Magruder's American Government: 12. Government and the Economy, Sections 1–2

Capitalism is an economic system in which individuals are free to own the means of production and maximize profits.

A second factor of production is capital—all the human-made resources that are used to produce goods and services.

An entrepreneur—literally, an “enterpriser”—is an individual with the drive and ambition to combine land, labor, and capital resources to produce goods or offer services, and is willing to risk losses and failure.

Capitalism is often referred to as a free enterprise system, which is an economic system characterized by private ownership of capital and by investments that are determined by private decision, not by public authorities.

Under these competitive conditions, the law of supply and demand determines the market price for goods or services. Supply is the quantity of goods or services available for sale at a range of prices.

Demand is buyers’ desire and ability to purchase a good or service.

A firm that is the only source of a product or service is called a monopoly.

Laissez-faire theory holds that government should play only a very limited, hands off role in society, confined to: (1) foreign relations and national defense, (2) the maintenance of police and courts to protect private property and the health, safety, and morals of the people, and (3) those few other functions that cannot be performed by private enterprise at a profit.

However, other economic systems— socialism and communism—do seek to distribute wealth more evenly across the society.

The father of modern socialism and communism, Karl Marx (1818–1883) was the most significant critic of capitalism as it developed during the early Industrial Revolution. He envisioned a society where social classes would vanish and the people would own all property in common.

Privatization is the process of returning nationalized enterprises to private ownership.

However, beginning in the early twentieth century, there were repeated economic panics and recessions.

The nation’s gross domestic product (GDP)—the total value of all final goods and services produced in the country each year—now exceeds $15 trillion.

A general increase in prices throughout the economy is called inflation.

A general decrease in prices is known as deflation.

When there is an absence of growth and the economy shrinks, a recession occurs.

Fiscal policy is a major tool with which both the executive and legislative branches of the Federal Government seek to achieve broad economic goals. Fiscal policy consists of the government’s powers to tax and spend to influence the economy.

Monetary policy involves the money supply (the amount of currency in circulation) and the availability of credit in the economy.

The discount rate is the rate of interest a bank must pay when it borrows money from a Federal Reserve Bank.

Interest is the cost borrowers incur and must repay in order to borrow money.