Case Study 2.2m "The Profit Incentive"

Directions: Complete the following case study and record your answers on a separate sheet of paper.

Topic: The role of profit as an incentive to entrepreneurs in a market economy.

Objective: To explore the basic ideas of classical economics and to demonstrate how the profit incentive benefits the U.S. and global marketplaces.

One of the most important aspects of a free market economy is the profit incentive. This incentive creates market competition. Market competition provides a variety of goods and services for consumers. It is also the reason for the development of new goods and services. The profit incentive motivates individuals to explore new economic opportunities. By creating new goods and services, individuals generate a profit for themselves. Their desire to make a profit is the reason that the economy grows and prospers. The free market economy depends upon individuals to produce and consume goods and services. Without a profit incentive, the economy would not exist.

CS Question #1: What is the profit incentive?

Adam Smith was a British economist in the 1800s. He developed the classical economic theory. Classical economics states that individuals purchase and produce goods and services. They are the driving force of a free market economy. A free market economy benefits the nation as a whole. Smith developed the theory of the invisible hand. This theory explains how a free market steers the economy without outside interference. Here is how it works. The market guides an individual or a business to create a good or service. These goods and services are developed to fulfill a need. In return for providing a needed good or service, the individual or business makes profits. The individual or business uses these profits to purchase goods and services from others. In a free market, money moves throughout the economy, benefiting the entire nation.

CS Question #2: What is classical economic theory?

Without the profit incentive, individuals would not be as motivated to develop new ideas within the marketplace. Without profits, nobody would bother to provide needed services. Individuals work according to their own needs. If there were no profits to be gained by starting a business, entrepreneurism would be a waste of valuable time. If individuals could not make a profit, they would not work long hours or produce quality goods and services. A free market economy would cease to function without a profit incentive driving individuals to create new markets, goods and services. Profit incentives are the fuel for the free market fire.

CS Question #3: How does the profit incentive drive a free market economy?

The 1990s changed the U.S. economy. Previously, it was a production-oriented economy. It is now an economy based on information and services. Improved technology gave birth to personal computers and the Internet. As the economy shifted, many people became entrepreneurs. These people saw new market opportunities. They created new goods and services and invested their money in areas of this technology. Some businesses began selling goods and services for building and using information systems. Others created a marketplace within the Internet. Many retail stores now have on-line catalogs. They sell everything from clothes to cars. All of these individuals and businesses were motivated by one common factor - profit. High costs have decreased production opportunities in the American marketplace. Many jobs related to production have been moved to other nations like Mexico. Because labor is less expensive, businesses can make a greater profit by building their goods in other nations. When this change occurred, individuals and businesses created new opportunities. These opportunities have replaced older, less profitable areas of the American economy.

CS Question #4: How does the profit incentive create innovation?

Further Thought: