U.S. Economy

their means of making a living.

PRODUCTION OF GOODS AND SERVICES

Before goods and services can be distributed to households and consumed,

they must be produced by someone, or by some business or organization. In

the United States and other market economies, privately owned firms

produce most goods and services using a variety of techniques. One of the

most important is specialization, in which different firms make different

kinds of products and individual workers perform specific jobs within a

company.

Successful firms earn profits for their owners, who accept the risk of

losing money if the products the firms try to sell are not purchased by

consumers at prices high enough to cover the costs of production. In the

modern economy, most firms and workers have found that to be competitive

with other firms and workers they must become very good at producing

certain kinds of goods and services.

Most businesses in the United States also operate under one of three

different legal forms: corporations, partnerships, or sole

proprietorships. Each of these forms has certain advantages and

disadvantages. Because of that, these three types of business

organizations often operate in different kinds of markets. For example,

most firms with large amounts of money invested in factories and

equipment are organized as corporations.

Specialization and the Division of Labor

In earlier centuries, especially in frontier areas, families in the

United States were much more self-sufficient, producing for themselves

most of the goods and services they consumed. But as the U.S. population

and economy grew, it became easier for people to buy more and more things

in the marketplace. Once that happened, people faced a choice they still

face today: In terms of time, money, and other things that they could do,

is it less expensive to make something themselves or to let someone else

produce it and buy it from them?

Over the years, most people and businesses realized that they could make

better use of their time and resources by concentrating on one particular

kind of work, rather than trying to produce for themselves all the items

they want to consume. Most people now work in jobs where they do one kind

of work; they are carpenters, bankers, cooks, mechanics, and so forth.

Likewise, most businesses produce only certain kinds of goods or

services, such as cars, tacos, or gardening services. This feature of

production is known as specialization. A high degree of specialization is

a key part of the economic system in the United States and all other

industrialized economies. When businesses specialize, they focus on

providing a particular product or type of product. For instance, some

large companies produce only automobiles and trucks, or even special

parts of cars and trucks, such as tires.

At almost all businesses, when goods and services are produced, labor is

divided among workers, with different employees responsible for

completing different tasks. This is known as division of labor. For

example, the individual parts of cars and televisions are made by many

different workers and then put together in an assembly line. Other well-

known examples of this specialization and division of labor are seen in

the production of computers and electrical appliances. But even kitchens

in large restaurants have different chefs for different items, and

professional workers such as doctors and dentists have also become more

specialized during the past century.

Advantages of Specialization

By specializing in what they produce, workers become more expert at a

particular part of the production process. As a result, they become more

efficient in these jobs, which lowers the costs of production.

Specialization also makes it possible to develop tools and machines that

help workers do highly specialized tasks. Carpenters use many tools that

plumbers and painters do not. Commercial bakeries have much larger ovens

and mixers than those used by people who only bake bread and pies once a

year. And unlike a household kitchen, a commercial bakery has machines to

slice and package bread. All of these tools and machines help workers and

businesses produce more efficiently, and lower the cost of producing

goods and services.

The advantages of specialization have led to the creation of many very

large production facilities in the United States and other industrialized

nations. This trend is especially prevalent in the manufacturing sector.

For example, many automobile factories produce thousands of cars each

day, and some shipyards employ more than 10,000 workers. One open-pit

mine in the western United States has dug a crater so large that it can

be seen from space.

When the market for a product is very large, and a company can sell

enough goods or services in that market to support a very large

production facility, it will often choose to produce on a large scale to

take advantage of specialization and division of labor. As long as

producing more in larger facilities lowers the average costs of

production, the producer enjoys what are known as economies of scale.

But bigger is not always better, and eventually almost all producers

encounter diseconomies of scale in which larger plants or production

sites become less efficient and more costly to operate. Usually that

happens because monitoring and managing increasingly larger production

facilities becomes more difficult. That is why most large manufacturers

have more than one factory to make their products, instead of one massive

facility where they make everything they produce. In recent years, many

steel companies have found it more efficient to build and operate smaller

steel mills than they once operated.

Specialization and International Trade

Over the past few decades, international trade has led to greater

specialization and competition among producers in the United States and

throughout the world. By selling worldwide, companies in the United

States and in other countries can reach many more customers.

Specialization is ultimately limited by the size of the market for a good

or service. In other words, larger markets always allow for greater

levels of specialization. For example, in small towns with few customers

to serve, there is often only one clothing store that carries a small

selection of many different kinds of clothing. In large cities with a

million or more potential customers, there are much larger clothing

stores with many more choices of items and styles, and even some stores

that sell only hats, gloves, or some other particular kind of clothing.

International trade is a dramatic way of expanding the size of a firm’s

market. In markets where transportation costs are low compared with the

selling price of a product, it has become possible for producers to

compete globally to take full advantage of highly specialized production.

But international trade also means that businesses must compete more

efficiently against firms from all around the world. That competition

also makes them try to take advantage of greater specialization and the

division of labor.

In many cases, products are produced and sold by firms from two or more

countries that have large production and employment levels in the same

industry. Often, however, these firms still specialize in the kinds of

products they produce. For example, though many small cars and small

pickup trucks are made in Japan and sent to the United States, large

pickups and four-wheel drive sport utility vehicles are often exported

from the United States to Japan and other nations. Similarly, the United

States exports large commercial passenger jets to most countries, but

imports many small jets from Canada, Brazil, and other nations. While

this may seem strange at first glance, it allows greater specialization

in production for particular kinds of products.

Transportation costs can also help to explain the pattern of

international production and trade. It often makes sense to produce goods

close to the markets where they will be sold, or close to where the

resources used in the production process are found or made. In recent

years, the availability of a skilled and hard-working labor force has

become more important to producers in many different industries, so new

factories are often located in areas with large numbers of well-trained

workers and good schools that provide a future supply of well-educated

workers.

Production Patterns: Past, Present, and Future

Several dramatic changes in production patterns occurred in the United

States during the 20th century. First, most employment shifted from

farming in rural areas to industrial jobs in cities and suburbs. Then,

during the second half of the century, production and employment patterns

changed again as a result of technological advances, increased levels of

world trade, and a rapid increase in the demand for services.

Technological changes in the transportation, communications, and computer

industries created entirely new kinds of jobs and businesses, and altered

the kinds of skills workers were expected to have in many others. World

trade led to increased specialization and competition, as businesses

adapted to meet the demands of international competition.

Perhaps the greatest change in the U.S. economy came with the nation’s

growing prosperity in the years following World War II (1939-1945). This

prosperity resulted in a population with more money to spend on services

and leisure activities. More people began dining out at restaurants,

taking vacations to far-off locations, and going to movies and other

forms of entertainment. As family incomes increased, a wealthier

population became more willing to pay others for services.

As a result of these developments, the closing decades of the 20th

century saw a dramatic increase in service industries in the United

States. In 1940 about 33 percent of U.S. employees worked in

manufacturing, and about 49 percent worked in service-producing

industries. By the late 1990s, only 26 percent worked in goods-producing

industries, and 74 percent worked in service-producing industries. This

change was driven by powerful market forces, including technological

change and increased levels of world trade, competition, and income.

Some observers worried that this growth of employment in service-

producing industries would result in declining living standards for most

U.S. workers, but in fact most of this growth has occurred in industries

where job skill requirements and wages have risen or at least remained

high. That is less surprising when you consider that this employment

includes business and repair services, entertainment and recreation

occupations, and professional and related services (including health

care, education, and legal services). United States consumers and

families are, on average, financially better off today than they were 50

or 100 years ago, and they have more leisure time, which is one of the

reasons why the demand for services has increased so rapidly.

During the 20th century, businesses and their workers had to adjust to

many changes in the kinds of goods and services people demanded. These

changes naturally led to changes in where jobs were available, and in

what kinds of education, training, and skills employees were expected to

have. As the base of employment in the United States has changed from

predominantly agriculture to manufacturing to services, individuals,

firms, and communities have faced often-difficult adjustments. Many

workers lost jobs in traditional occupations and had to seek employment

in jobs that required completely different sets of skills. Standards of

living declined in some communities whose economies centered on farming

or around large factories that shut down. In recent decades, populations

have decreased in some states where agriculture provides a significant

number of jobs. While high-technology industries in places such as

California's Silicon Valley were booming and attracting larger

populations, some textile and clothing factories in Southern and Midwest

states were closing their doors.

Public Policies to “Protect” Firms and Workers

Historically in the United States, the government has rarely stepped in

to protect individual businesses from changing levels of demand or

competition. There have been some notable exceptions, including the

federal government’s guarantee of $1.5 billion in loans to the Chrysler

Corporation, the nation’s third-largest automobile manufacturer, when it

faced bankruptcy in 1980.

Although direct financial assistance to corporations has been rare, the

government has provided subsidies or partial protection from

international competition to a large number of industries. Economic

analysis of these programs rarely finds such subsidies and protection to

be a good idea for the nation as a whole, though naturally the companies

and workers who receive the support are better off. But usually these

programs result in higher prices for consumers, higher taxes, and they

hurt other U.S. businesses and workers.

For example, in the 1980s the U.S. government negotiated limits on

Japanese car imports, and the price of new Japanese cars sold in the

United States increased by an average of $2,000. The price of new U.S.

cars also rose on average by about $1,000. Although the import limits did

save some jobs in the U.S. automobile industry, the total cost of saving

the jobs was several times higher than what workers earned from these

jobs. When fewer dollars are sent to Japan to buy new automobiles, the

Japanese companies and consumers also have fewer dollars to spend on U.S.

exports to Japan, such as grain, music cassettes and CDs, and commercial

passenger jets. So the protection from Japanese car imports hurt firms

and workers in U.S. export industries. Still other U.S. firms and workers

were hurt because some U.S. consumers spent more for cars and had less to

spend on other goods and services.

It is simply not possible to subsidize and protect everyone in the U.S.

economy from changes in consumer demands and technology, or from

international trade and competition. And while most people agree that the

government should subsidize the production of certain types of goods

required for national defense, such as electronic navigation and

surveillance systems, economists warn against the futility of trying to

protect large numbers of firms and workers from change and competition.

Typically such support cannot be sustained over the long run, when the

cost of protection and subsidies begins to mount up, except in cases

where producers and workers represent a strong special interest group

with enough political clout to maintain their special protection or

subsidies.

When the special protection or support is removed, the adjustments that

producers and workers often have to make then can be much more severe

than they would have been when the government programs were first

adopted. That has happened when price support programs for milk and other

agricultural products were phased out, and when policies that subsidized

U.S. oil production and limited imports of oil were dropped in the 1970s,

during the worldwide oil shortage.

For these reasons, if public assistance is provided to a particular

industry, economists are likely to favor only temporary payments to cover

some of the costs of relocation and retraining of workers. That policy

limits the cost of such assistance and leaves workers and firms free to

move their resources into whatever opportunities they believe will work

best for them.

Most producers in the United States and other market economies must face

competition every day. If they are successful, they stand to earn large

returns. But they also risk the possibility of failure and large losses.

The lure of profits and the risk of losses are both part of what makes

production in a market economy efficient and responsive to consumer

demands.

CORPORATIONS AND OTHER TYPES OF BUSINESSES

Three major types of firms carry out the production of goods and services

in the U.S. economy: sole proprietorships, partnerships, and

corporations. In 1995 the U.S. economy included 16.4 million

proprietorships, excluding farms; 1.6 million partnerships; and about 4.3

million corporations. The corporations, however, produce far more goods

and services than the proprietorships and partnerships combined.

Proprietorships and Partnerships

Sole proprietorships are typically owned and operated by one person or

family. The owner is personally responsible for all debts incurred by the

business, but the owner gets to keep any profits the firm earns, after

paying taxes. The owner’s liability or responsibility for paying debts

incurred by the business is considered unlimited. That is, any individual

or organization that is owed money by the business can claim all of the

business owner’s assets (such as personal savings and belongings), except

those protected under bankruptcy laws.

Normally when the person who owns or operates a proprietorship retires or

dies, the business is either sold to someone else, or simply closes down

after any creditors are paid. Many small retail businesses are operated

as sole proprietorships, often by people who also work part-time or even

full-time in other jobs. Some farms are operated as sole proprietorships,

though today corporations own many of the nation’s farms.

Partnerships are like sole proprietorships except that there are two or

more owners who have agreed to divide, in some proportion, the risks

taken and the profits earned by the firm. Legally, the partners still

face unlimited liability and may have their personal property and savings

claimed to pay off the business’s debts. There are fewer partnerships

than corporations or sole proprietorships in the United States, but

historically partnerships were widely used by certain professionals, such

as lawyers, architects, doctors, and dentists. During the 1980s and

1990s, however, the number of partnerships in the U.S. economy has grown

far more slowly than the number of sole proprietorships and corporations.

Even many of the professions that once operated predominantly as

partnerships have found it important to take advantage of the special

features of corporations.

Corporations

In the United States a corporation is chartered by one of the 50 states

as a legal body. That means it is, in law, a separate entity from its

owners, who own shares of stock in the corporation. In the United States,

corporate names often end with the abbreviation Inc., which stands for

incorporated and refers to the idea that the business is a separate legal

body.

Limited Liability

The key feature of corporations is limited liability. Unlike

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