Economic system

Economics and Politics: The American Economic System

Through Jennifer Nicoll Victor, Ph.D., George Mason University

The economy is closely linked to politics. Governments set economic policies that affect global markets, employment, wages, working conditions and other factors related to economic livelihoods. In turn, economics affects politics, sometimes in mysterious ways. In the United States, although there is a free market system, there are examples of free markets and controlled practices.

Photo of the Statue of Liberty with New York in the background.
The free market economy is based on the principles underlying the doctrine of laissez-faire economy. (Image: Chaay_Tee/Shutterstock)

laissez-faire economy

In 1776, Scottish economist Adam Smith formulated ideas about free market economics in his seminal book, The Wealth of Nations. The book describes the principles underlying what has become the doctrine of laissez-faire economy – a French term that literally means “laisser faire” or “to let go”. The idea is that if markets for goods and services are left untouched or unregulated, they will naturally develop an efficient balance or balance. The invisible forces that guide the economy towards equilibrium have been expressed by Smith as an “invisible hand”.

To better understand the idea of ​​laissez-faire economics, it helps to look at a basic supply and demand graph.

In this chart, the vertical Y-axis represents price and the horizontal X-axis represents quantity. The supply curve represents producers’ incentives and has a positive slope. When prices are low, suppliers have an incentive to produce only a few goods. When prices are high, suppliers prefer to produce and sell more goods. The demand curve is opposite. It has a negative slope and represents consumer incentives. When the price of products is very high, consumers demand a low quantity. When the price of goods is very low, consumers demand more. The point of intersection between the supply and demand curves represents a point of equilibrium.

Photo of Karl Marx.
Karl Marx wanted workers to own the means of production. (Photo: Everett Collection/Shutterstock)

This is a transcript of the video series Understanding the US Government. Watch it now, on Wondrium.

Industrial revolution and free market system

Smith’s ideas were compelling and ushered in a new era of liberal economic thought. But by the 1800s, the Industrial Revolution was in full swing. And with the great advances in technology and machinery, the producers of the world had greatly expanded their ability to manufacture goods and, in many cases, reduced their costs. As one might expect, the evolution of technology has had concrete implications for the ability of the free market to find balances.

In 1867, the influential German philosopher and economist Karl Marx wrote that the free market system did not sufficiently take into account the role of workers and that laissez-faire capitalism would lead to their exploitation.

In late 19th and early 20th century America, there were examples of abusive labor practices, 50 or 60 hour work weeks, low wages, unsafe conditions, and even child laborers. According to Marx, the solution to such problems was for the workers to own the means of production, so that there would be a stronger bond between the producers, managers and entrepreneurs, on the one hand, and the workers who performed work to create goods, products and services, on the other hand.

Learn more about early innovators of the American textile industry.

Economic Philosophies of Adam Smith and Karl Marx

To some extent, the economic philosophies of Adam Smith and Karl Marx can be viewed as the endpoints of a continuum.

At one end is a purely liberal capitalist system, without regulation or formal organization. At the other end is a purely socialist system where the collective rights of workers are privileged over an individual’s ability to produce and exchange goods.

In fact, no country in the world has an economic system that is a pure version of either of these examples.

Adam Smith’s ideas about the free market are so well supported by the mathematics behind them that you might wonder why markets don’t work perfectly all the time. It turns out, however, that under certain conditions, the invisible hand does not do its magic and balance is not found. This is called a market failure.

Why does a market failure occur?

First, the drive to create public goods imposes particular challenges on societies and markets. When individuals seek to create something to which access cannot be controlled, it is difficult to get people to contribute to that thing. In other words, public goods create the conditions for free-riding, which leads to collective action problems.

A chart showing blue bars with a red arrow pointing down.
The third source of market failure is in sectors where there is insufficient competition among suppliers. (Image: Eightshot_Studio/Shutterstock)

Second, some industries have significant barriers to entry. Often, high start-up costs are a common barrier for a producer trying to enter a market. For example, in a perfect market, a number of airlines at different prices and service levels would be created to meet market demand. However, an airline is a very expensive business to start, so barriers to entry into the airline market mean that there are often not enough suppliers relative to the demand for the service.

The third source of market failure is in sectors where there is insufficient competition among suppliers. This is often called a monopoly. Monopolies form when one or a small handful of producers dominate a particular economic sector. In many industries where monopolies exist, the problem is that a single producer can raise prices above an equilibrium price.

Learn more about american capitalism.

Other sources of market failure

Fourth, some industries naturally have negative externalities that are a direct consequence of the production of their goods. For example, coal and steel are gigantic industries with huge markets. However, their production process is extremely taxing on workers and the environment. These negative consequences are known as negative externalities and can be thought of as a type of market failure.

The last form of market failure comes from asymmetric information. In some industries, producers and consumers have access to different levels of product information. When consumers don’t really know how a product was made, what ingredients it contains, or the price at which other producers are selling a product, producers have more information about markets than consumers. When this happens, it is impossible for the invisible hand to produce the point of balance.

Common questions about the US economic system

Q: What is the idea behind the doctrine of laissez-faire economy?

The idea behind the doctrine of laissez-faire economy is that if markets for goods and services are left untouched or unregulated, they will naturally develop an efficient balance or balance.

Q: What were the economic philosophies of Adam Smith and Karl Marx?

Adam Smith purely favored free market capitalist system, without regulation or formal organization. On the other hand, Karl Marx supported a purely socialist system where the collective rights of workers were privileged over an individual’s ability to produce and exchange goods.

Q: What is meant by monopoly?

When sectors lack sufficient competition between suppliers, it is often referred to as monopoly. Monopolies form when one or a small handful of producers dominate a particular economic sector.

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