What Are the Four Parts to a Free Enterprise System?

  Reviewed by: Michelle Seidel, B.Sc., LL.B., MBA
  Written by: Annie Sisk      Updated October 25, 2018
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The hallmark of the free enterprise system is that the marketplace controls the production and sale of goods and services. Individuals are granted equal rights to start, operate and grow businesses. Whether the businesses fail or succeed depends solely on the behavior of the market.

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  • A free enterprise system is based on four key principles: private property rights, profit motive, equal individual rights and unrestricted competition.

What Is a Free Enterprise System?

Any reasonable free enterprise definition generally makes mention of a few of the underlying principles of such a system. For example, one such definition is “an economic system based strictly on principles of supply and demand in which governmental regulation is nonexistent or severely limited and in which market participants are free to control the terms of sale for their private property.”

A free enterprise economy is based on a free and fair exchange between a willing buyer and a willing seller who reach a voluntary consensus on a purchase price. If a seller has a couch to sell and asks $400 for it, but a buyer is only willing to pay $300, there is no agreement and hence no sale. One or the other (or both) must move from their position if a purchase is to take place. Perhaps the seller reduces the original price because a new furniture dealer opens up for business down the street, and prices there are 35 percent less. Or perhaps another buyer enters the store willing to pay more, thus coaxing the original buyer to pay more.

In a free enterprise, this transaction is determined solely by the buyer and seller. Despite market forces, such as competition, the decision is ultimately up to these two parties.

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The four principles underlying a free enterprise system support a free market that’s open to all, with the most competitive participants generally enjoying the most success. Underlying it all as the driving force that keeps the system functional is the profit motive.

Profit Motive and Free Enterprise

Free enterprise systems are driven by one key motivator above all others: the ability to realize a profit. Profit is defined as the difference between total price and total costs. In other words, profit is the financial gain recognized by a seller who sells an item for more than the seller paid for it.

Free enterprise systems are based in part on the ability of buyers and sellers to reach agreements on prices and other terms for sales of goods and services. However, sellers are generally intent on maximizing their profits in order to generate more wealth. This aspect of free enterprise systems is much the same as in capitalist economies, which are likewise focused on the creation of maximum possible wealth.

Private Property Rights

Free enterprise requires that all involved in the market are recognized as enjoying full personal control over their own property. Private property rights are what enable the free exchange of that property through sale. Other types of economic systems exist in which control of property vests not in individuals but in groups, communities or the government. However, when individuals enter the free enterprise market, they bring with them the right to sell, exchange or dispose of their property in any manner they wish.

Equal Rights for All Market Participants

In addition to the right to control one’s own property, all market participants in a free enterprise system enjoy equal rights. If a market is to be truly free, the buyers and sellers involved in that market must stand on equal, level footing. The recognition of equal rights for free market participants is what enables true market-driven competition.

Importance of Competition

Competition is vital to a healthy free enterprise system. In a free market economy, those businesses that succeed are the ones the market has chosen to reward. Typically, this means those successful businesses have provided a superior product or service, or they have filled a market need a bit more thoroughly than their competition. The process of competition is what fuels innovation, the development of superior products and greater creativity in the system as a whole.

Difference Between Free Enterprise and Capitalism

While it may seem that free enterprise and capitalism are the same thing, the truth is somewhat more complex. The concepts may be related and even share some common elements, but the terms do refer to different things. A country can be based on a capitalist economy but lack a free enterprise system that’s completely free. Likewise, a country could have a free market based on some other economic system than capitalism.

Capitalist economies are based on one primary feature: the control of the means of production by private individuals, not the government. Of course, capitalist economies may (and usually are) regulated by the government through laws. In addition, the government may (and usually does) tax profits from businesses in a capitalist economy.

By way of contrast, free enterprise means that the individual participants set the terms of economic transaction, relatively free of regulation and governmental control. Both systems rest on the foundation of the law of supply and demand. However, a capitalist economy stresses wealth creation and growth and focuses on who controls the means of production. The free enterprise system focuses more on the way wealth, goods and services are exchanged.

About the Author

Annie Sisk is a freelance writer who lives in upstate New York. She holds a B.A. in Speech from Catawba College and a J.D. from USC. She has written extensively for publications and websites in the business, management and legal fields.

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