One very important inquiry in managerial economics concerns the interrelationship between the firm and society. Managerial economics can help to clarify the vital role business firms play in our society and to point out ways of improving their operations for society's benefit. A business enterprise is a combination of people, physical assets and information (technical, sales, coordinative and so on). The people directly involved include stockholders, management, labor, suppliers and customers. In addition to these direct participants, all society is indirectly involved in the firm's operations because businesses use resources otherwise available for other purposes (including air and water), pay taxes if operations are profitable, provide employment, and generally produce most of the material output for our society.

Firms exist because they are useful in the process of allocating resources, producing and distributing goods and services. If social welfare could somehow be measured, business firms might be expected to operate in a manner that would lead toward maximizing some index of social well-being. Just which bundle of goods and services as well as which distribution pattern for the bundle would maximize social welfare is a complex, actually unanswerable, question. It is, however, one of the most vital questions facing us today.

As a result, the electric company could charge high prices and earn excessive profits. Society's solution to this potential exploitation is rate regulation. Prices charged by electric companies and certain other monopolistic enterprises are controlled and held down to a level just sufficient to provide stockholders with a "fair" rate of return on their investment. The regulatory process is simple in concept; but in practice, it is costly, difficult to operate, and in many ways arbitrary. It is a poor substitute for competition, but a substitute that is sometimes necessary.

A difficulty arises in the course of this development. Certain groups are likely to gain excessive economic power permitting them to obtain too large a share of the value created by firms. To illustrate, the economics of producing and distributing electric power are such that only one firm can efficiently serve a given community.

The traditional way of handling this matter in the United Stated has been through the economic and political systems. The economic system produces and allocates goods and services through the market mechanism. Firms determine what consumers desire, bid for the resources necessary to produce these products, and then make and distribute them. The participants -- suppliers of capital, labor and raw materials -- must all be compensated from the sale of the output. Further, the firm competes for the consumer's dollar with other firms in the same and other industries. This process is "natural" in the sense that it occurs in all human societies as they develop.

The third problem is that, under certain conditions, firms can exploit workers, so laws designed to equalize the bargaining power of firms and workers have been developed. These labor laws require firms to submit to collective bargaining and to refrain from certain "unfair" practices.

The second problem in the economic development of society occurs when a limited number of firms serve a given market. If the firms compete with one another, no exploitation occurs; however, if they conspire with one another in setting prices, they may be able to obtain excessive profits. The antitrust laws are designed to prevent such collusion, as well as to prevent the merging of competing firms whenever the effect of the merger would be to lessen competition substantially. Like direct regulation, the antitrust laws contain arbitrary elements and are costly to administer, but they, too, are necessary if economic justice, as defined by the body politic, is to be preserved.

The fourth problem by the economic system is that, in their production processes, firms may impose costs on society; for example, by dumping wastes into air or the water or by defacing the earth, as in strip mining. If a steel

mill creates polluted air, which requires people to paint their houses in three years instead of in five years or to have their clothes dry-cleaned more frequently or to suffer lung illness, the mill is creating a cost to society in general, or a social cost. The steel company should be required to install pollution-control equipment or to pay fines equal to the social cost of the pollution; otherwise, the steel company is gaining at the expense of society, because the company is not paying its full social costs. Additionally, failure to shift social costs back onto the firm results in an economically inefficient allocation of resources between industries and firms. Currently some of the practices being applied to avoid this include the establishment of emissions limits both for manufacturing processes and for products that pollute (for example, autos), as well as the imposition of fines or outright closures of firms that do not meet these standards.

All the measures discussed above -- utility regulation, antitrust laws, labor laws, and pollution control restrictions -- are examples of actions taken by society to modify the behavior of business firms and to make this behavior more consistent with broad social goals. Since these social measures all constrain firms, the economy of the United States could be called a constrained -enterprise system as opposed to a free-enterprise system.