Business Courses/
- AuthorReid Warren
Reid Warren has taught Middle and High School Social Studies (History, Economics, Psychology, and Sociology) for over 6 years. They have a Bachelors Degree in Secondary Education from Indiana University. They also have collegiate planning and teaching experience from Central Texas College
View bio - InstructorPatricia Jankowski
Patricia has a BSChE. She's an experienced registered nurse who has worked in various acute care areas as well as in legal nurse consulting.
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Learn about the economic system in the United States. Understand how the U.S. economy works, examine the U.S. economic growth, and review a graph of this growth.Updated: 11/21/2023
Table of Contents
- What is the Economic System in the United States?
- The Federal Reserve and The Constitution
- Lesson Summary
Frequently Asked Questions
What makes an economy strong?
Ordinarily, an economy's strength is measured by its Gross Domestic Product or GDP. GDP increase, and therefore economic strength, can be attributed to reduced unemployment, higher production of goods and services, and a level playing field of economic opportunity.
Has the U.S. economy grown in the 21st century?
The U.S. economy has grown significantly in the 21st century through the internet and information technology growth. Globalization and global trade have also contributed significantly to its growth.
Table of Contents
- What is the Economic System in the United States?
- The Federal Reserve and The Constitution
- Lesson Summary
What is the economic system in the United States? The American economy and economic system are primarily known as a free market system. This system is characterized by private ownership of property, competition, and the freedom to choose. Individual consumers and businesses are free to trade privately without much government interference. What influence the government does have over the economy primarily has to do with tax collection, safety regulations, and laws that deal with maintaining a level of an economic playing field as possible for all parties involved. As depicted on the circular flow chart below, the market comprises businesses, otherwise known as producers, and individuals, otherwise known as consumers, who offer incentives to work together. Individuals offer businesses money in exchange for the goods and services they need or want, such as food, shelter, clothing, entertainment, etc. Businesses offer individuals money in the form of an hourly wage or salary in exchange for their labor so that the business can continue to operate and produce its goods and services. Because of this mostly uninterrupted cycle of free trade among private citizens and businesses, the United States can be considered a capitalist country. People set out to gain profit and wealth for themselves, whether working for someone else or starting their own business. Because everyone within its system is motivated or incentivized to acquire personal wealth, everyone around them benefits through the labor they provide or the money they spend.
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One critical concept to maintain the United States' free-market capitalist system is the concept of supply and demand. This fundamental economic principle is the governing and driving force behind the economy. Market economies are primarily driven by competition and this law of supply and demand. Because of the lack of government involvement, businesses can decide how much money to charge for the goods and services they sell based on supply and demand; however, consumers can also decide whether they purchase. For example, if Tina and Brad are both lemonade of sales across the street, and consumer demand for Tina's lemonade is higher, Brad may choose to lower his price so that consumers have an incentive to buy from him instead. Tina could then choose to alter her supply and offer iced tea in addition to lemonade creating higher consumer demand for her business. This process ordinarily continues back and forth endlessly in a constant battle to gain consumer demand. If individuals demand something highly enough, businesses will create the supply to match.
U.S. Economic Growth
For most of the last century, US economic growth has been continuously steady and rising. As shown in the US economy graph below, the first notable exception to this growth was in the early 1900s during the Great Depression, which lasted until the second world war. The second was during the recession of 2008, when growth slowed for a couple of years but then slowly resumed its upward trajectory. Several factors throughout the past century have contributed significantly to the United States' steady economic growth. These factors are as follows:
- Women moving into the workforce. (More workers = higher production of goods and services)
- The Baby Boom (The higher the national population = the higher the eventual number of workers)
- Globalization (Increased global trade and cooperation post World War II)
- Technology (The airplane, radio, internet, etc. facilitate unprecedented speed in regards to global trade)
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U.S. Gross Domestic Product (GDP)
Gross Domestic Product (GDP) refers to the value of all goods and services produced within a country within a given year. This metric is used to provide a general indication of the health of a country's overall economy. When the GDP increases from one year to the next, otherwise known as expansion, it usually means that the economy is doing well. When the GDP decreases, also known as contraction, the country's economy is most likely not doing so well. The main factors influencing a country's GDP include natural resources, government-imposed interest rates, unemployment rates, etc. For example, if a home construction company experiences supply shortages for its lumber, it will more than likely be able to construct fewer homes in a given year. If lending interest rates are increased, that same company will likely experience a decreased demand for individuals seeking to buy homes until the rates are lower. If all of this occurs, the company may have to lay off some of its workforces due to decreased revenue leading to less overall production and a lessened GDP. US GDP is no exception to this process. However, it has somewhat changed in the past few decades with more domestic companies moving to manufacture overseas and an increased reliance on the international community for raw materials such as petroleum products and metals such as gold and platinum.
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The United States Federal Reserve is an organization that plays a key role in maintaining the stability of the US economy. It is an institution that exists outside of the government and operates autonomously to ensure the continued health and growth of the US economy. The federal reserve controls the amount of money created and distributed. If they produce too much money, the economy could experience inflation, leading to deflation if they produce too little money. Both of these scenarios are detrimental to the economy, and it is. Therefore the federal reserve's job is to maintain the delicate balance. It is also their responsibility to lend money to smaller banks throughout the country and control domestic interest rates. Suppose the federal reserve believes that it needs to lessen consumer spending. It will simply increase the interest rates to discourage the lower banks and their customers from borrowing and spending more money. In contrast, if they need to increase consumer spending, they might choose to lower the interest rates.
The US constitution is a document that serves as the basis for both the US system of government and its economic system. In most cases, it protects the American economy indirectly by establishing laws and policies that protect private citizens and private businesses from being directly interfered with by the government. The role of the government in the American economy is to look out for public welfare and maintain a level playing field for all those who participate in the economy. For example, the government established the Food and Drug Administration to help protect consumers from harmful products or contaminants that they may unknowingly use or ingest from the goods and services of producers. The government also established minimum wage and child labor laws to help further protect consumers from what was perceived as being unjust working conditions. This limited government interference is far from the other types of economy, such as the command economy. In a command economy, the government controls all of the factors of production. It makes decisions regarding how goods and services are made, sold, etcetera, and how consumers may purchase and use those goods and services. This characteristic differs significantly from a market economy where government control and oversight are limited, and producers and consumers make most decisions based on their own free will.
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Overall, the American economy is a free market economic system that is characterized by private ownership of property, competition, and the freedom to choose. It is also predicated upon incentives and supply and demand. Supply and demand, along with competition, are the primary driving forces behind market economies as a whole. Individuals and businesses make daily decisions regarding how goods and services are produced and consumed. The overall health of the American economy is measured by its GDP, which has primarily been expanding steadily over the past century. The American constitution, along with the federal reserve, helps to further ensure the continued health and stability of the US economy through methods of limited government interference such as laws regarding taxes, regulatory organizations, interest rates, etc. The American economy as a free market, as opposed to a command economy, allows for producers and consumers to have the ability to come together and create mutually beneficial relationships for everyone involved without being directly controlled by the government.
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Additional Info
A Unique Economy
An economy is the combination of all the interactions involving the exchange of goods and services. This includes the distribution, the production, and the consumption of these goods and services. The economy of the United States of America is truly a unique one. The Gross Domestic Product, or GDP, is a measurement of all the goods and services produced by a particular country. The GDP of the US is over twenty trillion dollars and is the highest in the world, as of 2020. The GDP of the state of California alone, if it were a country, would be the fifth highest in the world. While the GDP does not completely reflect the overall well-being of citizens of a given country, it does show that there's lots of production and consumption going on in the US.
A Mixed Market Economy
The economy of the United States is based on the idea of a market economy, which is the type of economy that capitalist societies have. A purely communist or socialist society would instead have a command economy, which is an economy whose operations are controlled by a government. In a market economy, the law of supply and demand is in control to a very large extent. This means that when the demand for a good or service increases, its price goes up, and then when more of the good or service is produced, the price is lowered as it becomes less scarce. Competition is the driving force in this supply and demand activity. In the market economy, everyone is free to produce or consume whatever they want, within legal limits (for example, it is not legal to sell heroin). Government intervention is limited, but it does exist.
Most capitalist countries, including the US, do not have a pure market economy, but instead have a mixed market economy. In a mixed market economy, the government does control some aspects of economic activity that it can handle more efficiently for a society, like the building of roads or the creation of public schools for all children. The government also may intervene when the activity of a free market is unethical or does not benefit everyone in the society. An example of this is anti-trust laws that protect the competition of a free market from huge monopolies.
The Role of the Federal Reserve
Although the US economy is a capitalist, mixed market economy that is primarily based on a free market system, an organization called the Federal Reserve plays a key role in maintaining it and in ensuring its smooth operation. The Federal Reserve is the central bank of the US, and is not totally either private or public, but is instead a combination of the two. It was created by the Federal Reserve Act of 1913, and it consists of the Federal Reserve Board of Governors, the network of twelve Federal Reserve banks, and the Federal Open Market Committee (FOMC), which makes monetary policy. While the Federal Reserve Board of Governors is a government agency, the twelve banks operate like private corporations.
The Federal Reserve seeks to create economic stability by keeping loan interest rates near a target rate and by supervising monetary policy so that the US has low inflation and a high rate of employment. The Federal Reserve is like a financial gatekeeper for the economy whose goal is to maintain stability of the US economy even after events like the 911 terrorist attacks.
Characteristics of the US Economy
Since the US economy is a mixed market economy with an emphasis on free market, it has some characteristics in common with the economies of other capitalist countries. Some of these include:
- Freedom to Choose: In a free market economy, people may buy, sell, or produce whatever they can afford to buy, sell or produce. As long as someone can use it and will buy it, it will be profitable for someone else to produce it.
- Competition: People wanting to sell goods or services in a free market economy can analyze their market to determine how best to make a profit. Whether that works will depend upon the competition that exists for their product or service. A free market economy is driven by competition. This helps keep prices relatively low.
- Limited Government Interference: The role of the government in a free market economy is largely to simply ensure that it is free to operate smoothly. This means that unscrupulous individuals may not manipulate the market, operate a monopoly, or spread false information about their products or services.
- Private Ownership of Property: People in a free market may own goods and property privately and may also rent it out or sell it to make a profit.
The US Economy and the Constitution
The United States of America has the strongest market economy in the entire free world. Perhaps it is a bit ironic that the strength of its market economy is protected by the US Constitution, which outlines provisions that help it to remain free. The US Constitution is the basis for the US system of government, but it is also the basis for the operation of its economy, and it allows for the expansion of the role of government in that economy when there is a need. For example, the US has social programs like Medicare, Social Security, and food stamps to address specific needs of its population. Here's a look at some parts of the Constitution that protect the US economy:
- Amendment V protects the right of people to own private property.
- Amendment XIV prohibits the government from taking away private property without legal due process.
- Amendment IV protects citizens from unreasonable searches and seizures, thus protecting their private property.
- Article I, Section 8 establishes a copyright clause to protect the inventions of innovators as their private property
- The Preamble of the Constitution specifies a goal to ''promote the general welfare'' of the public. This helps to ensure that the US government oversees its free market economy at all times with the welfare of the people in mind.
Lesson Summary
The United States has a unique economy with the highest Gross Domestic Product, or GDP, in the world. The GDP is a measurement of the cost of all the goods and services produced by a country. Capitalist countries like the US have primarily a market economy, while communist or socialist countries have a command economy. A market economy employs a free market that is largely ruled by the law of supply and demand, while the operations of a command economy are controlled by a government.
The US economy is actually a mixed market economy, which means that its government does control some aspects of the economy for the benefit of all citizens, like the building of roads. The Federal Reserve is an organization that is both public and private and that plays a key role in maintaining the efficiency and stable operation of the US economy. It is the central bank of the US.
Some characteristics of the US economy include:
- Freedom to choose
- Competition
- Limited government interference
- Private ownership of property
The US economy is also protected by the US Constitution, which outlines various provisions that protect the operation of the free market. Some of these include Amendment V, Amendment XIV, Amendment IV, Article I, Section 8, and the Preamble. These provisions prevent unreasonable search and seizure and protect private property ownership as well as putting forth the goal to ''Promote the general welfare'' of the public.
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