Economy
Production of Goods and Services

Before goods and services can be distributed to households and consumed, they must be produced by someone, or by some business or organization. In the United States and other market economies, privately owned firms produce most goods and services using a variety of techniques. One of the most important is specialization, in which different firms make different kinds of products and individual workers perform specific jobs within a company.

Successful firms earn profits for their owners, who accept the risk of losing money if the products the firms try to sell are not purchased by consumers at prices high enough to cover the costs of production. In the modern economy, most firms and workers have found that to be competitive with other firms and workers they must become very good at producing certain kinds of goods and services.

Most businesses in the United States also operate under one of three different legal forms: corporations, partnerships, or sole proprietorships. Each of these forms has certain advantages and disadvantages. Because of that, these three types of business organizations often operate in different kinds of markets. For example, most firms with large amounts of money invested in factories and equipment are organized as corporations.

Specialization and the Division of Labor

In earlier centuries, especially in frontier areas, families in the United States were much more self-sufficient, producing for themselves most of the goods and services they consumed. But as the U.S. population and economy grew, it became easier for people to buy more and more things in the marketplace. Once that happened, people faced a choice they still face today: In terms of time, money, and other things that they could do, is it less expensive to make something themselves or to let someone else produce it and buy it from them?

Over the years, most people and businesses realized that they could make better use of their time and resources by concentrating on one particular kind of work, rather than trying to produce for themselves all the items they want to consume. Most people now work in jobs where they do one kind of work; they are carpenters, bankers, cooks, mechanics, and so forth. Likewise, most businesses produce only certain kinds of goods or services, such as cars, tacos, or gardening services. This feature of production is known as specialization. A high degree of specialization is a key part of the economic system in the United States and all other industrialized economies. When businesses specialize, they focus on providing a particular product or type of product. For instance, some large companies produce only automobiles and trucks, or even special parts of cars and trucks, such as tires.

At almost all businesses, when goods and services are produced, labor is divided among workers, with different employees responsible for completing different tasks. This is known as division of labor. For example, the individual parts of cars and televisions are made by many different workers and then put together in an assembly line. Other well-known examples of this specialization and division of labor are seen in the production of computers and electrical appliances. But even kitchens in large restaurants have different chefs for different items, and professional workers such as doctors and dentists have also become more specialized during the past century.

Specialization and the Division of Labor - Advantages of Specialization

By specializing in what they produce, workers become more expert at a particular part of the production process. As a result, they become more efficient in these jobs, which lowers the costs of production. Specialization also makes it possible to develop tools and machines that help workers do highly specialized tasks. Carpenters use many tools that plumbers and painters do not. Commercial bakeries have much larger ovens and mixers than those used by people who only bake bread and pies once a year. And unlike a household kitchen, a commercial bakery has machines to slice and package bread. All of these tools and machines help workers and businesses produce more efficiently, and lower the cost of producing goods and services.

The advantages of specialization have led to the creation of many very large production facilities in the United States and other industrialized nations. This trend is especially prevalent in the manufacturing sector. For example, many automobile factories produce thousands of cars each day, and some shipyards employ more than 10,000 workers. One open-pit mine in the western United States has dug a crater so large that it can be seen from space.

When the market for a product is very large, and a company can sell enough goods or services in that market to support a very large production facility, it will often choose to produce on a large scale to take advantage of specialization and division of labor. As long as producing more in larger facilities lowers the average costs of production, the producer enjoys what are known as economies of scale.

But bigger is not always better, and eventually almost all producers encounter diseconomies of scale in which larger plants or production sites become less efficient and more costly to operate. Usually that happens because monitoring and managing increasingly larger production facilities becomes more difficult. That is why most large manufacturers have more than one factory to make their products, instead of one massive facility where they make everything they produce. In recent years, many steel companies have found it more efficient to build and operate smaller steel mills than they once operated.

Specialization and the Division of Labor - Specialization and International Trade

Over the past few decades, international trade has led to greater specialization and competition among producers in the United States and throughout the world. By selling worldwide, companies in the United States and in other countries can reach many more customers. Specialization is ultimately limited by the size of the market for a good or service. In other words, larger markets always allow for greater levels of specialization. For example, in small towns with few customers to serve, there is often only one clothing store that carries a small selection of many different kinds of clothing. In large cities with a million or more potential customers, there are much larger clothing stores with many more choices of items and styles, and even some stores that sell only hats, gloves, or some other particular kind of clothing.

International trade is a dramatic way of expanding the size of a firm’s market. In markets where transportation costs are low compared with the selling price of a product, it has become possible for producers to compete globally to take full advantage of highly specialized production. But international trade also means that businesses must compete more efficiently against firms from all around the world. That competition also makes them try to take advantage of greater specialization and the division of labor.

In many cases, products are produced and sold by firms from two or more countries that have large production and employment levels in the same industry. Often, however, these firms still specialize in the kinds of products they produce. For example, though many small cars and small pickup trucks are made in Japan and sent to the United States, large pickups and four-wheel drive sport utility vehicles are often exported from the United States to Japan and other nations. Similarly, the United States exports large commercial passenger jets to most countries, but imports many small jets from Canada, Brazil, and other nations. While this may seem strange at first glance, it allows greater specialization in production for particular kinds of products.

Transportation costs can also help to explain the pattern of international production and trade. It often makes sense to produce goods close to the markets where they will be sold, or close to where the resources used in the production process are found or made. In recent years, the availability of a skilled and hard-working labor force has become more important to producers in many different industries, so new factories are often located in areas with large numbers of well-trained workers and good schools that provide a future supply of well-educated workers.

Production Patterns: Past, Present, and Future

Several dramatic changes in production patterns occurred in the United States during the 20th century. First, most employment shifted from farming in rural areas to industrial jobs in cities and suburbs. Then, during the second half of the century, production and employment patterns changed again as a result of technological advances, increased levels of world trade, and a rapid increase in the demand for services.

Technological changes in the transportation, communications, and computer industries created entirely new kinds of jobs and businesses, and altered the kinds of skills workers were expected to have in many others. World trade led to increased specialization and competition, as businesses adapted to meet the demands of international competition.

Perhaps the greatest change in the U.S. economy came with the nation’s growing prosperity in the years following World War II (1939-1945). This prosperity resulted in a population with more money to spend on services and leisure activities. More people began dining out at restaurants, taking vacations to far-off locations, and going to movies and other forms of entertainment. As family incomes increased, a wealthier population became more willing to pay others for services.

As a result of these developments, the closing decades of the 20th century saw a dramatic increase in service industries in the United States. In 1940 about 33 percent of U.S. employees worked in manufacturing, and about 49 percent worked in service-producing industries. By the late 1990s, only 26 percent worked in goods-producing industries, and 74 percent worked in service-producing industries. This change was driven by powerful market forces, including technological change and increased levels of world trade, competition, and income.

Some observers worried that this growth of employment in service-producing industries would result in declining living standards for most U.S. workers, but in fact most of this growth has occurred in industries where job skill requirements and wages have risen or at least remained high. That is less surprising when you consider that this employment includes business and repair services, entertainment and recreation occupations, and professional and related services (including health care, education, and legal services). United States consumers and families are, on average, financially better off today than they were 50 or 100 years ago, and they have more leisure time, which is one of the reasons why the demand for services has increased so rapidly.

During the 20th century, businesses and their workers had to adjust to many changes in the kinds of goods and services people demanded. These changes naturally led to changes in where jobs were available, and in what kinds of education, training, and skills employees were expected to have. As the base of employment in the United States has changed from predominantly agriculture to manufacturing to services, individuals, firms, and communities have faced often-difficult adjustments. Many workers lost jobs in traditional occupations and had to seek employment in jobs that required completely different sets of skills. Standards of living declined in some communities whose economies centered on farming or around large factories that shut down. In recent decades, populations have decreased in some states where agriculture provides a significant number of jobs. While high-technology industries in places such as California's Silicon Valley were booming and attracting larger populations, some textile and clothing factories in Southern and Midwest states were closing their doors.

Public Policies to “Protect” Firms and Workers

Historically in the United States, the government has rarely stepped in to protect individual businesses from changing levels of demand or competition. There have been some notable exceptions, including the federal government’s guarantee of $1.5 billion in loans to the Chrysler Corporation, the nation’s third-largest automobile manufacturer, when it faced bankruptcy in 1980.

Although direct financial assistance to corporations has been rare, the government has provided subsidies or partial protection from international competition to a large number of industries. Economic analysis of these programs rarely finds such subsidies and protection to be a good idea for the nation as a whole, though naturally the companies and workers who receive the support are better off. But usually these programs result in higher prices for consumers, higher taxes, and they hurt other U.S. businesses and workers.

For example, in the 1980s the U.S. government negotiated limits on Japanese car imports, and the price of new Japanese cars sold in the United States increased by an average of $2,000. The price of new U.S. cars also rose on average by about $1,000. Although the import limits did save some jobs in the U.S. automobile industry, the total cost of saving the jobs was several times higher than what workers earned from these jobs. When fewer dollars are sent to Japan to buy new automobiles, the Japanese companies and consumers also have fewer dollars to spend on U.S. exports to Japan, such as grain, music cassettes and CDs, and commercial passenger jets. So the protection from Japanese car imports hurt firms and workers in U.S. export industries. Still other U.S. firms and workers were hurt because some U.S. consumers spent more for cars and had less to spend on other goods and services.

It is simply not possible to subsidize and protect everyone in the U.S. economy from changes in consumer demands and technology, or from international trade and competition. And while most people agree that the government should subsidize the production of certain types of goods required for national defense, such as electronic navigation and surveillance systems, economists warn against the futility of trying to protect large numbers of firms and workers from change and competition. Typically such support cannot be sustained over the long run, when the cost of protection and subsidies begins to mount up, except in cases where producers and workers represent a strong special interest group with enough political clout to maintain their special protection or subsidies.

When the special protection or support is removed, the adjustments that producers and workers often have to make then can be much more severe than they would have been when the government programs were first adopted. That has happened when price support programs for milk and other agricultural products were phased out, and when policies that subsidized U.S. oil production and limited imports of oil were dropped in the 1970s, during the worldwide oil shortage.

For these reasons, if public assistance is provided to a particular industry, economists are likely to favor only temporary payments to cover some of the costs of relocation and retraining of workers. That policy limits the cost of such assistance and leaves workers and firms free to move their resources into whatever opportunities they believe will work best for them.

Most producers in the United States and other market economies must face competition every day. If they are successful, they stand to earn large returns. But they also risk the possibility of failure and large losses. The lure of profits and the risk of losses are both part of what makes production in a market economy efficient and responsive to consumer demands.