General Economic Principles

Economics and Economic Systems

What Is Economics?

Economics is in many ways the study of everyday life. People put economics into practice almost daily—as they work to earn money and use their earnings to buy things.

Specifically, economics deals with how people make choices to satisfy their needs and wants with their limited resources. The basic things people must have to survive—food, shelter, clothing, and the like—are needs. Things that are not necessary for survival but make life more comfortable—such as computers and DVD players—are wants. Resources are all the things that people can use to make the products that they need or want.

In the language of economics, resources are called factors of production. Factors of production are usually divided into three categories: land, labor, and capital. Land in economics is a general term that includes not only the soil but also other natural resources, such as oil, coal, and forests. Labor means the human work, both physical and mental, used to produce goods or services. Capital in economics means human-made items, such as machinery, tools, and buildings, that are used in production. In everyday language, capital may be used to mean money.

One important issue in economics is the problem of scarcity. Scarcity means simply that people’s wants are unlimited while the resources to satisfy those wants are limited. A person is dealing with the problem of scarcity, for example, if she wants a dishwasher and a new stove but has enough money to pay for only one of them.

Because of the scarcity problem, both individuals and nations must make choices that enable them to satisfy some of their unlimited wants with limited resources. People differ widely in the economic choices they make. Nations differ too, but each has an overall economic system that guides the choices made in that country. Every economic system must provide ways to make three basic economic decisions:

  1. What will be produced?
  2. How will it be produced?
  3. For whom shall it be produced?

Modern Economic Systems

The graph to the right lists the names of the three basic economic systems: capitalism, socialism, and communism. It also shows that each system has a special plan for dividing basic economic decisions between the government and the private sector. The private sector includes all those businesses that individuals own and run by themselves.

The private sector makes most of the economic decisions under the system of capitalism. Under communism, the opposite is true: the government makes nearly all the economic decisions. Socialism is an in-between case: the private sector makes fewer decisions than the government does, but it still plays an important role in the nation’s economy.

In actual practice, it is impossible to find examples of nations that follow either pure capitalism or pure communism. The United States is the world’s leading capitalist nation, yet the government carries on a number of very important economic activities. The People’s Republic of China is a leading communist nation. Yet in recent years, the government of China has encouraged a greater role for the private sector. That is why economists say most modern nations have “mixed economies” rather than pure forms of capitalism or communism.

The main forces that make capitalism work are self-interest and competition. Private citizens own most of the land and capital. They operate businesses to make profits for themselves. Profit is the money left after all the expenses of running a business have been paid. Business owners must compete, or try to stay ahead of other businesses that are also working for profits.

In a communist system, self-interest and competition are less important. Communists believe that the goals of society are more important than individual wants. The government controls the land, capital, and labor. The government plans the nation’s economic goals and directs all the economic activities.

In a socialist system, the government controls the major resources and capital, such as the mines, steel mills, and air and rail networks. Individuals in the private sector may own smaller businesses.

The Free Enterprise System

Free Enterprise in the United States

The U.S. economic system is largely capitalistic. Another name for capitalism is free enterprise. Free enterprise is based on a principle known as the free market system. In economics, a market is business carried on between buyers and sellers.

In the free market system, prices help decide what, how, and for whom to produce. Self-interest, profits, competition, and the right to own private property are the key factors in free enterprise and the free market system.

Self-interest is the single, most powerful force in the U.S. economy. Consumers, or the people who buy goods and services, shop for the best possible goods at the lowest prices. Producers look for ways to make the largest possible profits. Their search often leads them to invent better products and to develop the most efficient ways to produce them. High profits may encourage producers to expand their businesses. That growth will make more goods available to consumers and provide more jobs for workers.

Competition has a similar effect. Because producers must compete with one another, each business tries to keep the quality of its goods high and prices low so that consumers will choose its products over others on the market. Consumers, in turn, get a broad choice of products to buy.

The U.S. economic system also protects the right to own private property. Private property includes factories and stores as well as people’s homes.

Under free enterprise, the U.S. government makes no central plan for the nation’s economy as the Communist government in the former Soviet Union once did. However, the government does make laws and regulations that limit the freedoms of private business owners. The minimum wage, for example, is a government regulation.

The government also produces certain kinds of goods and services. The postal system, local schools, and city bus lines are all government sponsored. The purpose of these government regulations and services is to keep the country running more smoothly.

Deciding What To Produce

Most people have unlimited wants, but everybody has a limited amount of money. A producer cannot decide what to produce simply on the basis of what people want; he or she must take into account whether people will have the money to pay for the product. For instance, it would be foolish for a businessperson to try to produce and sell expensive sports cars in a poor country. Although people in that country might want those cars, most of them would not have the money to buy them. Moreover, the few people who could afford such cars might prefer to spend their money on something else.

Producers, therefore, have to take into account not only whether consumers will want their product, but also whether potential consumers will be able and willing to pay for it. The desire for a product, plus the ability and willingness to pay for it, is called the demand for that product.

Demand usually leads to production. But before a businessperson decides to go into production to meet a certain demand, he or she must consider one more question: Will consumers be willing to pay more for the product than it costs the businessperson to produce it? Suppose, for instance, that a company is planning to manufacture shirts. It will cost the company $15 to make each shirt. Customers, however, are unwilling to pay more than $15 for the shirt the company offers them. In this case, if the owners of the company are smart, they will get into some other product line because they will not make a profit selling shirts.

The previous example illustrates that the decisions about what, how, and for whom to produce are closely related to the search for profits. What will successful business people or companies produce? They will produce those goods and services that can give them profits. How will they produce? They will use the most efficient methods in order to make quality products, keep production costs low, and gain the largest profits. For whom will they produce? They will produce only for people who want their products and are willing and able to spend money on them.

Determining Prices

In some countries, prices are set by the government. In a free enterprise system, however, prices are determined in the market. A market exists when buyers, who have money and want to buy goods and services, are in contact with sellers, who offer goods and services and want money. The price of a given product is established both by the buyers, who want to buy at the lowest possible price, and the sellers, who want to sell at the highest possible price.

Economists say that prices are determined by the relationship between supply and demand. Supply is the quantity of a good or service that a seller is willing to sell at a certain price. The law of supply says that if the price of a product is high, the producers will be willing to sell more of it. If the price is low, they will want to sell less of it Economists picture supply by using a line graph. Prices on a supply graph are shown on the vertical axis, and quantities are shown on the horizontal axis. The graph on the left is an example of a supply graph for peaches.

The supply curve in the graph slopes upward. This shows that the quantity of peaches offered for sale increases as the price per pound increases. At a price of $0.50 per pound, the seller would be willing to sell 10 pounds. At a price of $1.00 per pound, he or she would be willing to sell 40 pounds, and so on.

Demand is wanting a product, plus being willing and able to pay for it. The law of demand states that if the price of a product is high, consumers will demand less of it. If the price is low, they will demand more.

The demand curve in the graph to the right slopes downward. This is because the lower the price of peaches, the greater the quantity demanded.

In a free market economy, the price of a product is determined at the point where the quantity that consumers want to buy is equal to the quantity that producers want to sell. This is called the market price. The market price of peaches is illustrated in the graph on the left.

Developing Goods and Services

In the early days of U.S. history, Americans produced what they needed and wanted on a small scale. Often the family was the producer. All the factors of production—land, labor, and capital—were used, but there was a much heavier emphasis on human labor than there is today.

The earliest families raised animals, grew their own crops, and built their own houses. People churned butter, preserved meat, made candles, built wagons and furniture, and sometimes even wove the cloth from which they made their clothing. Men, women, and often children worked long hours the year round.

In today’s economy, Americans make goods in mass production. Mass production is production on a large scale. It uses factory machines and modern power sources. Because of modern mass production methods, the United States now uses fewer workers to produce many more goods and services than in the past. The number of Americans now working in agriculture, for example, has declined considerable since 1900. Thanks to modern methods, however, U.S. farmers still produce enough food to meet the needs of U.S. consumers as well as surpluses to other countries

The Role of Consumers

Savings, Investment, and Insurance

Savings are personal earnings that are not spent. There are many reasons that consumers may decide to save part of their money rather than spend it. They may save to take a vacation, buy a house, or send their children to school. How much people saves depends on such factors as the level of their income and personal preferences. The rich can afford both to spend more and to save more. People with low incomes are often unable to save; they may even have to borrow money to meet everyday expenses. And some people who can afford to save may prefer to spend most of their money.

Investments are savings that people put to work to earn additional money. If people keep their extra money in a drawer at home, they are saving but they are not investing. These people are not using what they already have to earn more money. A savings account, on the other hand, is an investment. It earns interest. Interest is the additional money the bank pays people for depositing their money in a savings account. In most banks, savings accounts are insured by the federal government for up to $100,000 for each depositor. Money market funds, another form of investment, usually earn higher interest than savings accounts. Money market certificates and treasury bills (“T-bills”) offer even higher rates of interest. Buying property, such as a house, with the hope of selling it later at a higher price can be yet another form of investment.

Many people invest part of their savings in some type of insurance. This type of investment protects the insured person against possibly large financial losses that could occur from accidents, long illnesses, or deaths in the family. Under the terms of the insurance policy, the insured person agrees to pay a premium to the insurance company. In return, the insurance company agrees to pay up to a maximum amount to an insured person who suffers a loss.

There are many types of insurance, including life insurance, automobile insurance, and home insurance. Insurance can be useful because few families could afford to pay the large debts that can result from accidents or the death of the main wage earner.


Many consumers plan ahead when it comes to spending their money. They do this by making budgets. A budget is simply a list of expected spending and expected income. A budget can cover different periods of time: a week, a month, or a year.

When people prepare a budget, they usually start with those costs they know they are going to have to meet. Rent, electric bills, and loan payments would be in this group. Then they compare these costs with their expected income for the same period of time. The difference between the two amounts gives them an idea of what they can spend on other things.

No two persons or families have identical budgets. Families with high incomes can afford to spend more on nonessential things, such as sports equipment or long vacations. They may also have substantial savings. Economists advise that everyone should try to save, but many low-income families are unable to do so. Differences in taste, interests, and values also account for differences in budgets. Even people with the same income will spend differing amounts on entertainment, education, clothes, and any number of other items.


While people may or may not enjoy watching TV commercials, they wouldn’t be able to watch many television programs at all without the financial backing of advertisers. The costs of TV programs are paid by advertisers who want the public to learn of their products or services. TV commercials are only one of the advertising methods that businesses use; radio announcements, billboards, and Internet, newspaper, and magazine ads are some of the others. Advertising is a major industry in many countries. In 1999 advertisers spent more than $165 billion to reach the public.

Advertising is useful for several reasons. It provides a way for consumers to learn about the products available to them. When a person wants to buy a car, for instance, he or she can learn about the features and prices of different models through advertising. Advertising can also help bring about better products. Producers look for ways to improve their products so that they can claim to have a better product than similar ones on the market.

Advertising boosts the nation’s economy by increasing people’s desire to buy; in this way it creates demand. For example, many children desire certain toys after they see commercials during a children’s TV program. This is a very important function of advertising. It is not enough to have a high level of production in the country. For the economy to run well, there must also be a high level of demand.

The advertising industry has many critics. A basic complaint is that the main goal of advertising is not to help the consumer but to increase the profits of producers. Information presented by advertisers is often one-sided: the good points of the product are stressed, but the bad points are not mentioned. Large companies with millions of dollars are able to reach millions of buyers through mass advertising. Small producers may, therefore, have difficulty competing with large producers. And advertisers may try to encourage people to buy products they don’t really need.

Protection and Education

A number of different agencies protect consumers in the United States against fraud and harmful products. All levels of government—local, state, and federal—have such agencies.

At the local level, most cities have departments that inspect restaurants. Both state and local governments enforce laws to make sure that accurate weights and measures are used by sellers. To accomplish this, inspectors frequently check merchants’ scales and gasoline pumps. State and local governments also have strict regulations concerning the quality of perishable goods, such as milk.

The federal government has many agencies that protect consumer health and safety. The Food and Drug Administration (FDA) prevents dangerous foods, drugs, and cosmetics from reaching the market. The FDA has very strict standards for testing new drugs before they can be marketed. Another federal agency, the U.S. Department of Agriculture (USDA) is responsible for inspecting and grading food sold across state lines. The USDA also provides booklets on food and nutrition to the public.

There are several other federal agencies that work to educate and inform the consumer. For example, the Federal Trade Commission (FTC) tries to eliminate false or misleading advertising throughout the country. The list of ingredients and nutritional information on packaged food is included to fulfill FTC requirements. Another agency, the Consumer Information Center, publishes hundreds of booklets to provide important information to the buying public.

There are also some private organizations that help protect consumers. For instance, Better Business Bureaus are sponsored by private business in many cities. These bureaus fight misleading advertising and other unfair business practices. They keep information files on many companies and record any known complaints against them. If people have doubts about whether to deal with a specific company, a call to their local Better Business Bureau can often help them make up their mind. If consumers feel they have been misled or unfairly treated by a company, they can file a complaint with the Better Business Bureau.

Business Organizations and Labor

Sole Proprietorships and Partnerships

A sole proprietorship is a business owned by only one person; it may be managed by the owner or by persons the owner chooses. Some businesses commonly organized as sole proprietorships are barber shops, repair shops, service stations, restaurants, and boutiques.

The owner of a sole proprietorship enjoys the advantage of not having to share the profits. The owner is also free to make decisions on his or her own. However, he or she is also responsible for all the losses and debts of the business. If the business fails, debts can ruin the owner financially. Unfortunately, a great many sole proprietorships do fail, and some owners are never able to repay their debts. For this reason, many banks do not like to lend money to sole owners.

In a partnership, the business is owned by two or more individuals, or partners. Each partner contributes work or money to the business, and together the partners share profits and losses. The rights and responsibilities of each partner are usually specified in a written contract called a partnership agreement.

Professionals such as lawyers, doctors, dentists, and accountants often form partnerships. Each partner can bring different skills and talents to the partnership. In a law partnership, for instance, each partner may be a specialist in a different aspect of the law.

Partnerships have less difficulty borrowing money than sole proprietorships do. Partnership organizations usually have more possessions and money to back their requests for loans. On the other hand, business decisions become more difficult in a partnership because the individuals involved may disagree. If the business fails, all partners must pay a share of the losses, even if only one partner was responsible for the failure.


Only about 14 percent of all profit-making organizations in the United States are corporations. However, corporations are by far the nation’s most important kind of business organization. Why is that? Corporations hire the largest number of workers in the United States and produce the most goods and services. And, as recorded in the graph on the right, corporations also claim the largest share of business income.

A corporation may have just a few owners or hundreds of thousands of them. Ownership in a corporation is divided into a number of equal shares. The people who own the shares are called shareholders or stockholders. They are the true owners of the corporation.

A corporation is managed by a board of directors, which is elected by the stockholders. The board of directors selects the main officers of the corporation, such as the president and the treasurer. In the election of the board of directors, the voting rights of each stockholder are determined by the number of shares of stock he or she has. Stockholders with many shares have considerable influence in the election of the board of directors. Sometimes these majority stockholders elect themselves to the board of directors.

The corporation has several advantages over other forms of business organization. It is easier for corporations to raise funds; they can do so by selling shares of stock or by borrowing money. If the corporation fails, its stock will lose value, but the stockholder cannot be held responsible for the debts of the corporation. Remember that the owners of sole proprietorships and partnerships must pay for their companies’ debts. Moreover, the owners of a corporation do not have to be involved in management of the company; that is the responsibility of the corporation’s board of directors and managers. If one of the owners of a corporation decides to sell his or her shares of stock, he or she can easily do it, unless the corporation is in very serious financial trouble. While sole proprietorships or partnerships have to be closed or reorganized if an owner withdraws or dies, corporations hardly change if an owner withdraws or dies.

The Labor Force and the Economy

Labor is one of the factors of production. Labor provides the work needed to produce goods and services. This work can be mainly physical, like that of a fruit picker, or mainly mental, like that of a lawyer. The labor force is the group of men and women who are available to work.

In the United States, the labor force is made up of people 16 years of age or older who either are employed in nonmilitary jobs or are looking for work. People with military jobs usually are not considered part of the labor force. The U.S. labor force, in the early days of the country’s history, was about 2 million people. Now it is more than 100 million.

The nature of the work also has changed. Most workers are now in white-collar office jobs, sales and marketing, managerial positions, or service industries. In contrast, when the United States became independent in 1776, about 90 percent of the people in the country were farmers. Today, the U.S. farm population is less than 2 percent of the total population. The dramatic decline of the farm population over the last five decades is illustrated in the graph on the left.

In return for their work, members of the labor force are paid wages. Some workers are paid by the amount of work actually completed; others are paid a specific amount by the hour, week, month, or year. In a free market economy like that of the United States, wages—like prices—are determined by supply and demand. For instance, wages of unskilled workers are usually low because the supply of workers is usually larger than the demand for such workers. On the other hand, skilled workers, who have received special training, usually receive higher wages. This is because the supply of skilled workers is not as large as the demand for them.

In dealing with employers, workers have often found themselves at a disadvantage. A worker who looses a job may be unable to support his or her family. The loss of a worker, however, is not a serious problem to a company. In the past, workers sometimes had to accept low wages or unsafe working conditions because the alternative, not having a job at all, was even worse.

Labor unions are workers’ organizations that have been formed to protect the members’ interests and increase their bargaining power with employers. Labor unions are very influential in the United States, even though only about a fifth of all workers in the country are union members.

The U.S. Economy

Measuring the Economy

In order to plan for the needs of its people, a nation must be able to tell how its economy is doing. Economists use a number of ways to measure a national economy.

The gross national product, or GNP, measures a country’s total production. GNP is the market value of all the goods and services a country produces in a given year. To avoid double counting, only the final goods and services are included. The values of the bricks, glass, mortar, and wood used to build a house, for instance, are not counted. Only the worth of the final good, the house itself, is included in the GNP.

Many economists think that in order to measure the true value of a country’s GNP, they must look at the per capita GNP. The per capita GNP is the dollar amount they get when they divide the GNP by the number of people in the country. A country with a very large GNP may still be a poor country if its GNP must be distributed among a huge population. A country with a comparatively small GNP may be a rich country if its population is small.

Another important economic indicator is the consumer price index, or CPI. Increases in the CPI are used to measure inflation. Inflation occurs when prices keep rising. The CPI is calculated by keeping track of price changes in a “basket,” or a particular group of goods and services that consumers normally buy in all parts of the country. Inflation in the United States is actually moderate compared with that of most other parts of the world.

Unemployment in a nation is measured by means of the unemployment rate. Unemployment occurs when there is not enough work for all the people who are looking for work. The unemployment rate is found by dividing the number of unemployed persons by the number of workers in the labor force, and then multiplying the result by 100. This gives a percentage figure. If 5 million people are unemployed, for example, and the labor force is 50 million, the unemployment rate will be 10 percent.

Economic Growth

If a country’s gross national product is increasing each year, economists say that its economy is growing. The percent of change in the GNP or per capita GNP from one year to the next measures the rate of a country’s economic growth. If a country’s GNP stays the same or goes down, it has experienced no economic growth for that year.

Most countries believe that economic growth is a good thing. If more and more goods and services are produced, there will be more and more jobs for workers. There will also be more products for consumers, and life in general should keep getting better for the people of the country.

Economic growth can benefit more than one nation at a time. If the economy of the United States is growing, its producers will need to buy more materials from other countries. U.S. businesses will also have more money to invest in foreign businesses. The United States in turn can benefit from growing economies in other countries. The United States needs markets in other countries to sell its products. Countries with growing economies will have more money to buy U.S. goods. And the sale of U.S. goods abroad helps both business owners and workers at home.

Some people argue that economic growth does not always mean that a country is doing a good job of meeting its people’s needs. In many countries, economic growth may help mainly those people who already have money—while the poor remain poor. And even though economic growth may bring more material goods, the people may not always be enjoying life more. Growth may go together with pollution of the environment and a hectic pace of life that increases everyday tensions.

Economic Instability

Economic stability is a difficult goal for most countries to achieve. In a perfectly stable economy, economic growth would be combined with little or no inflation and low employment. No country, however, is free from inflation or unemployment.

Inflation is a constant rise in prices. It does not affect all people in the same way. Most salaried people and wage earners will feel some ill effects from inflation. People drawing Social Security or public welfare checks will suffer the most. Their incomes increase too slightly or much too slowly to keep up with the rate of price increases. The rich suffer least from inflation. They usually cut back on their savings rather than their spending. In addition, they are apt to own many stocks and bonds. During times of inflation, the interest earned by stocks and bonds may also go up; the income of rich shareholders may keep pace with inflation.

Another form of economic instability is recession. When a country is suffering from a recession, the production of goods and services declines. Some capital equipment, such as factories and machines, will be idle, and some workers will be unemployed. As a recession becomes more severe, unemployment increases.

A recession exists when a nation’s GNP declines or fails to grow for a period of at least six months. When a recession lasts a long time and is very severe, it is called a depression. The worst depression in the history of the United States, the “Great Depression,” occurred during the 1930s.

Inflation and recession occur under opposite circumstances. When the amount of money circulating—or being spent—in the economy greatly exceeds the value of available goods and services, prices go up. Inflation occurs. When there is too little money to pay for the available goods and services, production goes down and unemployment goes up. A recession occurs. At times, the United States and other countries have experienced yet a third form of instability, called stagflation. Stagflation means that the economy suffers from both high inflation and high unemployment.

Policies for Economic Stability

The U.S. government fights economic instability on two main fronts: fiscal (budget) policy and monetary (money) policy. The government’s fiscal policies decide how it will tax the people and how it will spend the money it collects. Its monetary policies dictate how much money will flow through the economy.

Inflation occurs when total demand and spending are greater than total production. To control inflation, the government may adopt a fiscal policy to cut down on its spending. Reducing the government’s demand for goods and services reduces total demand. The decrease in demand tends to reduce inflation. The government can achieve the same result by increasing taxes without increasing government spending. Higher taxes will mean that individuals and businesses will have less income to spend. This will lower total demand and will tend to reduce inflation.

To fight recession, the government will reverse its fiscal policy. Instead of trying to reduce spending, the government will try to encourage it. The government probably will increase its own spending with the aim of boosting production, increasing jobs, and raising incomes. Or the government might reduce taxes. This would leave individuals and businesses with more money to spend and to invest.

Monetary policy in the United States lies with the Federal Reserve System, a government agency that is basically independent of Congress and the president. The Federal Reserve is basically a bank for banks. It holds a certain percentage of the banks’ deposits, and it provides loans to banks.

The Federal Reserve controls the size of the money supply on a daily basis. During periods of inflation, the Federal Reserve reduces the amount of money flowing through the economy. Money then becomes scarcer, so it increases in value. The rise in prices slows down. During a recession, the Federal Reserve expands the money supply. This encourages producers to make more goods, and it gives the economy a needed boost.

Controlling the money supply has little to do with printing money. The Federal Reserve controls the money supply mainly through its dealings with banks. For instance, to fight inflation, the Federal Reserve can raise the discount rate. The discount rate is the rate of interest the Federal Reserve charges when it makes loans to private banks. Because banks must pay higher interest rates, they will raise the interest rates for their loans to customers. Individuals and businesses will borrow less money. Consequently, there will be less money in use and less pressure to increase prices. In times of recession, the Federal Reserve will take the opposite tack. It will lower the discount rate to increase the amount of money available for spending.

Government Spending and Regulation

The government provides many services that are vital to all Americans. National defense, food and drug safety, highways, and Social Security’s health and retirement benefits are just a few examples. The first graph below shows that the federal government gets most of the money to run its programs from taxes. It also borrows sizable sums from banks or from individuals who buy government bonds. The second graph shows that the government spends more than two-thirds of its money on national defense and benefit programs for individuals.

If the government spends more than it takes in, the federal budget will show a deficit. Each year that the budget shows a deficit, the government’s debt grows larger. The amount of interest the government owes on money it has borrowed also grows. The federal deficit for 2003 is expected to exceed $200 billion. Many economists believe that large deficits will lead to higher interest rates. They also predict that other economic problems may result. Federal budget deficits have attracted the concern of thoughtful government leaders, citizens, and economists.

Private business is well aware of the government’s presence in the economy. Government antitrust laws stand to prevent any one company from becoming so large that it eliminates all competitors. The government also plays public watchdog on private business practices. Factories that pollute the environment, for instance, must pay higher taxes.

Some people charge that the government’s involvement in the economy does more harm than good. Some believe that government taxes discourage people in business. Other critics think that many of the government’s safety standards are so high and so expensive that producers are forced to raise prices of goods. And then there is the enormous paperwork that government requires of business.

Global Markets and Foreign Trades

Exports and Imports

A country’s exports are goods and services that it produces and sells to other countries. A country’s imports are goods and services that it buys from other countries. All countries export and import goods and services, and all countries benefit from it. By exporting, a country gains income. By importing, it can obtain products that it does not have within its borders.

The United States trades heavily with other nations. It exports more food than any other country in the world. It also exports many metals and other natural resources. Its manufactured goods, however, bring in the most money among all its exports. The most valuable goods the United States imports are oil and cars. The U.S.’s major trading partners, or the countries with which it exchanges the most goods and services, are listed in the on the left.

Overall, U.S. production methods are very efficient. The country could actually produce some of the goods it imports for less money than it pays for the foreign goods. To produce these items at home, however, the country would have to use more of its limited natural resources. The United States chooses instead to import certain products and to specialize in exports that other countries are less able to produce.

Trade Balances and Money Values

A country’s balance of trade is the difference between the value of its exports and the value of its imports in any given year. If the value of exports is greater than the value of imports, a country has a positive balance of trade for that year. It is selling more than it is buying. If the value of its imports is greater, the country has a negative balance of trade. It is buying more than it is selling. A positive balance of trade is called a trade surplus; a negative balance of trade is called a trade deficit. Of course, a trade surplus is more desirable. However, since the 1950s, the U.S. has had a trade deficit. In 1999, Americans imported $1.23 worth of goods for each dollar they exported.

In order to trade with a foreign company, businesspeople of a country must exchange their own money for the money of the other country. For instance, if a U.S. importer wants to buy cameras from Japan, he or she must first use U.S. dollars to buy Japanese yen. They the importer can buy Japanese products with the yen he or she has bought. On the other hand, a Japanese person who wants to import U.S. machinery must first buy dollars to purchase the machinery. The price of a country’s money in terms of another country’s money is called the exchange rate.

Exchange rates can go up or down without warning and can contribute to changes in the trade balances. If the value of the U.S. dollar increases with regard to the money of other countries, U.S. importers can benefit, but exporters may suffer. Suppose, for instance, that the U.S. dollar is worth about 120 Japanese yen. Then the value of the dollar increases to 150 yen. U.S. importers could buy more yen with each of their dollars. They could then use the extra yen to import more Japanese cameras. U.S. exporters, on the other hand, would be able to sell less machinery to Japan because Japanese importers would be able to buy fewer dollars with their yen.

American companies have worked hard to market their products throughout the world. However, as seen in the graph on the right, the trade deficit is still increasing.

Multinational Corporations

Almost every day, people come into contact with businesses of various sizes. A family may have dinner in a family-owned restaurant in their neighborhood. A businessman might buy his lunch in a fast-food restaurant that has a chain of restaurants all over the country. Other businesses people deal with are so large that they extend to almost all parts of the world. Such businesses are called multinational corporations.

A multinational corporation is a business organization that has its main office and possibly some production plants in one country. At the same time, it also has factories, sales offices, mining operations, or other business operations in foreign countries.

Sometimes a multinational corporation is just a single company that produces only one product. More often, though, a multinational corporation is a conglomerate. A conglomerate is a group of businesses that come together under one name and one organization but produce many different products. Ford Motor Company is a good example. Ford companies around the world make such varied products as cars, tools, and radios.

Some people think that multinational corporations are good forms of business. They say that multinational corporations help keep the price of consumer goods down in the United States and help people in poorer countries.

A multinational corporation is likely to have one or more factories in a developing country. A developing country is one where most people are poor and unskilled, and the nation’s economy is too weak to help them. A multinational corporation can create badly needed jobs in a developing country. In addition, the corporation may build housing for its workers, pay taxes to the country’s government, and build modern roads and airports so it can ship its products out of the country.

Many people object to multinational corporations. They note that some of these corporations have more money than the countries where they build their plants. Critics say that the corporations sometimes use their wealth to influence government leaders in those countries.

Critics also claim that U.S. multinational corporations are increasing the unemployment at home, and so weakening the United States economy. A multinational corporation pays its workers in developing countries much less money than it would have to pay U.S. workers. It may pass these savings on to U.S. consumers by charging lower prices for its products. At the same time, however, its use of cheap labor abroad is costing U.S. workers jobs at home.

Foreign Competition

Competition is a strong force in a country’s free enterprise system. Competition among U.S. producers is intense. Those who succeed are usually the ones who produce the best products at reasonable prices. Most people agree that this is good for the economy and the consumer. Some people are not so sure, however, that foreign producers should be totally free to compete in U.S. markets.

Some people are in favor of free trade, or unrestricted trade among nations. They believe that competition is always helpful, whether it takes place among the producers in just one country or among producers from many different countries. If producers compete internationally, they will have to sell goods of high quality. They will feel constant pressure to keep prices as low as possible. Consumers will also have a wider choice of goods and services.

On the other hand, some people believe that free trade can hurt a country like the United States. Because some foreign countries pay low wages to their workers, they can afford to sell their products at low prices. If these products enter the United States in unlimited amounts, the U.S. market would be flooded with cheap imports. U.S. companies, which pay higher wages, would be unable to compete with the low prices of foreign goods. They would have to lower wages, lay off workers, or even close down. In all cases, U.S. workers would suffer.

The U.S. government sometimes protects the country’s industries by charging tariffs, which are also called duties.Tariffs are taxes placed on imports to raise their prices. The consumer pays these taxes. If the U.S. government places a tariff on Brazilian shoes, for example, this tariff will be included in the price a person pays if she buys a pair of shoes imported from Brazil. Tariffs, therefore, can reduce the price advantage that imports may have over U.S. goods.

The U.S. government can also set quotas to protect the country’s producers. Quotas limit the amount of certain imports that may come into the country over a specific period, usually a year. The United States places quotas on steel, textiles, and many food products.

In 1992, the U.S., Mexico, and Canada completed the North American Free Trade Agreement. Over 15 years it would eliminate most trade barriers and tariffs and create the world’s largest trading zone.

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