Economy
U.S. Economic System

An economic system refers to the laws and institutions in a nation that determine who owns economic resources, how people buy and sell those resources, and how the production process makes use of resources in providing goods and services. The U.S. economy is made up of individual people, business and labor organizations, and social institutions. People have many different economic roles—they function as consumers, workers, savers, and investors. In the United States, people also vote on public policies and for the political leaders who set policies that have major economic effects. Some of the most important organizations in the U.S. economy are businesses that produce and distribute goods and services to consumers. Labor unions, which represent some workers in collective bargaining with employers, are another important kind of economic organization. So, too, are cooperatives—organizations formed by producers or consumers who band together to share resources—as well as a wide range of nonprofit organizations, including many charities and educational organizations, that provide services to families or groups with special problems or interests.

For the most part, the United States has a market economy in which individual producers and consumers determine the kinds of goods and services produced and the prices of those products. The most basic economic institution in market economies is the system of markets in which goods and services are bought and sold. That is where consumers buy most of the food, clothing, and shelter they use, and any number of things that they simply want to have or that they enjoy doing. Private businesses make and sell most of those goods and services. These markets work by bringing together buyers and sellers who establish market prices and output levels for thousands of different goods and services.

A guiding principle of the U.S. economy, dating back to the colonial period, has been that individuals own the goods and services they make for themselves or purchase to consume. Individuals and private businesses also control the factors of production. They own buildings and equipment, and are free to hire workers, and acquire things that businesses use to produce goods and services. Individuals also own the businesses that are established in the United States. In other economic systems, some or all of the factors of production are owned communally or by the government.

For the most part, U.S. producers decide which goods and services to make and offer to sell, and what prices to charge for those products. Goods are tangible things—things you can touch—that satisfy wants. Examples of goods are cars, clothing, food, houses, and toys. Services are activities that people do for themselves or for other people to satisfy their wants. Examples of services are cutting hair, polishing shoes, teaching school, and providing police or fire protection.

Producers decide which goods and services to make and sell, and how much to ask for those products. At the same time, consumers decide what they will purchase and how much money they are willing to pay for different goods and services. The interaction between competing producers, who attempt to make the highest possible profit, and consumers, who try to pay as little as possible to acquire what they want, ultimately determines the price of goods and services.

In a market economy, government plays a limited role in economic decision making. However, the United States does not have a pure market economy, and the government plays an important role in the national economy. It provides services and goods that the market cannot provide effectively, such as national defense, assistance programs for low-income families, and interstate highways and airports. The government also provides incentives to encourage the production and consumption of certain types of products, and discourage the production and consumption of others. It sets general guidelines for doing business and makes policy decisions that affect the economy as a whole. The government also establishes safety guidelines that regulate consumer products, working conditions, and environmental protection.

Factors of Production

The factors of production, which in the United States are controlled by individuals, fall into four major categories: natural resources, labor, capital, and entrepreneurship. 

Factors of Production - Natural Resources

Natural resources, which come directly from the land, air, and sea, can satisfy people’s wants directly (for example, beautiful mountain scenery or a clear lake used for fishing and swimming), or they can be used to produce goods and services that satisfy wants (such as a forest used to make lumber and furniture).

The United States has many natural resources. They include vast areas of fertile land for growing crops, extensive coastlines with many natural harbors, and several large navigable rivers and lakes on which large ships and barges carry products to and from most regions of the nation. The United States has a generally moderate climate, and an incredible diversity of landscapes, plants, and wildlife.

Factors of Production - Labor

Labor refers to the routine work that people do in their jobs, whether it is performing manual labor, managing employees, or providing skilled professional services. Manual labor usually refers to physical work that requires little formal education or training, such as shoveling dirt or moving furniture. Managers include those who supervise other workers. Examples of skilled professionals include doctors, lawyers, and dentists.

Of the 270 million people living in the United States in 1998, nearly 138 million adults were working or actively looking for work. This is the nation's labor force, which includes those who work for wages and salaries and those who file government tax forms for income earned through self-employment. It does not include homemakers or others who perform unpaid labor in the home, such as raising, caring for, and educating children; preparing meals and maintaining the home; and caring for family members who are ill. Nor, of course, does it count those who do not report income to avoid paying taxes, in some cases because their work involves illegal activities.

Factors ofProduction - Capital

Capital includes buildings, equipment, and other intermediate products that businesses use to make other goods or services. For example, an automobile company builds factories and buys machines to stamp out parts for cars; those buildings and machines are capital. The value of capital goods being used by private businesses in the United States in the late 1990s is estimated to be more than $11 trillion. Roughly half of that is equipment and the other half buildings or other structures. Businesses have additional capital investments in their inventories of finished products, raw materials, and partially completed goods. 

Factors of Production - Entrepreneurship

Entrepreneurship is an ability some people have to accept risks and combine factors of production in order to produce goods and services. Entrepreneurs organize the various components necessary to operate a business. They raise the necessary financial backing, acquire a physical site for the business, assemble a team of workers, and manage the overall operation of the enterprise. They accept the risk of losing the money they spend on the business in the hope that eventually they will earn a profit. If the business is successful, they receive all or some share of the profits. If the business fails, they bear some or all of the losses.

Many people mistakenly believe that anyone who manages a large company is an entrepreneur. However, many managers at large companies simply carry out decisions made by higher-ranking executives. These managers are not entrepreneurs because they do not have final control over the company and they do not make decisions that involve risking the companies resources. On the other hand, many of the nation’s entrepreneurs run small businesses, including restaurants, convenience stores, and farms. These individuals are true entrepreneurs, because entrepreneurship involves not merely the organization and management of a business, but also an individual’s willingness to accept risks in order to make a profit.

Throughout its history, the United States has had many notable entrepreneurs, including 18th-century statesman, inventor, and publisher Benjamin Franklin, and early-20th-century figures such as inventor Thomas Edison and automobile producer Henry Ford. More recently, internationally recognized leaders have emerged in a number of fields: Bill Gates of Microsoft Corporation and Steve Jobs of Apple Computer in the computer industry; Sam Walton of Wal-Mart in retail sales; Herb Kelleher and Rollin King of Southwest Airlines in the commercial airline business; Ray Kroc of MacDonald’s, Harland Sanders of Kentucky Fried Chicken (KFC), and Dave Thomas of Wendy’s in fast food; and in motion pictures, Michael Eisner of the Walt Disney Company as well as a number of entrepreneurs at smaller independent production studios that developed during the 1980s and 1990s.

Acquiring the Factors of Production

All four factors of production—natural resources, labor, capital, and entrepreneurship—are traded in markets where businesses buy these inputs or productive resources from individuals. These are called factor markets. Unlike a grocery market, which is a specific physical store where consumers purchase goods, the markets mentioned above comprise a wide range of locations, businesses, and individuals involved in the exchange of the goods and services needed to run a business.

Businesses turn to the factor markets to acquire the means to make goods and services, which they then try to sell to consumers in product or output markets. For example, an agricultural firm that grows and sells wheat can buy or rent land from landowners. The firm may shop for this natural resource by consulting real estate agents and farmers throughout the Midwest. This same firm may also hire many kinds of workers. It may find some of its newly hired workers by recruiting recent graduates of high schools, colleges, or technical schools. But its market for labor may also include older workers who have decided to move to a new area, or to find a new job and employer where they currently live.

Firms often buy new factories and machines from other firms that specialize in making these kinds of capital goods. That kind of investment often requires millions of dollars, which is usually financed by loans from banks or other financial institutions.

Entrepreneurship is perhaps the most difficult resource for a firm to acquire, but there are many examples of even the largest and most well-established firms seeking out new presidents and chief executive officers to lead their companies. Small firms that are just beginning to do business often succeed or fail based on the entrepreneurial skills of the people running the business, who in many cases have little or no previous experience as entrepreneurs.

Markets and the Problem of Scarcity

A basic principle in every economic system—even one as large and wealthy as the U.S. economy—is that few, if any, individuals ever satisfy all of their wants for goods and services. That means that when people buy goods and services in different markets, they will not be able to buy all of the things they would like to have. In fact, if everyone did have all of the things they wanted, there would be no reason for anyone to worry about economic problems. But no nation has ever been able to provide all of the goods and services that its citizens wanted, and that is true of the U.S. economy as much as any other.

Scarcity is also the reason why making good economic choices is so important, because even though it is not possible to satisfy everyone’s wants, all people are able to satisfy some of their wants. Similarly, every nation is able to provide some of the things its citizens want. So the basic problem facing any nation’s economy is how to make sure that the resources available to the people in the nation are used to satisfy as many as possible of the wants people care about most.

The U.S. economy, with its system of private ownership, has an extensive set of markets for final products and for the factors of production. The economy has been particularly successful in providing material goods and services to most of its citizens. That is even more striking when results in the U.S. economy are compared with those of other nations and economic systems. Nevertheless, most U.S. consumers say they would like to be able to buy and use more goods and services than they have today. And some U.S. citizens are calling for significant changes in how the economic system works, or at least in how the purchasing power and the goods and services in the system are divided up among different individuals and families.

Not surprisingly, low-income families would like to receive more income, and often favor higher taxes on upper-income households. But many upper-income families complain that government already taxes them too much, and some argue that government is taking over too many things in the economy that were, in the past, left up to individuals, families, and private firms or charities.

These debates take place because of the problem of scarcity. For individuals and governments, resources that satisfy a particular want cannot be used to satisfy other wants. Therefore, deciding to satisfy one want means paying the cost of not satisfying another. Such choices take place every time the government decides how to spend its tax revenues.