Succeeding in Our Economic System

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1 21 Succeeding in Our Economic System Key Terms capital free enterprise system productive resources needs wants profi t supply demand monopoly proprietorship partnership corporation organization chart Chapter Objectives After studying this chapter, you will be able to describe the economic system of the United States. compare the three forms of business ownership. describe the responsibilities involved in managing a business. Reading Advantage As you read the chapter, put sticky notes next to the sections where you have questions. Write your questions on the sticky notes. Discuss the questions with your classmates or teacher. 428

2 Key Concepts The free enterprise system of the United States is based on six major factors: private ownership and control of productive resources, a free market, the profi t motive, supply and demand, competition, and limited government involvement. Business can be organized as proprietorships, partnerships, or corporations. Businesses may have tall or fl at management structures. Businesses must be well managed to succeed.

3 430 Part 5 Job Satisfaction Thinking n It Through What helped the United States develop into a strong industrial nation? For years, the United States has been recognized as a highly industrialized nation that developed through a strong business economy. This was not always the case. In the early years of our nation, agriculture was the main industry. Land was available to farmers and ranchers who moved freely across the country. The land was developed, and thousands of communities sprang up. The United States did not develop into a great producer of world goods until the 1800s. With the industrial revolution, American industries were born. Machines were invented to mass produce goods. The production of goods steadily increased, which made more goods available to more people. Manufacturers worked hard to produce more and better goods at ever-lower prices. Along with a good production system, the United States had great supplies of natural resources, such as lumber, coal, iron ore, and copper. The rivers were used to supply power and energy and provide easy transportation of goods. Through the United States patent system, inventions of all kinds were encouraged. The patent system helped protect inventors. It required all inventions to be registered with the federal government, which issued a patent number. Once an invention was patented, it was illegal for someone to copy the invention and assume it as his or her own. As a result, many inventors around the world moved to the United States for this protection. With the invention of new products and processes, industries grew and everyone seemed to benefit. The working people who immigrated to the United States brought their training and skills with them. What tools they could not bring, they made. With their skill and desire to succeed, these workers provided a very productive labor force that industries needed to manufacture goods. To pull the entire industrial system together required organization. Business leaders gave the needed direction as they built their companies and produced their goods and services for the world market. As businesses continued to grow and expand, more emphasis was placed on management. The owners of many companies continued to provide capital, which are possessions and money used to increase business. However, they eventually depended on highly trained persons to manage their businesses and keep them profitable. Why did the United States develop into such a strong industrial nation? It became strong economically because it had natural resources, a patent system, skilled labor, good management, and capital for investments. The United States also had another very important asset a system of government that permitted industry to operate as a free enterprise. It was the free enterprise system that allowed individuals and groups the right to start businesses and earn profits from them. The Free Enterprise System Free enterprise is only one of many names used to describe our economic system. It is also called a consumer economy, a market economy,

4 Chapter 21 Succeeding in Our Economic System 431 a profit system, and capitalism. Although all these words have slightly different meanings, they all represent the same basic economic system. In a free enterprise system, people are free to make their own economic decisions. This system is based on six major factors: private ownership and control of productive resources, a free market, the profit motive, supply and demand, competition, and limited government involvement. Private Ownership and Control of Productive Resources The government does not own or control business and industry. Private citizens do. Individuals and businesses decide how to use their productive resources to produce and provide goods and services. Productive resources are resources such as labor, land, capital, and equipment that can be used to produce and provide goods and services. See Consumer decisions about which goods and services to buy or use are affected by resources. Resources are limited, but needs and wants are unlimited. Needs are the basics a person must have to live. Wants are the items a person would like to have, but can live without. Having nutritious food is a need, but having your favorite fast-food meal is a want. Individuals and families have limited resources, such as time and money. However, their needs and wants for food, clothing, and entertainment are unlimited. Because their resources are limited, they must first take care of their needs before they decide which wants to satisfy. They may choose between a play or a concert when they do not have time to do both. If money is limited, they may choose between saving money for college costs or taking a vacation. Some choices are Thinking It Through Why is competition so important in a free enterprise system? 21-1 Labor, land, equipment, and capital (money) are all productive resources.

5 432 Part 5 Job Satisfaction more difficult than others. For instance, parents take extra part-time jobs to make extra money or use the time to devote to the family. Free Market In the free enterprise system, the market is not controlled by the government. People have the right to decide how and where to earn, spend, save, and invest their money. They also have the freedom to produce whatever they think they can sell, provided they follow existing rules and laws. If there is a demand for their product, they make a profit. On the other hand, if the demand is small and they make too many products, they suffer financial losses. When losses occur, a company will search for ways to become profitable again. It may mean reorganizing the company, laying off workers, or installing newer technology. Sometimes a company cannot produce goods as cheaply as its competition. If a company cannot turn losses into profits, they may need to take more serious action. They may reduce the number of workers they employ, or in some cases close the business. Thinking n It Through What is the one principle on which all businesses operate? Give examples of this principle in action. Profit Motive The main reason for operating a business is to make a profit. Profit refers to the amount of money a business makes from selling goods and services beyond the cost of producing them. Businesses, motivated by their desire to earn profits, use their resources to produce goods and services. If consumers buy enough of the product and the production costs are not too high, then the business makes a profit. This reason for doing business is called the profit motive. Profits motivate people to be productive. Without this opportunity to earn a profit, they would not be motivated to work or to invest their money. Productive people receive a profit in the form of income, called a return on their investments. Without productive people, there would be no labor or money to produce goods and services. Supply and Demand Our economic system is based on supply and demand. Supply is the amount of products and services available for sale. The amount of products and services consumers want to buy is called demand. Businesses decide what and how much to produce based on consumer demand. Consumers express their demand for products and services through their spending choices in the marketplace. Whatever consumers are willing to buy, there are businesses willing to supply it. The relationship between supply and demand affects the prices of products and services. When consumer demand is high, prices tend to go up. As the supply increases and more competition enters the market, prices tend to go down. Prices can also change as supplies increase or decrease. A product shortage can cause prices to rise. For instance, when bad weather ruins

6 Chapter 21 Succeeding in Our Economic System 433 the orange crop, the supply is low and prices are high. When the supply increases, creating a surplus, orange prices go down. See Competition Any individual or business has the right to enter into the same business as any other company and compete for consumer dollars. Competition encourages businesses to produce quality goods and services at low prices. If a USDA company charges too high a price for a product or service, consumers can go to a competitor who sells a similar or better product or service and buy it for less. The company that produces the best products and services at the lowest prices will earn the most profits. BJ s Shoe Store is an example of how consumers benefit from competition. Since no other shoe stores were in the area, customers paid BJ s prices for years. When a competitive shoe store opened about a block away, it advertised the same quality shoes at much lower prices. As a result, BJ s sales dropped. To stay competitive, BJ s owner decided to buy cheaper shoes and advertise more. To compete successfully, he knew he had to offer lower prices than his competitor. Without competition, prices tend to be high for a couple reasons. First, businesses can charge whatever price they think consumers will pay without fear of losing business to someone selling for less. Secondly, if there is only one manufacturer and it is successful, there is little need for the company to reduce production costs. Competitors usually must work harder to get a share of the business. Consequently, they find ways to make 21-2 The price of fresh oranges is highly affected when bad weather sharply reduces the annual crop. Extend Your Knowledge Competition Is Mightier Than the Pen When ballpoint pens were first introduced, consumer demand was high, and the steps involved in making pens was unknown. The initial process was relatively expensive, and consumers paid several dollars to buy one. As more companies started making ballpoint pens, they offered greater variety at lower prices. Competition among businesses improves product choice and lowers prices for consumers. The desire to compete also inspires a search for breakthroughs that allow a business to offer these improvements.

7 434 Part 5 Job Satisfaction Thinking It Through Name at least fi ve proprietorships that exist in your community or surrounding area. products quicker and less expensively. They also explore consumer needs and wants, then offer products and services that address them more directly. Limited Government Involvement To keep the free enterprise system free and fair requires some government involvement. Federal, state, and local governments establish and enforce economic laws and policies to promote economic growth and stability. They also protect consumers from unsafe and unfair business practices. To promote fair competition among businesses, the government enforces laws that prevent monopolies. A monopoly is a single company that controls the entire supply of a product or service. If a monopoly was allowed to exist, it could charge consumers unfair prices for goods and services and limit their production and availability. This practice prevents competition and does not allow the economy to operate on a free enterprise basis. How Businesses Are Organized As a result of our free enterprise system, the United States has thousands of businesses that produce a variety of products and services. Businesses range from only one person as the owner-worker to thousands of employees in a large company. However, they all operate on the same basic principle. They must earn a profit to stay in business. This means all businesses depend on consumers to buy their goods and services, which creates a demand for more goods and services. To understand more about the way businesses operate in our economic system, it helps to understand the three forms of business ownership proprietorship, partnership, and corporation This store is a proprietorship because it is a neighborhood business that has only one owner. Proprietorship A proprietorship is a business that has only one owner. It is the simplest form of business organization because usually only one person makes the decisions and manages the business. There are no business partners or board of directors to consult. For these reasons, there are many singleowner businesses. In a proprietorship, the owner or proprietor supplies all the money to start and operate the business. As a result, the owner receives all the profits that are made and assumes all the debts and losses. Most proprietorships are small companies in which the owner does much of the work. Many retail and service shops such as the corner restaurant, barbershop, hair salon, dry cleaner, and auto repair shop are proprietorships, However, a proprietorship can be a multimillion dollar business with hundreds of employees.

8 Chapter 21 Succeeding in Our Economic System 435 Partnership A partnership is a form of business organization where two or more people go into business together, Have you ever seen or heard of a company with two names in its title? Wagner and Son suggests a father and son in partnership. Smith and Jones Plumbing suggests a company formed by two friends who own and operate the business as equal partners. In a partnership, all the partners pool their money to establish and operate the business. The partners share the work responsibilities as well as the profits and debts. One of the advantages of a partnership over a proprietorship is that more money is available to finance the business. A partnership also brings together the skills and experiences of two or more people. This often makes it easier for a partnership to solve problems and make wise business decisions. It follows the logic that two heads are better than one. Partnerships may have their disadvantages as well. Problems can arise when partners do not agree on business decisions. There can also be problems when one partner feels he or she is assuming more of the work and responsibility than the other partner(s). In addition to regular partnerships, there are limited partnerships. Limited partners, sometimes called silent partners, invest money or property into a business but do not work in the business. As the business makes a profit from the sale of its goods or services, limited partners receive a percentage of those profits. If the business fails, limited partners are only responsible for any debts of the business up to the amount of their investments. Corporation A corporation is a business owned by many people. A corporation is formed by selling portions or shares of a business that are called stocks. The people who buy the stocks become part owners of the business and are called stockholders. See A stockholder is only responsible for business debts up to the amount of his or her investment. Therefore, if a stockholder invests $500 in a corporation, the most the stockholder can lose if the business fails is $500. This is called limited liability. Stockholders are only liable for the amounts they have invested. If the corporation makes a profit, the stockholder receives a share of those profits according to the amount he or she has invested. Corporate ownership offers two advantages. Limited liability is one of the major advantages of forming a corporation. The other advantage of corporate ownership is that large amounts of money can be raised to expand a business and produce more goods or services The law firm of Qualls & Fry is a partnership because it is a business that has more than one owner Although this company s name implies a single owner, Sally s Beauty Supply is a corporation with shops in many states.

9 436 Part 5 Job Satisfaction Levels of Management Thinking n It Through What does limited liability mean? Board of Directors President Vice President Plant Manager Department Head Supervisor Worker 21-6 Many levels of management exist in some corporations. Most of the important business decisions are made by the board of directors and top level managers. Although stockholders are part owners in a corporation, they have very little input in the decision making. A board of directors, elected by stockholders, makes most of the business decisions along with the leaders hired to run the corporation. The president and vice presidents of a corporation are the top level managers. These officials give leadership and direction to the entire corporation. They work together to see that the corporation makes a profit. See 21-6 for an example of the levels of management that exist in some corporations. The president oversees all corporate activities and hands down decisions to the vice presidents. The vice presidents delegate responsibilities to managers (in this example, plant managers). The plant managers oversee the department heads. The department heads oversee the supervisors. The supervisors comprise the lowest level of management and oversee the workers. Each person reports to the person in the next highest position and, in turn, receives direction from that person. The larger the corporation, the more specialized the levels of management become. How Businesses Are Structured There are many different management structures within businesses. The type of management structure within a company may directly influence the responsibilities of your job. Two common types of management structures are tall, sometimes called vertical, versus flat, sometimes called horizontal. A chart that shows an organization s internal structure is called an organization chart. See In the tall structure, a low-level worker is quite removed from the top managers. Jobs tend to be more specialized, requiring very specific skills. Responsibilities also tend to be narrower. In the flat structure, a worker usually has closer contact with supervisors, vice presidents, and other personnel. Employees usually have a broader range of skills. They also tend to have greater responsibility for their work. More emphasis is placed on teamwork, with each member of the team having a major role in the work being done. There may be fewer delays and mistakes with fewer layers of personnel due to improved communications.

10 Chapter 21 Succeeding in Our Economic System 437 Types of Organizational Structure Tall (vertical) Structure President Executive Vice President Executive Vice President Vice President Staff Specialists (6) Operating Managers (6) Operating Managers (10) Staff Specialists (5) Staff Specialists (5) Flat (horizontal) Structure President Operating Managers (6) Staff Specialists (4) Business Management For a business to be successful, it must be well managed. Managing a business involves many responsibilities. It requires careful attention to the details of the specific business. It also requires planning, staffing, directing, marketing, and financing. The purpose of planning is to set goals for the business to make it more successful and profitable. This involves deciding which goods to produce or services to provide and how to market them well. Planning includes researching the competition and turning out the products or services consumers prefer. Planning also includes organizing the business so it can operate efficiently and reach its goals. Staffing involves hiring workers to help produce, market, and distribute goods and services. The larger the business, the larger this function is. In large corporations, the staffing and training of employees is usually handled by a personnel manager The type of organizational structure may affect the number of executives, effectiveness of communications, and job responsibilities within the company. Thinking It Through Explain the levels of management that exist in many corporations.

11 438 In the Real World Starting a Multimedia Business Renata and Marc are close friends. Both want to start a business they can operate from a home office. They both have experience with multimedia. Coincidentally, both are considering similar business ideas. One business idea involves creating interactive high school yearbooks. Since the majority of high school students have access to computers in their own homes, it is felt there may be high potential in this product. The other business idea is designing Web sites for individuals and businesses. They both feel they have the background in computer language to use simple software to make Web pages come alive. They know how to use graphics, animation, and sound in Web sites and have successfully created Web sites for several local companies. Since Renata and Marc have such similar career plans, they wonder if a partnership is a better work arrangement for them than individual proprietorships. Perhaps they should consider forming a corporation. Questions to Discuss 1. What type of business organization would you recommend for Renata and Marc? Explain. 2. If they asked you to invest money in their business venture(s), how would you respond? 3. Which business management responsibilities will Renata and Marc probably handle well, based on their abilities? For which business management responsibilities might they need help? Directing the production of goods is another job for management. Production managers and supervisors oversee the manufacture of goods. Managers of stores, restaurants, health clubs, and other service businesses make sure they operate efficiently and provide customer satisfaction. Production and service managers are both responsible for the quality of goods and services their businesses provide. Marketing includes the promotion, selling, and distribution of goods and services. The purpose of marketing is to persuade customers to buy the products or services and become repeat customers. Financing involves keeping records of accounts, paying debts, collecting payments from customers, handling the payroll, and paying taxes. As managers plan, staff, direct, market, and finance their businesses, they must constantly make decisions. A personnel manager must decide

12 Chapter 21 Succeeding in Our Economic System Running a business successfully requires the input of experts on staff or outside consultants hired for specific projects. who to hire. A production manager must decide how goods will be manufactured. A marketing manager must decide how products or services will be promoted. A business manager must decide how to keep accurate financial records. Because decision making is such an important part of management, workers with the most training and experience are most often promoted to management positions. The more knowledge and experience people have, the more likely they are to make wise business decisions. See Thinking It Through Describe the responsibilities involved in managing a business.

13 440 Part 5 Job Satisfaction Summary The economic system in the United States is known as the free enterprise system. This means people have the freedom to make their own economic decisions and possess property. Businesses and individuals can decide how to use resources to produce products and services. The free market gives people control over their money and the ability to be both buyers and sellers in the marketplace. Competition encourages better quality products at lower prices. Profi t motivates people to work and produce more goods and services. Consumer choices largely affect supply and demand in the marketplace. Government involvement helps the economy stay healthy and competitive. Businesses are organized under three basic forms of ownership and may be structured in many different ways. Two common types of management structures are tall and fl at. All types of business organizations must be well managed to be successful. Business management involves careful planning, staffi ng, directing, marketing, and fi nancing. Facts in Review 1. What are the six basic factors on which the U.S. free enterprise system is based? 2. Why is some government involvement necessary in a free enterprise system? 3. What would happen if monopolies were allowed to exist? 4. Name and describe the three forms of business ownership. 5. Name two advantages of a partnership over a proprietorship. 6. What are the disadvantages of a partnership? 7. What is a limited partnership? 8. If a business fails, for what are limited partners responsible? 9. What are the two major advantages of corporate ownership? 10. Who makes most of the business decisions in a corporation?

14 Chapter 21 Succeeding in Our Economic System 441 Developing Your Academic Skills 1. Math. Prepare a presentation on current examples of products in high demand. How has demand affected the price of the products? What is likely to happen to the prices once a surplus of the product is available? Present your fi ndings to the class. 2. Social Studies. Research the differences between the United States free enterprise system and economic systems in other countries. Discuss your fi ndings in class. Information Technology Applications 1. Give examples of technology invented during the industrial revolution. Explain how these inventions changed America s economy. 2. Search the Internet for examples of companies that were declared monopolies in the U.S. Report to the class what actions were taken against these companies. 3. Use drawing software to draw an organization chart of the company for which you or family members work. Applying Your Knowledge and Skills 1. Systems. Ask someone who has lived under an economic system different from the free enterprise system in the United States to speak to the class about life under that system. Discuss the differences between that economic system and a free enterprise system. 2. Problem Solving and Critical Thinking. Prepare an organization chart showing the levels of management that exist in your school system. Begin with the school board and work down to the teaching and nonteaching positions. 3. Communications. Invite the president of a proprietorship, a partnership, and a small corporation to your class to discuss their responsibilities as a company president. After hearing them speak, discuss the similarities and differences in their responsibilities. Developing Workplace Skills Work with two classmates to create a new business on paper. Imagine that your group s life savings will be invested into its development, so select one everyone believes will be successful. Then answer the following questions on paper: What product(s) and/or service(s) will your business provide? What type of business organization will it have? Approximately how many people will it employ? Will the organization chart be tall or fl at? Why will consumers patronize your business instead of your competitors? Be prepared to present your business idea to the class.

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