The U.S. Economy in Historical Perspective

The U.S. economic system is a market economy based on private property and the markets in which individuals decide how, what, and for whom to produce

• Markets work through a system of rewards and payments

• Individuals are free to do whatever they want as long as it is legal

• Fluctuations in prices play a central role in coordinating individuals’ wants in a market economy Most economists believe the market

is a good way to coordinate economic activity

Capitalism and Socialism• Capitalism is an economic system based on the

market in which the ownership of the means of production resides with a small group of individuals (called capitalists)

• Socialism is an economic system based on individuals’ goodwill towards others, not on their own self-interest, and in which, in principle, society decides what, how, and for whom to produce

3-2

Evolving Economic SystemsFeudalism is an economic system based on tradition and

dominated the Western world from the 8th to the 15th century

Mercantilism is an economic system in which the government controls economic activity by doling out the

rights to undertake economic activities and was dominant until the 18th century

During the Industrial Revolution, technology and machines rapidly modernized industrial production

Capitalism

1. Adam Smith’s The Wealth of Nations

(new theory) The best way to increase the wealth of a country is through individual decision making with

minimal government influence. Laissez faire

(new) The Invisible Hand – people serve their own interests. They produce what is in demand and will

profitable.

Problems developed

1. Large businesses became monopolies and trusts

2. Living conditions became harsh - long hours, low wages, slums, child labor

3. Government Responsea. Anti-trust legislation - FTC, Food and Drug Act, Sherman Anti-Trust

Act

b. Movement away from laissez faire

The Great Depression

a. Problems of the 20’s.

b. Creates a need for inputs and a need for markets

- production for WWI not needed any longer - tariffs eliminated markets - farmers were overproducing - unemployment rising - inside of the Production Possibilities Curve

b. The government took action

Government required to take action: - full employment - full production - stable prices

- farmers paid not to grow - government work projects set up - Social Security created - FDIC - Employment Act of 1946

HouseholdsBusinesses

Product Markets

Factor Markets

1. Receiving a paycheck at the end of each month?2. Delivering a specially ordered car to a buyer?

3. Receiving patient car in a hospital?4. Using a credit card to buy a meal in a restaurant?5. Earning profit at your summer ice

cream stand?6. Obtaining college credits?

Households

• The largest source of household income is wages and salaries

• Households supply the factors of production with which businesses produce and government governs

• In the economy, households vote with their dollars to determine what businesses produce

• Households are groups of individuals living together making joint decisions

Dividends

Interest

Proprietor’s Income

Rental Income

Transfer Payments

Wages and Salaries

1.7

4.9

8.4

11.1

13.4

64.7

Source of income %

Social Security

-4.3

All Households

Headed by married coupleHeaded by female – husband gone

Household head 25-34 years old

Household head HS grad

Household head BA degree

44,473

42,148

28,116

59,346

35,744

64,406

Characteristic Average Income

Household head 65+

23,043

Savings

Spending

Taxes

84

15.2

1.9

Services

Durable Goods

Non-durable Goods

59

29

12

Business

• Businesses produce what they believe will sell and make a profit

• Businesses in the U.S. decide what to produce, how much to produce, and for whom to produce it

• By channeling the desire to make a profit for the general good of society, the U.S. economic system allows the invisible hand to work

• Although businesses decide what to produce, they are guided by consumer sovereignty

• Businesses are private producing units in our society

proprietorship

partnership

corporation

72.2

7.7

20.1

4.8

7.9

87.3

Type Number

Revenue

Business: Forms of Business

Advantages Disadvantages

Proprietorship

• Minimum bureaucratic hassle

• Direct control by owner

• Limited ability to get funds• Unlimited personal liability

Partnership• Ability to share work and

risk• Relatively easy to form

• Limited ability to get funds• Unlimited personal liability (even for a partner's blunder)

Corporation

• No personal liability• Increasing ability to get funds

• Ability to avoid personal income taxes

• Legal hassle to organize• Possible double taxation of income

• Monitoring problems

Government

1. An actor who collects money in taxes and spends that money on projects, such as defense and education

The government plays two general roles in the economy:

3-19

Government: Income of the Federal

Government

Corporate income taxes

14%Social Security

taxes and contributions

36%

Individual and inome tax

44%

Excise taxes and other

6%

Government: Expenditures of the Federal

Government

3-21

Government2. A referee who sets the rules that determine

relations between businesses and householdsa. Provide a stable set of institutions and

rules.b. Promote effective and workable

competition.c. Correct for externalities.

e. Provide public goods.

f. Adjust for undesirable market results.

-Enforce contracts and protect property rights

-restrict and regulate monopolies

-pollution

-Enforce contracts and protect property rights

-Employment Act of 1946

-drug busts

d. Ensure economic stability and growth.

HouseholdsBusinesses

Product Markets

Factor Markets

Resources

Payments $$

Goods and

Services

Business Taxes

Goods and

Services

Income Taxes

Paym

en

ts an

d L

eg

al

Reso

urce

sP

aym

en

ts

Good

s an

d

Serv

ices

Market Failures and Government Failures

• Government failures are situations in which the government intervenes and makes things worse

• Market failures are situations in which the market does not lead to a desired result

• Policy makers must decide which failure is the least problematic, a market or government failure

Global Institutions and Corporations

• U.S. economic institutions are integrated with the world’s economy

• The U.S. economy makes up 20% of the world output and consumption, but only 6% of the world’s land mass and less than 5% of the world’s population

• Global corporations are corporations with substantial operations in both production and sales in more than one country

• Global corporations create jobs, bring new technologies, and provide competition for domestic companies

Coordinating Global Issues No global government to regulate global corporations

- international institutions developed to promote negotiations and coordinate economic relations among countries

Some examples of international institutions:• The United Nations is an organization designed

to achieve international cooperation but it has no ability to tax or enforce its policies on its members• The World Bank is a multinational, international financial institution that works to secure loans for developing countries

1. Highly-developed economies must make the basic economic choices, whereas less-developed economies produce so little that no choices are possible.2. Price is the language through which buyers and sellers communicate their intentions to one another in a pure market economy.3. Households buy goods and services in output markets and sell factors of production in input markets.4. The least-cost method of production is the method that uses resources most efficiently.

True or False?

6. In a socialist economy, goods and services go only to those who can pay for them with money earned from resources they own.7. A socialist system favors collective ownership of society's factors of production.

5. The value judgments of persons running households and businesses play virtually no role in economic decision making in a pure market economy.

8. The invisible hand doctrine was Adam Smith's idea that allowing competing sellers to act in their own best interests advances the economic interests of all society.

9. The Employment Act of 1946 gave the federal government the right and responsibility to provide an environment for the achievement of full employment, full production, and price stability.

10. Over the years, government's intervention in the economy has increased, but the increase has not been smooth or continuous.