U.S. Economy

U.S. Economy

United States (Economy)

INTRODUCTION

The U.S. economy is immense. In 1998 it included more than 270 million

consumers and 20 million businesses. U.S. consumers purchased more than

$5.5 trillion of goods and services annually, and businesses invested

over a trillion dollars more for factories and equipment. Over 80 percent

of the goods and services purchased by U.S. consumers each year are made

in the United States; the rest are imported from other nations. In

addition to spending by private households and businesses, government

agencies at all levels (federal, state, and local) spend roughly an

additional $1.5 trillion a year. In total, the annual value of all goods

and services produced in the United States, known as the Gross Domestic

Product (GDP), was $9.25 trillion in 1999.

Those levels of production, consumption, and spending make the U.S.

economy by far the largest economy the world has ever known—despite the

fact that some other nations have far more people, land, or other

resources. Through most of the 20th century, U.S. citizens also enjoyed

the highest material standards of living in the world. Some nations have

higher per capita (per person) incomes than the United States. However,

these comparisons are based on international exchange rates, which set

the value of a country’s currency based on a narrow range of goods and

services traded between nations. Most economists agree that the United

States has a higher per capita income based on the total value of goods

and services that households consume. American prosperity has attracted

worldwide attention and imitation. There are several key reasons why the

U.S. economy has been so successful and other reasons why, in the 21st

century, it is possible that some other industrialized nations will

surpass the U.S. standard of living. To understand those historical and

possible future events, it is important first to understand what an

economic system is and how that system affects the way people make

decisions about buying, selling, spending, saving, investing, working,

and taking time for leisure activities.

Capital, savings, and investment are taken up in the fourth section,

which explains how the long-term growth of any economy depends upon the

relationship between investments in capital goods (inventories and the

facilities and equipment used to make products) and the level of saving

in that economy. The next section explains the role money and financial

markets play in the economy. Labor markets, the topic of section six, are

also extremely important in the U.S. economy, because most people earn

their incomes by working for wages and salaries. By the same token, for

most firms, labor is the most costly input used in producing the things

the firms sell.

The role of government in the U.S. economy is the subject of section

seven. The government performs a number of economic roles that private

markets cannot provide. It also offers some public services that elected

officials believe will be in the best interests of the public. The

relationship between the U.S. economy and the world economy is discussed

in section eight. Section nine looks at current trends and issues that

the U.S economy faces at the start of the 21st century. The final section

provides an overview of the kinds of goods and services produced in the

United States.

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.

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.

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.

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.

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.

What Are Markets?

Goods and services are traded in markets. Usually a market is a physical

place where buyers and sellers meet to make exchanges, once they have

agreed on a price for the product. One kind of marketplace is a grocery

store, where people go to buy food and household products. However, many

markets are not confined to specific locations. In a broader sense,

markets include all the places and sources where goods and services are

exchanged. For example, the labor market does not exist in a specific

physical building, as does a grocery market. Instead, the term labor

market describes a multitude of individuals offering their labor for sale

as well as all the businesses searching for employees.

Traders do not always have to meet in person to buy and sell. Markets can

operate via technology, such as a telephone line or a computer site. For

example, stocks and other financial securities have long been traded

electronically or by telephone. It is becoming increasingly common in the

United States for many other kinds of goods and services to be sold this

way. For instance, many people today use the Internet—the worldwide

computer-based network of information systems—to buy airline tickets,

make hotel reservations, and rent a car for their vacation. Other people

buy and sell items ranging from books, clothing, and airline tickets to

baseball cards and other rare collectibles over the Internet. Although

these Internet buyers and sellers may never meet face to face the way

buyers and sellers do in more traditional markets, these markets share

certain basic features.

How a Single Market Works

Buyers hope to buy at low prices and will purchase more units of a

product at lower prices than they do at higher prices. Sellers are just

the opposite. They hope to sell at high prices, and typically they will

be willing to produce and sell more units of a product at higher prices

than at lower prices.

The price for a product is determined in the market if prices are allowed

to rise and fall, and are not legally required to be above some minimum

price floor or below some maximum price ceiling. When a product, for

example, a personal computer, reaches the market, consumers learn what

producers want to charge for it and producers learn what consumers are

willing to pay. The interaction of producers and consumers quickly

establishes what the market price for the computer will actually be. Some

people who were considering buying a computer decide that the price is

higher than they are willing to pay. And some producers may determine

that consumers are not willing to pay a price high enough for them

profitably to produce and sell this computer.

But all of the buyers who are willing and able to pay the market price

get the computer, and all of the sellers willing and able to produce it

for this price find buyers. If more consumers want to buy a computer at a

specific market price than there are suppliers are willing to sell at

that price—or in other words, if the quantity demanded is greater than

the quantity supplied—the price for the computer increases. When

producers try to sell more of their computers at a price higher than

consumers are willing to buy, the quantity supplied exceeds the quantity

demanded and the price falls.

The price stops rising or falling at the price where the amount consumers

are willing and able to buy is just equal to the amount sellers are

willing and able to produce and sell. This is called the market clearing

price. Market clearing prices for many goods and services change

frequently, for reasons that will be discussed below. But some market

prices are stable for long periods of time, such as the prices of candy

bars and sodas sold in vending machines, and the prices of pizzas and

hamburgers. Most buyers of these products have come to know the general

price they will have to pay for these items. Sellers know what prices

they can charge, given what consumers will pay and considering the

competition they face from other sellers of identical, or very similar,

products.

A System of Markets for All Goods and Services

How markets determine price is simple enough to understand for a single

good or service in a single location. But consider what happens when

there are markets for nearly all of the goods and services produced and

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