by a period of contraction

Promoting Growth and Stability

PreviewObjectivesAfter studying this section you will be able to:1. Explain how the government tracks and

seeks to influence business cycles.2. Analyze how the government promotes

economic strength.3. Analyze the effect of technology on

productivity.


Section FocusThe government attempts to stabilizebusiness cycles, aids the growth ofthe economy, and encouragestechnological innovation.

Key Termsmacroeconomicsmicroeconomicsgross domestic product

(GDP)business cyclework ethictechnology


public policies that aim to stabilize theeconomy. Policymakers pursue threemain outcomes as they seek to stabi-lize the economy: high employment,steady growth, and stable prices.

EmploymentOne aim of federal economic

policy is to provide jobs foreveryone who is able to work. In the

United States, many economists consider anunemployment rate of between 4 percentand 6 percent to be desirable. In the last halfof the twentieth century, the jobless rateranged between 3 percent and 11 percent.

GrowthPart of the American Dream has alwaysbeen for each generation to enjoy a higherstandard of living than that of previousgenerations. For each generation to dobetter, the economy must grow to provideadditional goods and services tosucceeding generations. GDP is a measureof such growth.

StabilityAnother macroeconomic task that thegovernment pursues is keeping theeconomy stable and secure. Stability givesconsumers, producers, and investorsconfidence in the economy and in ourfinancial institutions, promotingeconomic freedom and growth.

One indicator of economic stability isgeneral price levels. The government’saim is to help prevent sudden, drasticshifts in prices. A surge in overall pricesputs a strain on consumers, especiallypeople on fixed incomes. When pricessink, producers and consumers feel thepain. A jump in the price of milk, forexample, is hard on families withchildren, while a plunge in milk priceshurts dairy farmers. In either direction,major fluctuations in price levels can

cause a macroeconomic chain reactionthat policymakers seek to avoid.

Another sign of economic stability is thehealth of the nation’s financial institutions.None of us wants to go to the bank andfind it boarded up and empty. When wemake a bank deposit or a stock purchase,we want to know that our money will beprotected from fraud or mismanagementand shielded from the damaging effects ofsudden economic downturns.

To provide such assurances, the federalgovernment monitors and regulatesAmerican banks and other financial institu-tions. It produces hundreds of regulations,and it has the power to enforce them.

Federal banking regulations protect bankdeposits and retirees’ pensions. Federalregulators investigate fraud and manageinterest rates and the flow of moneythrough the economy. You’ll learn moreabout these functions in later chapters.

Economic CitizenshipAchieving macroeconomic growth andstability is not easy. Through the way itspends money and influences other macro-economic factors such as interest rates, thegovernment helps to compensate for thetypical swings of the business cycle in oureconomy.

U.S. economic growth soared in the1990s but slowed somewhat in the 2000s. Economic Systems How does thegrowth of GDP reflect the strengths ofthe free enterprise system?

Figure 3.3 Gross Domestic Product, 1990–2004Figure 3.3 Gross Domestic Product, 1990–2004

GD

P (b

illio

ns o

f dol

lars

)

14000

12000

10000

8000

6000

4000

2000

0

Year1990 1992 1994 1996 1998 2000 2002 2004

Source: Bureau of Economic Analysis

2006


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Do you expect your generation to havea higher standard of living than that ofpast generations? As a voter, your electivechoices will help guide governmenteconomic policy. That’s why it’s moreimportant than ever for American citizensto understand the macroeconomic processesthat shape our futures.

Technology and ProductivityThe American economy maintains a farhigher standard of living, in terms of GDP,than most of the world. You’ve read thatone way to preserve that high standard isby increasing productivity—shifting theproduction possibilities frontier outward.How do we do that? One way is throughthe American work ethic, a commitment tothe value of work and purposeful activity.Another way to increase productivity isthrough improved technology.

Technological ProgressTechnology is the process used to produce agood or service. Improvements in tech-nology allow an economy to produce moreoutput from the same or a smaller quantityof inputs, or resources. Technologicalprogress allows the United States economyto operate more efficiently and productively,increasing GDP and giving U.S. businesses acompetitive advantage in the world.

American history is full of innovationsthat improved productivity. ThomasEdison’s invention of the light bulb in 1879made possible a longer workday. Fromweaving looms to tractors to computers,machines have allowed us to generate moregoods in a shorter amount of time withfewer raw materials.

In addition, although innovation makessome production processes and workers out-of-date, or obsolete, these resources can beused in other ways. For example, old indus-

work ethic acommitment to thevalue of work andpurposeful activity

technology theprocess used toproduce a good orservice

� The inventions of a single man, Thomas Edison (right), brought a technological revolution to theUnited States and launched a new era of economic growth. Following that tradition oftechnological innovation, Charlie Matykiewicz (left) displays his automatic dog washer, a prizewinner at an Invention Convention in Philadelphia.



trial buildings can be convertedinto stores or apartments. Oldmachines can be recycled andused to produce new machines.

The Government’s RoleInventions are the engine of thefree enterprise system. Theyhelp us to build “more-better-faster,” thus giving consumersmore economic choices.Recognizing the need for inno-vation to maintain America’stechnological advantage, thegovernment provides incen-tives for innovation.

Federal agencies fundscores of research and development projectsat universities. The Morrill Acts of 1862and 1890 created so-called land-grantcolleges that received federal land andmoney to pursue the study of “agricultureand the mechanical arts.” Land-grantschools from the Massachusetts Instituteof Technology to Texas A&M Universityhave been powerhouses of innovation.

The government’s own research institu-tions also produce a steady stream of newtechnologies that make their way into themarketplace. Probably the best-known

example of such an institution is theNational Aeronautics and SpaceAdministration (NASA). Technologycreated by NASA to blast humans intospace and to explore distant planets hasproduced amazing “spinoffs,” productswith commercial uses. NASA spinoffsinclude everything from a muscle stimulatorfor people with paralysis to a scanner thatallows firefighters to see “invisible flames”given off by alcohol or hydrogen fires.

The government also plays a role in inno-vation by offering inventors the possibilityof making huge profits in the free market. Itdoes so by granting patents and copyrights.

A U.S. patent gives the inventor of a newproduct the exclusive right to produce andsell it for 20 years. A copyright grants anauthor exclusive rights to publish and sellhis or her creative works.

The Framers of the Constitution foresawthe economic need to create incentives forinnovation. Congressional authority toissue patents and copyrights is stated inArticle 1, Section 8 of the Constitution. Itgives Congress the power to “promote theprogress of science and useful arts, bysecuring for limited times to authors andinventors the exclusive right to their respec-tive writings and discoveries.”


Key Terms and Main Ideas1. Compare macroeconomics with microeconomics, and

give an example of each.

2. How does gross domestic product (GDP) provide ameans to analyze economic growth?

3. What does GDP tell economists about business cycles?

4. Give one example of a new technology that has resultedin greater productivity for the United States.

5. (a) How do patents and copyrights promote innovation?(b) How does innovation help the economy?

6. Describe and analyze how economic stability ismeasured.

Applying Economic Concepts7. Decision Making Are the macroeconomic goals of

employment, growth, and stability best met by the publicsector or by the private sector? Explain.

8. Critical Thinking Explain how scientific discoveries andtechnological innovations create the need for rules andregulations to protect individuals and businesses.

How can technology help ensure both our energy future and continuing economic growth? Resources that can be tapped today are "known (proven) reserves." Resources that can perhaps be tapped in the future using new technology are "ultimately recoverable reserves." Many scientists believe that we will be able to unlock these vast "ultimately recoverable reserves" as technology continues to improve. In addition, each unit of energy can be made more efficient through expanding technology.

FAST FACT

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A Boy Tramp Tells of the ”Big Trouble“

But we got along swell before the bigtrouble came even if there were seven of uskids. I shined shoes in a barber shop. Jimcarried papers. And Marie took care of Mrs.Rolph’s kids. Mother always did some sewingfor the neighbors. We had a Chevvie and aradio and a piano. I even started to highschool mornings, the year the big troublecame…

Dad got sick as usual but we neverthought anything of it. When he comes to goback to work he can’t get a job, and every-body all of a sudden-like seems to be hard up.I cut the price of shines to a nickel, but it didn’t help much…

Mrs. Rolph’s husband got a cut and shecans Marie. Jim had to quit the paper routebecause he lost all his cash customers, andthe others never paid. Nobody wantedMother to sew anything.

Source: Thomas Minehan, Boy and GirlTramps of America, (New York: Holt, Rinehart & Winston, Inc., 1934).

Find a primary source documentthat concerns unemployment in adifferent period of the history of theUnited States. What similarities anddifferences do you notice?

Additional Practice

1926 1927 1928 1929 1930 1931 1932 1933

Num

ber

Une

mpl

oyed

(in

mil

lion

s)

Year

4

2

0

6

12

10

8

14

Unemployment 1925–1933Unemployment 1926–1933

Source: Historical Statistics of the United States: Colonial Times to 1970

Analyzing Primary Sources

A primary source is information produced during or soon after an event,usually by a participant or observer. Although primary sources can con-

vey a strong sense of an event or historical period, they may be inaccurate orbiased. For that reason, you must analyze primary sources critically. Read thepassage below, written during the early 1930s, and then practice analyzingprimary sources by following these steps.

1. Identify the document. Read the passagefor tone and authorship. (a) What sortof document is this? (b) Who is theauthor? How can you tell?

2. Interpret the contents of the document.Compare the details of this documentto what you already know about theGreat Depression. (a) How did thefamily live before the Depression?

(b) How did the Depression affect the family?

3. Analyze the document. Read criticallyto determine the importance of theselection. (a) What do you think thepurpose of the story was when it waspublished in 1934? (b) Is this storyconsistent with the economic statisticsbelow?

LIFESkills for

61

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WW hat if the government decided toleave the business of road-building

up to private citizens? If you wanted a roadin front of your house, you’d have to pay acontractor to build it. Or more likely, youand your neighbors could chip in and hiresomeone to build you a small networkof streets.

What problems might arise in thisscenario? For one thing, if groups of individ-uals pooled their money to build a road or afreeway, who would they allow to use it?Would drivers have to constantly stop andpay the owners of each road they drove on?How would individuals living in sparselypopulated areas come up with enoughmoney to build the roads they needed?

Public GoodsRoads are one of many examples in whichthe government provides a public good, ashared good or service for which it wouldbe inefficient or impractical (1) to makeconsumers pay individually and (2) toexclude nonpayers. Dams are anotherexample of public goods.

Let’s look at the first feature, makingconsumers pay individually: How wouldyou like to receive a bill in your mailboxfor your share of launching a spaceshuttle or cleaning Mount Rushmore? Tosimplify the funding of government

projects in the public interest, the govern-ment collects taxes.

What about the second feature of apublic good, excluding nonpayers? As asociety, we believe that certain facilities orservices should be available to all. Besides,excluding nonpayers from highways wouldbe a nightmare.

Most goods are public simply because aprivate provider could not charge thosewho benefit or exclude nonpayers frombenefiting. For example, in 1872, Congresscreated the nation’s first national park,Yellowstone. The national park systemensured that the natural resourcesAmericans value would be protected.

If a park were privately owned, theowner could charge an admission fee. Yetsome benefits generated by the park, suchas the preservation of wildlife, would beenjoyed by nonpayers as well as payers.The owner could neither charge peoplefor that public benefit nor exclude themfrom it.

Public goods have other characteristics:Any number of consumers can use themwithout reducing the benefits to any singleconsumer. For the most part, increasing thenumber of consumers does not increase thecost of providing the public good. So ifyou’re driving on a highway and eightother drivers come along, they do notsignificantly reduce the road’s benefits to

public good a sharedgood or service forwhich it would beimpractical to makeconsumers payindividually and toexclude nonpayers

Providing Public GoodsPreviewObjectivesAfter studying this section you will be able to:1. Identify examples of public goods.2. Analyze market failures.3. Evaluate how the government allocates

some resources by managing externalities.


Section FocusThe government sometimes steps into provide a shared good or resourcewhen it would be impractical forconsumers to pay individually.

Key Termspublic goodpublic sectorprivate sectorfree ridermarket failureexternality



you or increase the government’s cost ofproviding it.

Costs and BenefitsAs you read in Section 1, the federalgovernment steps in to act in the publicinterest whenever it determines that thebenefits of a policy outweigh the draw-backs. In road construction, the advan-tages are obvious. The drawback is theeconomic freedom we give up, since noneof us individually gets to decide whatroads will be built, and where. Still, in thisexample the advantages of public roadconstruction outweigh the drawback. Inother cases, weighing benefits against costsis more complicated and open to debate.

Cost is critical in determining whethersomething gets produced as a public good.When a good or service is public,

1. the benefit to each individual is less thanthe cost that each would have to pay if itwere provided privately, and

2. the total benefits to society are greaterthan the total cost.

In such circumstances, the market wouldnot provide the good; the governmentwould have to, or else it wouldn’t get done.

Study carefully Figure 3.4 on the next page.Does the dam-building project meet thetwo criteria for a public good?

Public goods are financed by the publicsector, the part of the economy thatinvolves the transactions of the govern-ment. The private sector, the part of theeconomy that involves transactions of indi-viduals and businesses, would have littleincentive to produce public goods.

Free-Rider ProblemA phenomenon associated with publicgoods is called the “free-rider problem.” Afree rider is someone who would not chooseto pay for a certain good or service, butwould get the benefits of it anyway if itwere provided as a public good.

Would you voluntarily contribute, say,$3,500 to buy army helmets—your portionof America’s military cost this year?Perhaps not. Yet when the governmentprovides a system of national defense, youbenefit, whether you pay or not.

Try another example: Everyone on yourstreet wants fire protection except onepenny-pinching neighbor, who says it’s notworth the money. Do you want him tohave fire protection anyway? Yes. If his

public sector the partof the economy thatinvolves thetransactions of thegovernment

private sector the partof the economy thatinvolves thetransactions ofindividuals andbusinesses

free rider someonewho would not chooseto pay for a certaingood or service, butwho would get thebenefits of it anyway if it were provided as apublic good

� Identify the publicgoods shown inthese photos.



market failure asituation in which themarket does notdistribute resourcesefficiently

house catches fire, yours could ignite aswell. So local taxes pay for firefightingservices for all property in a given area,because all residents are better off if thegovernment provides this service.

Returning to the example of roads, youmight not be willing to pay for a newfreeway in your area. But if it is built, youwould use it. You would be a free rider.

Free riders consume what they do notpay for. The free-rider problem suggeststhat if the government stopped collectingtaxes and relied on voluntary contribu-tions, many public services would have tobe eliminated.

Market FailuresFree riders are examples of market failure, asituation in which the market, on its own,does not distribute resources efficiently. Tounderstand market failure, recall how asuccessful free market operates: Choices

made by individuals determine what goodsget made, how they get made, and whoconsumes the goods. Profit incentivesattract producers, who, because of compe-tition, provide goods and services thatconsumers need at a price they can afford.

In the road-building scenario, are thesefeatures of a free market present? No. If acompany did build a road, it could charge ahigh price for tolls because it would have nocompetition. Also, companies would notchoose to build roads in sparsely populatedareas because profit incentives in those areasmight be non-existing. This way of gettingroads built would be highly impractical.

In this scenario, the criteria for aproperly functioning market system do notexist. That’s why economists consider thissituation a market failure.

Note that public ownership can sometimesproduce negative externalities, however.Some public lands, for example, might bemore usefully managed if owned privately.

This diagram shows the process that determines whether a public good will be generated.Opportunity Costs If the farmers also wanted irrigation ditches built to carry the lake waterto their fields, would the ditches be built as a public good? Explain.

ProposalFarmers want a localriver to be dammed.

Decision: NoThe farmers would collectively benefit froma dam, but no single farmer will build it.

BenefitThe dam will provideflood protection.

If an individual farmer were to build the dam, the cost to him would outweigh the benefits.

Cost

Proposal

Step 2: A public good is created.

The government considersfunding the dam.

Decision: YesThe government willfund the project.

ResultThe benefits of the damextend to so manypeople that theircollective benefit exceeds the total costof the dam.

BenefitThe dam will provideflood protection.

If the cost is shared among all farmers,the cost to each farmer will be less than the benefit to each farmer.

Cost

Step 1: A market failure occurs.

Figure 3.5 The Creation of a Public GoodFigure 3.5 The Creation of a Public Good



ExternalitiesAll of the previous examples involve sideeffects of some sort. They illustrate whateconomists call externalities. An externality isan economic side effect of a good or servicethat generates benefits or costs to someoneother than the person deciding how much toproduce or consume. Externalities can bepositive or negative, as follows.

Positive ExternalitiesWe’ve said that public goods generatebenefits to many people, not just those whopay for the goods. Such beneficial sideeffects are called positive externalities.

The private sector can create positiveexternalities, too. In fact, many expertsbelieve that the private sector generatespositive externalities more efficiently thanthe public sector can, and at less cost totaxpayers. For instance:

• Dynamo Computers hires underprivilegedteenagers and trains them to be computerprogrammers. Those workers are thenavailable to be hired by other companies,who benefit from the workers’ skillswithout having paid for them.

• Mrs. Garland buys an old house that isan eyesore in the neighborhood. She

paints the house, cuts the grass, andplants flowers. Her neighbors were notinvolved in her economic decision. Butthey receive benefits from it, such ashigher property values and a better view.

Whether private or public, positiveexternalities cause part of the benefit of agood to be gained by someone who did notpurchase it. In the 1990s, several endan-gered species, including the bald eagle andthe peregrine falcon, were saved fromextinction. Protection of species critical toour ecosystem benefits us all.

Negative ExternalitiesOf course, some decisions to produce goodsand services generate unintended costs,called negative externalities. Negativeexternalities cause part of the cost ofproducing a good or service to be paidfor by someone other than the producer.For example:

• The Enchanted Forest Paper Mill dumpschemical wastes into a nearby river,making it unsafe for swimming. Thedownstream city of Tidyville is forced toinstall special equipment at its water-treatment plant to clean up the mess. Ifthe treatment cost is $20 per ton of paper

externality aneconomic side effect ofa good or service thatgenerates benefits orcosts to someone otherthan the persondeciding how much toproduce or consume

Construction of a new dam creates dozens of externalities, positive and negative,depending on your point of view. Public Policy What groups of people might feel thegreatest economic impact from the new dam?

Step 3: Externalities result.

Figure 3.6 Positive and Negative ExternalitiesFigure 3.6 Positive and Negative Externalities

The creation of the dam and the lake generates externalities.

• swimming• boating• fishing• lakefront views

Positive externalities

• loss of wildlife habitat due to flooding upriver from the dam• disruption of fish migration along the river• overcrowding due to tourism• noise from racing boats and other watercraft

Negative externalities



produced, and the mill’sproduction cost is $100 (thecost of all the materials,labor, and machineryrequired to produce it), thefull, or social, cost of a ton ofpaper is $120. The commu-nity, not the polluter, windsup paying that $20.• Your next-door neighbor,Mr. Fogler, takes up theaccordion and holds Fridaynight polka parties in hisbackyard. Unfortunately,you hate polka music.

Government’s GoalsWhen externalities are present, we have amarket failure, because the costs or benefitsof a good or service are not assignedproperly. Understanding externalities helpsus see how the government functions in theAmerican economy.

First, the government encourages thecreation of positive externalities. Education,for example, benefits students, yet societyas a whole also benefits from an educated

population. This is because educatedworkers are generally more productive.

Next, the government aims to limitnegative externalities, such as acid rain.Pollutants from coal-burning power plantsand auto emissions can drift high into theatmosphere and come down in the form ofacid rain, which causes ecological damage.Why is acid rain a negative externality? It ispart of the cost of producing power anddriving cars, but for decades that cost wasbeing imposed upon people other than theproducers of this pollution. The cost wasdamaged trees, lakes, and wildlife.

To help address this negative externality,the federal government now requires allnew cars to have an expensive antipollu-tion device called a catalytic converter. Inaddition, the Environmental ProtectionAgency offers incentives to power-plantoperators to put “scrubbers” on theirsmokestacks to cut emissions. Theseactions transfer the costs of pollution backto its producers.

See the Fast Fact on this page for anexplanation of pollution permits. These areanother way to help eliminate this negativeexternality.


Key Terms and Main Ideas1. Explain this sentence: Most public goods generate

positive externalities.

2. Why is a free rider a type of market failure?

3. What is the difference between the public sector andthe private sector? Give examples of each.

Applying Economic Concepts4. Critical Thinking How does the government attempt to

encourage positive externalities and limit negative exter-nalities? Give two examples of each.

5. Critical Thinking Is the criminal justice system (policeand the courts) a public good? Explain.

6. Decision Making A city has a shortage of parkingspaces near downtown businesses. Should the city builda new parking garage or leave it to the private sector?Explain your reasoning.

7. Problem Solving Explain why this statement is true orfalse: Government steps in to allocate resources effi-ciently so that the country is operating on its productionpossibilities curve instead of under it.

“Pollution permits” issued by the government can be used to limit the negative externalities of industrial production. Each permit allows a firm such as a paper mill to produce a certain amount of a given pollutant in a given time period. As long as the total amount of the pollutant remains within government limits, the mills may buy and sell permits among themselves. Some firms may make enough money from selling permits to offset the cost of extra reductions in waste. Over time, the paper industry will achieve the same reduction in waste at a lower cost per gallon.

FAST FACT

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PP rosperity is a hazy memory in East St.Louis. Tumble-down buildings and

weed-covered lots scar the urban landscape.Poverty and unemployment are constantcompanions in this Illinois city of 40,000 orso residents.

The city hugs the banks of the MississippiRiver across from its prosperous bigbrother, St. Louis, Missouri, a city of morethan 330,000 people. At one time, bothcities profited from their locations on thebusy river. But in the 1970s the firms ofEast St. Louis packed up and fled, havingfound better business opportunities else-where. With few businesses to tax and ajobless population, the city edged towardbankruptcy, unable to provide even themost basic services, like garbage collectionand police and fire protection. At the end ofthe twentieth century, while much of theUnited States enjoyed economic growth,East St. Louis struggled merely to exist.

The Poverty ProblemWhile the free market has proven better atgenerating wealth than has any othereconomic system, that wealth is spreadunevenly throughout society. This leavessome people below the poverty threshold, anincome level below that which is needed tosupport families or households. The povertythreshold is a relative figure determined bythe federal government and adjusted period-ically. In 2004, the poverty threshold for a

single parent under age 65, with one child,was $12,490. For a four-person family withtwo children, it was $18,850. In East St.Louis, 42 percent of families with childrenlive below the poverty line. The medianhousehold income is about $25,000 a year.

The Government’s RoleThe opportunities that the free marketoffers can lift the working poor into themiddle class. Yet, in poor areasfrom East St. Louis to ruralAppalachia to south-central Los

poverty thresholdan income level belowthat which is needed tosupport families orhouseholds

Providing a Safety NetPreviewObjectivesAfter studying this section you will be able to:1. Summarize the U.S. political debate on

ways to fight poverty.2. Describe the main programs through which

the government redistributes income.


� Members of the East St. Louis Action Research Project, founded in 1990,help rehabilitate an economically depressed neighborhood.

EastSt. Louis

St. Louis

MississippiRiver

Section FocusSometimes the United Statesgovernment has to step in to createprograms to aid poor, disabled, andelderly people.

Key Termspoverty thresholdwelfarecash transfersin-kind benefits


welfare governmentaid to the poor

Angeles, economic opportunities are limitedbecause of factors such as a lack of localjobs and few educational opportunities.

As a society, we recognize some responsi-bilities to the very young, the very old, thesick, the poor, and the disabled. For thesepeople, the government tries to provide asafety net. Various federal, state, and localgovernment programs help to raise people’sstandard of living, their level of economicwell-being as measured by the ability topurchase the goods and services they needand want.

Yet, in a society that prefers limitedgovernment activity in the economy,poverty poses tough questions: What canthe government do to combat poverty?What should it do? Is government regula-tion the best way to help the poor?

The Welfare SystemSince the 1930s, the main governmenteffort to ease poverty has been to collecttaxes from individuals and redistributesome of those funds in the form of welfare.Welfare is a general term that refers togovernment aid for the poor. It includesmany types of redistribution programs.

The nation’s welfare system began underPresident Franklin Delano Roosevelt,

following the Great Depression. Welfarespending increased considerably in the1960s under President Lyndon B.Johnson’s “War on Poverty.”

Welfare payments soared in the 1970sand 1980s. In the 1990s, critics of welfarevoiced increasing concern about peoplebecoming dependent on welfare andbeing unable or unwilling to get off it.Some also pointed out that income redis-tribution discourages productivity, thusactually aggravating poverty. In 1996,Congress made sweeping changes in thewelfare system.

Redistribution ProgramsIncome data are gathered by the U.S.Bureau of the Census, an agency within theLabor Department. The Census Bureauconducts monthly surveys of households totrack key economic data. Using the data,the Census Bureau estimates how manypeople are living in poverty.

Chapter 13 will treat the causes ofpoverty in detail. In the meantime, here isan overview of the major types of redistri-bution programs through which thefederal government helps the poor andthe elderly.

1916 Kern-McGillicuddy Act establishes workers’compensation for federal employees

1935 Congresscreates SocialSecurity, Aid toDependentChildren (ADC),and unemploymentcompensation

1950 SocialSecurity extended

to 10.5 million morerecipients; ADCbecomes AFDC(Aid to Families

with DependentChildren)

1948Truman’sFair Dealbegins

1933 FederalEmergency Relief

Administration (FERA)founded

1932Roosevelt’s

New Dealbegins

Figure 3.6 A Century of Federal Programs to Help Those in Need Figure 3.6 A Century of Federal Programs to Help Those in Need

1910 1920 1930 1940 1950


Throughout the1900s, federalspending on socialprograms grew toinclude more andmore people in need.Opportunity CostsWhat are some of thetrade-offs involved inspending on socialprograms?


cash transfers directpayments of money toeligible poor people

1964 Johnson’sGreat Society

program expandswelfare with new

programs suchas Head Start

preschooleducation

1965 MedicalCare Act createsMedicare (for retirees and thedisabled) andMedicaid (for thepoor)

1996 AFDCchanged toTemporaryAssistance forNeedy Families(TANF)

2001 PresidentBush establishes

White House Officeof Faith-Based and

CommunityInitiatives

1960 1970 1980 1990 2000


1974 FoodStamp programextended nationwide

Cash TransfersState and federal governments provide cashtransfers, direct payments of money to poor,disabled, and retired people. The followingprograms distribute direct cash transfers:1. Temporary Assistance for Needy Families

(TANF) This program grew out of the1990s debate about how to ease povertywhile decreasing government payments tothe poor. TANF replaced the earlierwelfare program, Aid to Families withDependent Children (AFDC). Critics ofAFDC said that it made people dependenton welfare and did not encourage them totake responsibility for their lives.

Launched in 1996 as part of compre-hensive welfare reform, TANF discon-tinues direct federal welfare paymentsto recipients. Instead, federal moneygoes to the states, which design and runtheir own welfare programs. Statesmust adhere to federal rules that creatework incentives and establish a lifetimelimit for benefits. The program aims tomove people from welfare dependenceto the work force.

2. Social Security The Social Securityprogram was created in 1935, during theGreat Depression, when many of theelderly lost their life savings and had no

new income. Social Securityprovides cash transfers ofretirement income to theelderly and living expensesto disabled Americans. Theprogram collects payrolltaxes from current workersand then redistributes thatmoney to current recipients.

3. Unemployment insuranceAnother cash transfer is theunemployment insuranceprogram, which is fundedjointly by federal and stategovernments. Unemploy-ment compensation checksprovide money to eligible workers whohave lost their jobs. Workers must showthat they have made efforts to get workduring each week that they receivebenefits.

4. Workers’ compensation This programprovides a cash transfer of state funds toworkers injured on the job. Mostemployers must pay workers’ compensa-tion insurance to cover any future claimstheir employees might make. This insur-ance has become more and more expensiveas medical expenses and the number ofreported on-the-job injuries have increased.

In the News Read more about incomeredistribution in “Low-Income, LowTech,” an article in The Wall Street Journal Classroom Edition.

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In-Kind BenefitsThe government also provides poor peoplewith in-kind benefits, goods and servicesprovided for free or at greatly reducedprices. The most common in-kind benefitsinclude food giveaways, food stamps,subsidized housing, and legal aid.

Medical BenefitsAnother social service that the U.S.government provides is health insurancefor the elderly, the disabled, and the poor.Medicare covers Americans over age 65 aswell as the disabled. Medicaid coverssome poor people who are unemployed ornot covered by their employer’s insuranceplans. Administered under the SocialSecurity program, Medicare and Medicaidare enormously expensive programs. Wewill examine them further in Chapter 14.

EducationFederal, state, and local governments allprovide educational opportunities to thepoor. The federal government fundsprograms from preschool to college. Stateand local programs aid students withlearning disabilities.

Education programs add to the nation’shuman capital and labor productivity. As

you saw in Chapter 1, improved educationand technology can make an entireeconomy more productive by shifting theproduction possibilities frontier outward.

Faith-Based Initiatives In 2001, President George W. Bushannounced an initiative to rely on non-governmental support for people in need.His administration “will look first to faith-based organizations, charities, and commu-nity groups that have shown the ability tosave and change lives.”

The President believes that religious orga-nizations have frequently been among themost successful groups delivering socialservices. These groups not only spendmoney to solve problems, but also provide aspecial compassion. He therefore proposedas a next step in welfare reform that faith-based organizations be allowed to competefor federal funds. In 2003, both houses ofCongress passed bills enacting some ofPresident Bush’s proposals.

Mr. Bush established an Office of Faith-Based and Community Initiatives to helpfaith-based groups work more effectivelywith the federal government. He alsoencouraged the states to create state officesof faith-based action.

in-kind benefits goodsand services providedfor free or at greatlyreduced prices


Key Terms and Main Ideas1. How does welfare attempt to raise poor people’s

standard of living?

2. Why does poverty exist in a free market economy?

3. What is the difference between cash transfers and in-kind benefits?

4. How is Social Security an example of income redistribution?

Applying Economic Concepts5. Math Practice Assume that the poverty threshold is

$8,980 for an individual and $12,120 for a two-person

household. Based on a 40-hour work week, how muchwould you need to earn per hour in order to be above thepoverty threshold for (a) an individual and (b) a two-person household?

6. Critical Thinking An old adage states, “Give a person afish, feed him for a day; teach a person how to fish, feedhim for a lifetime.” Do any of the government programsin this section reflect this saying? Explain your answer.

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71

Government and the Interstate Highway System

The United States did not always have a good network of roads. In the 19thcentury, when horse-drawn vehicles were dominant, almost all roads were

unpaved. Many became rutted and uneven, makingtravel difficult, slow, and uncomfortable. The pushto build a network of smoother roads began in the1880s—through the efforts of a bicycle club.

Early Efforts In 1886, a bicycling craze was sweep-ing the nation. Many American cyclists belongedto the League of American Wheelmen, an organi-zation that wanted smoother roads for cycling.This club was the first to convince Congress toconsider building a national highway system. Asmotor vehicles later became more common, auto-mobile manufacturers, road builders, and gasolinecompanies took up the crusade for better roads.

State Highways By the early 1900s, Congressbegan to provide funding to the states to buildhighways. Each state, however, focused on build-ing highways within its own borders with its ownnumbering and sign systems—and the highwaysdid not always connect at state borders.

Federal Highways In 1921, the Federal Highway Act got the U.S. governmentdirectly involved in highway construction by setting up a system of major high-ways that connected from state to state, so that drivers could travel betweenstates without ever having to leave a high-speed highway. The government thencreated a simple system of numbering and marking these interstate highways, tomake navigating the system easy. In the 1950s, the Cold War raised concernsabout the military’s ability to defend the country with existing roads. In 1956,the Federal Aid-Highway Act authorized the construction of 41,000 miles ofhighways to tie the nation together, creating the interstate highway system weknow today.

Today, America’s interstate highway system is one of the most important fea-tures of the country’s infrastructure. It allows people and goods to travel quicklyfrom one part of the country to another, reducing transportation costs andspeeding up commerce.

Applying Economic Ideas1. Why was it inefficient to leave highway construction to individual states?

2. Why do you think it took Congress so long to authorize funds for highway construction?

� President Dwight Eisenhower signed theFederal Aid-Highway Act on June 29, 1956.

Government

ECON_07NA_se_CH03_CS 6/17/05 9:41 AM Page 71

Chapter SummaryChapter Summary

AA summary of major ideas in Chapter 3 appearsbelow. See also the Guide to the Essentials

of Economics, which provides additional review andtest practice of key concepts in Chapter 3.

Section 1 Benefits of Free Enterprise (pp. 51–55)The benefits of the American free enterprise systemare the result of the basic principles of profit motive,voluntary exchange, private property rights, and competi-tion. These benefits include individual freedom forconsumers and producers and a wide variety ofgoods. To protect economic freedoms, the govern-ment intervenes in matters of public interest. Federalagencies monitor and regulate certain types of busi-nesses. Public disclosure laws provide critical infor-mation to consumers.

Section 2 Promoting Growth and Stability (pp. 57–60)Macroeconomics concerns the behavior of wholeeconomies, while microeconomics concerns thebehavior of smaller economic units, such as house-holds. When necessary, the government takes actionto influence macroeconomic business cycles. It aidsthe growth of the economy, as measured by GDP. Itencourages the creation of new technologies by giv-ing patents and copyrights to entrepreneurs.

Section 3 Providing Public Goods (pp. 62–66)The government provides public goods, such asroads, when it would be impractical for individualsto pay for them. Providing public goods producespositive and negative externalities.

Section 4 Providing a Safety Net (pp. 67–70)The government uses tax money to raise the stan-dard of living of people in poverty. The nation’s wel-fare system includes programs that distribute vari-ous benefits, including cash transfers, in-kind pay-ments, and medical benefits.

Key TKey TermsermsChoose the italicized word in parentheses thatbest completes each sentence.

1. Acid rain is an example of a(n) (externality/free rider).

2. The tradition of (private property/openopportunity) allows everyone to compete inthe free market.

3. The right of (free contract/voluntaryexhange) allows people to decide whatagreements they want to enter into.

4. Someone who benefits from a good withoutpaying for it is an example of a (freerider/public good).

5. Food stamps are an example of a/an (cashtransfer/in-kind payment).

6. We can use figures on (gross domestic product/public goods) to measure economic growth.

7. Study of the behavior of the entire U.S.economy is an example of (macroeconom-ics/microeconomics).

Using Graphic OrganizersUsing Graphic Organizers8. On a separate sheet of paper, copy the tree

map below to help you organize informationabout the American free enterprise system.Complete the tree map by writing descrip-tions and examples for each of the headingsshown. You may add branches to the tree.

maximizeshuman capital

American Free

Enterprise

Private

property

Legal

equality Profit

motive Free

contract

72

ECON_07NA_se_CH03_CA 8/3/05 9:46 AM Page 72

Reviewing Main IdeasReviewing Main Ideas9. (a) How does the government support free enter-

prise and protect public interest? (b) Describe andevaluate the government rules and regulationsdescribed in this chapter.

10. Explain the basic principles of free enterprise inyour own words.

11. Why does the U.S. government track and influ-ence business cycles?

12. Explain why each of the following is either a cashtransfer or an in-kind payment. (a) unemploy-ment insurance (b) Social Security (c) food stamps

Critical ThinkingCritical Thinking13. Drawing Inferences Choose one of the federal

agencies mentioned in Section 1, and explainhow it acts to limit negative externalities.

14. Synthesizing Information Based on your readingof the chapter, write a paragraph in which youdescribe and analyze the economic rights of busi-nesses.

15. Predicting Consequences How might the inven-tion of a new, powerful fuel source for cars andtrucks affect the country’s production possibilitiesfrontier? How might the new fuel affect GDP?

Problem-Solving ActivityProblem-Solving Activity16. Suppose that there is a three-person city. The

three residents are considering having a fire-works display. Gabriela is willing to contribute$100 toward the display, while Jerome is willingto pay $80, and Katelyn is willing to pay $60.The fireworks display costs $120. (a) Will anysingle citizen alone be willing to pay for the fire-works? (b) What recommendation can you maketo this city that will benefit all three citizens?

Skills for LifeSkills for LifeAnalyzing Primary Sources Review the stepsshown on page 61; then read the primary sourcebelow and answer the following questions.17. What course of action is President Johnson sug-

gesting in this speech?18. In your own words, state three economic reasons

Johnson uses to support his argument.19. For what type of assignment might you use this

primary source quotation? Explain.

Brainstorming Reread your Economics Journalentry for Chapter 3. Of the benefits of free enter-prise that you listed, which are most important toyou and your family?

Economics Journal

73

The war on poverty is not a struggle simply to sup-port people, to make them dependent on the generosityof others. It is a struggle to give people a chance. . . . Wedo this, first of all, because it is right that we should. . . .We do it also because helping some will increase theprosperity of all. Our fight against poverty will be aninvestment in the most valuable of our resources—theskills and strength of our people. And in the future, as inthe past, this investment will return its cost many fold toour entire economy.

If we can raise the annual earnings of 10 millionamong the poor by only $1,000 we will have added $14billion a year to our national output. In addition we canmake important reductions in public assistance pay-ments which now cost us $4 billion a year, and in thelarge costs of fighting crime and delinquency, diseaseand hunger. . . .

This is only part of the story. Our history has provedthat each time we broaden the base of abundance, giv-ing more people the chance to produce and consume,we create new industry, higher production, increasedearnings and better income for all.

—President Lyndon B. Johnson, Public Papers of the Presidents of the

United States, 1965

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Should doctors considercost when treating apatient?

BY ABBIE LEIBOWITZ

It is absolutely reasonable and ethical for physi-cians to consider the costs of care when evaluatingtreatment options.

The principle of “first do no harm” that all doctors aretaught has broader implications than just its applica-tion to the patient. Do no harm in your treatment of thepatient for the patient’s sake, do no harm in treatingyour patient from a public-health perspective, and do noharm to the system of health care we all depend upon.

As a percentage of our gross domestic product, theU.S. has the most expensive health-care system in theworld. Medical-insurance premiums in the private sec-tor have been increasing far faster than the pace ofgeneral inflation. They are projected to double between2003 and 2012 to $3.1 trillion or 17.7% of the nation’sGDP. Such increases are unsustainable and are a pre-scription for an economic and public-health disaster.

As costs increase, payors—whether the governmentor employers—shift more financial responsibility tothe individual in the form of diminished benefits orincreasing co-payments and deductibles. The increas-ing burden of paying for otherwise uncompensatedcare is like a hidden tax on those who pay for medicalservices. Providers simply build these costs into therates they charge those who pay.

Is it good care to so burden a patient with expensesthat could have been avoided? Is it good care to prescribe

an expensive brand-name product when there is anequally effective generic equivalent that costs less thanhalf as much? If because they cannot afford the cost ofcare or medicine, patients do not get their prescriptionsfilled, have we helped them? We have no choice but toexert a conscious control over medical costs.

Resources are not limitless. When given the choiceof equally effective diagnostic tests, treatmentapproaches, or medication options, physicians mustconsider which is likely to cost less. Our patients’needs are our first priority, but the health-care systemwe all depend upon is also our “patient.”

DEBATING CURRENT ISSUES: Health-Care Costs

74

As health-care costs have skyrocketed in recent years, both patients and caregivers havehad to ask a difficult question: Should cost be a deciding factor in medical treatment? Inthis debate from The Wall Street Journal Classroom Edition, Abbie Leibowitz, an execu-tive at Health Advocate and former chief medical officer at Aetna, and Dr. David Rogers, aphysician in private practice, discuss the role of costs in the health-care system.

Doctors must consider both the costs and benefits

of treatments when choosing the best treatment for

a sick patient.

◆◆◆

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Should doctors considercost when treating apatient?

BY DAVID E. ROGERS, M.D.

As stated in the American Medical Association’sDeclaration of Professional Responsibility, oneof the duties of all physicians is to “Treat the

sick and injured with competence and compassion andwithout prejudice.” “Without prejudice” means toavoid any bias that could possibly interfere with orreduce the quality of care the patient receives. In myopinion, this would include considering costs whenmaking treatment decisions.

Of course, a physician should not provide anyunnecessary care just because the cost is covered. Onthe other hand, limiting or withholding care or choos-ing potentially inferior options just to reduce costwould be unethical. For physicians, the quality of thepatient’s medical care should always be the first andforemost consideration. I have always felt that “man-aged care” created cost-related, ethical dilemmas forphysicians trying to act in a patient’s best interest.

One economic model that brings physicians intodirect conflict with cost considerations is the capitationsystem that is the basis of managed care. This is a sys-tem where a uniform or set fee is paid to the physicianper patient (per capita) and in return the physicianagrees to provide all the health care needed for thosecovered patients. The payment is not reduced if few ser-vices are necessary, so the physician makes more moneywhen fewer services are rendered. However, the pay-ment is no greater than if many services are provided.Physicians in this situation may actually be forced tooperate at a loss. From a business standpoint, the incen-

tive is to take care of only well patients and provide aslittle service as possible. Fortunately, most “capitation”agreements have disappeared because physiciansrefuse to compromise their patients’ care in such a way.

One example of where cost has played a role in med-ical decision-making can be found at your local phar-macy. Often, doctors will prescribe a brand-name drugand the patient will find that the generic version of thedrug has been substituted. That’s because many insur-ers require that if a generic version of a drug is avail-able, that is what should be dispensed.

In most situations, generic drugs are just as effec-tive as their brand-name counterparts. But there aremany instances where the patient does not get thesame desired effect.

We all like to say we are worried about costs—untilwe are the one who is sick or injured. When that hap-pens, all we care about is getting well, regardless ofthe cost.

Source: U.S. Census Bureau Age

25–34 45–6435–44Under 18 18–24

Perc

enta

ge W

ithou

tH

ealth

Insu

ranc

e

0

5

10

15

20

25

30

35

65 and over

Uninsured Americans, 2003 Uninsured Americans, 2003

75

1. Why does David Rogers disagree with “managedcare”?

2. What data does Abbie Leibowitz cite to showthat the health-care system is facing a crisis?

3. Drawing Conclusions The two authors disagreeabout whether a doctor’s obligations extendbeyond the patient to the overall public-healthsystem. With which author do you agree? Why?

4. Reading Graphs Which age group’s members aremost likely to lack health insurance?

DEBATING THE ISSUE

Increasing health-care costs have led to higher pricesfor health insurance. As a result, more and more youngerAmericans do not have health insurance.

PHSchool.com

For: You Decide PollVisit: PHSchool.comWeb Code: mnp-1031

PHSchool.com

Web Code: mng-1039

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