Comprehend how the 3 basic economic questions are answered in the free-market economy

Study and Learn the Words:

Economics is the study of how wealth is created and distributed. By wealth we mean anything of value, including the products produced and sold by business. "How wealth is distributed" simply means "who gets what."

According to economic theory, every society must decide on the answers to three questions:

1. What goods and services—and how much of each—will be produced?

2. How will these goods and services be produced? (That is, who will
produce them and which resources will be used to do so?)

3. For whom will these goods and services be produced? (This is the
question "Who gets what?")

The way in which a society answers these questions determines the kind of economic system, or economy, that society has chosen. In the United States, their particular answers have provided them with a mixed economy, which is based on laissez-faire capitalism, or private enterprise. Their free enterprise business system is the practical application of this economic system.

Laissez-Faire Capitalism

Laissez-faire capitalism stems from the theories of Adam Smith, a Scot. In 1776, in his book The Wealth of Nations, Smith argued that a society's interests are best served when the individuals within that society are allowed to pursue their own self-interest.

Every individual endeavors to employ his capital so that its produce may be of greatest value…And he is in this led by an INVISIBLE HAND to promote an end which was no part of his intention. By pursuing his own interest he frequently promotes that of Society more effectually than when he really intends to promote it.

In other words, Smith believed that each person should be allowed to work toward his or her own economic gain, without interference from government. In doing so, each person would unintentionally be working for the good of society as a whole. And society would benefit most when there was the least interference with this pursuit of economic self-interest. Government should therefore leave the economy to its citizens. The French term laissez faire implies that there shall be no interference in the economy; loosely translated, it means "let them do" (as they see fit).

The features of laissez-faire capitalism are:

Private Ownership of Property Smith argued that the creation of wealth (including products) is properly the concern of private individuals, not of government. Hence the resources that are used to create wealth must be owned by private individuals. Economists recognize three categories of resources: land, labor, and capital, also known as the factors of production. Land includes the land and the natural resources on and in the land. Labour is the work performed by people. Capital includes financial re­sources, buildings, machinery, tools, and equipment that are used in an organization's operations. We have referred to these resources as material, human, and financial resources, and we shall continue to do so. Today, business people use the term capital to mean both capital goods and the money needed to purchase them. The private ownership and use of both kinds of capital give us the names capitalism and private enterprise for our economic system.

Smith argued further that the owners of the factors of production should be free to determine how these resources are used. They should also be free to enjoy the income and other benefits that they might derive from the ownership of these resources.

Economic Freedom Smith's economic freedom extends to all those in­volved in the economy. For the owners of land and capital, this freedom includes the right to rent, sell, or invest their resources and the right to use their resources to produce any product and offer it for sale at the price they choose. For workers, this economic freedom means the right to accept or reject any job they are offered. For all individuals, economic freedom includes the right to purchase any good or service that is offered for sale by producers. These rights, however, do not include a guarantee of economic success. Nor do they include the right to harm others during the pursuit of one's own self-interest.

Competitive Markets A crucial part of Smith's theory isthe competitive market composed of large numbers of buyers and sellers. Economic freedom ensures the existence of competitive markets, because sellers and buyers can enter markets as they choose. Sellers enter a market to earn profit, rent, or wages; buyers enter a market to purchase resources and want-satisfying products. Then, in a free market, sellers compete for sales and buyers compete for available goods, services, and resources.

This freedom to enter or leave a market at will has given rise to the name free-market economy for the capitalism that Smith described.

Limited Role of Government InSmith's view, the role, of government should be limited to providing defense against foreign enemies, ensuring internal order, and furnishing public works and education. With regard to the economy, government should act only as rule maker and umpire. As rule maker, government should provide laws that ensure economic freedom and promote competition.As umpire,it should act to settle disputes arising from conflicting interpretations of its laws. Government, according to Adam Smith, should have no major economic responsibilities beyond these.