How Economics Affects Business Chapter 2 How Economics Affects Business

Learning Objectives Understand the basics of economics. Explain supply and demand. Describe free market capitalism and degrees of competition. Understand the differences between socialism and communism. Discuss the three major indicators of economic conditions. See text page: 39

Understanding Economics Economics impacts every business Basics of Economics Definition Economic systems of the world Microeconomics and Macroeconomics Two basic types of economic study: Macro Micro Resource Development See Learning Objective 1: Understand the basics of economics. See text pages: 40-41 Understanding Economics In this chapter, we will discuss the study of economics and its relationship to business. Economics impacts every business, small or large. This chapter will provide an overview of the study of economics using examples from small and medium-sized businesses.   Basics of Economics In this chapter, we explore the various economic systems of the world and how they either promote or hinder business growth, the creation of wealth, and a higher quality of life. Economics is the study of how society chooses to employ resources to produce goods and services and distribute them for consumption among various competing groups and individuals. Microeconomics and Macroeconomics There are two basic types of economic study, macro and micro. First, the term macro means something very big in scale. Therefore macroeconomics looks at the operation of a nation’s economy as a whole. Microeconomics, on the other hand, examines the behavior of people and organizations in particular markets. Some economists define economics as the allocation of “scarce” resources. Resource Development is the study of how to increase resources and to create the conditions that will make better use of those resources.

Understanding Economics Economic Theorists Neo-Malthusians Solution to poverty is birth control Adam Smith People will work for rewards The “invisible hand” See Learning Objective 1: Understand the basics of economics. See text pages: 42-43 Economic Theorists In the early 1800s, Thomas Carlyle called economics “the dismal science” in response to Thomas Malthus’ view that there would soon be too many people and not enough food and other resources to support them. Followers of Malthus today (who are called neo-Malthusians) still believe that there are too many people in the world and that the solution to poverty is birth control, which includes such measures as limits on the number of children people can have, forced abortions, and forced sterilization. The challenge for macroeconomics is to determine what makes some countries relatively wealthy and other countries relatively poor, and then to implement policies and programs that lead to increased prosperity for everyone in all countries. The Scottish economist Adam Smith was one of the first people to imagine a system for creating wealth and improving the lives of everyone. Smith envisioned creating more resources so that everyone could be wealthier. According to Smith, as long as farmers, laborers, and businesspeople can see economic rewards for their efforts, they will work long and hard to achieve those rewards. Under Adam Smith’s theory, businesspeople don’t necessarily deliberately set out to help others. Yet as people try to improve their own situations in life, Smith said, their efforts serve as a guiding “invisible hand” that helps the larger economy grow and prosper through the production of all kinds of needed goods, services, and ideas. However, some people end up with so much wealth, they would not be able to spend it all within a lifetime. Of course, business owners must meet the needs of customers when producing products or this wealth would not spread through-out the community.

Understanding Economics Supply and Demand Supply increases as price increases Quantity demanded increases as the price decreases Equilibrium point See Learning Objective 2: Explain supply and demand. See text page: 44-47 Supply and Demand Supply refers to the quantity of products that manufacturers or owners are willing to sell at different prices tat a specific time. Generally speaking, the amount supplied will increase as the prince increases because sellers can make more money with a higher price. Demand refers to the quantity of the products that people are willing and able to buy at different prices at a specific time. Generally speaking, the quantity demanded will increase as the price decreases. If demand goes up, supply will go up—at least in an ideal world. If supply does not go up and the demand is still high, the price will then increase because there isn’t enough of the product to meet the need of the customers. The equilibrium point is the point where the amount of goods sought by buyers is equal to the amount of goods produced by suppliers.

Understanding Economics Supply and Demand Business Cycle See Learning Objective 2: Explain supply and demand. See text page: 46-47 Supply and Demand The business cycle denotes a common pattern where there is a period of rapid growth in the economy when supply and demand stimulate each other; alternating with a period of decline with diminishing supply and demand.

Free Market Capitalism Consumers control the market Competition in Free Markets Four common types: Perfect (Agriculture) Monopolistic (Fast food burger companies) Oligopoly (Tobacco, automobiles) Monopoly (Cable companies) See Learning Objective 3: Describe free market capitalism and degrees of competition. See text pages: 48-49 Free Market Capitalism A free market is one in which decisions about what to produce and in what quantities are made by the market—that is, by buyers and sellers negotiating prices for goods and services. Consumers in the United Stated and in other free market countries send signals to tell producers what to make, how many, in what color, and so on. We do that by choosing to buy, or not to buy, certain products and services. Those goods which are priced too high or not in demand will not sell, as a result, we as consumers are telling the manufacturers what we want. There are four types of competition, which we will discuss next. Competition in Free Markets There are four commonly recognized degrees of competition: (1) perfect competition, (2) monopolistic competition, (3) oligopoly, and (4) monopoly. Perfect Competition exists when there are many sellers in a market and no seller is large enough to dictate the price of a product. Agricultural products are often considered to be examples of such products. Monopolistic Competition exists when a large number of sellers produce products that are very similar but are perceived by buyers as different. Under Monopolistic competition product differentiation is a key to success. An oligopoly is a form of competition in which just a few sellers dominate a market. Oligopolies exist in industries that produce products such as breakfast cereal, tobacco, automobiles, soft drinks, aluminum, and aircraft. Intense price competition would lower profits for all the competitors, since a price cut on the part of one producer would most likely be matched by the others. A monopoly occurs when there is only one seller that controls the total supply of a product and its price. In the United States, laws prohibit the creation of monopolies, which is one reason Microsoft got into trouble with the law: It appeared to have monopoly power in the market for computer operating systems.

Socialism and Communism Definition The Benefits of Socialism Social equality Free education Longer vacations The Negative Consequences of Socialism Takes away incentives for businesses Brain drain See Learning Objective 4: Understand the differences between socialism and communism. See text pages: 50-52 Socialism and Communism Socialism is an economic system based on the premise that some, if not most, basic businesses-such as steel mills, coal mines, and utilities-should be owned by the government so that profits can be evenly distributed among all the people. Such distribution of profits among everyone may come through health care benefits and retirement benefits. As you can imagine, private businesses and individuals are taxed relatively steeply to pay for such social programs. High taxation can discourage entrepreneurship in a country. Socialists acknowledge the major benefit of capitalism-wealth creation-but believe that wealth should be more evenly distributed than occurs in free market capitalism. Socialism has become the guiding economic platform for many countries in Europe, Africa, India, and in much of the rest of the world. Some countries, such as France, are moving slightly away from socialism, however, and leaning more to the center to get their economies moving faster. The Benefits of Socialism The major benefit of socialism is supposed to be social equality. There is more equality of outcome in socialism than in capitalism because income is taken from the wealthier people,. In the form of taxes, and redistributed to the poorer members of the population through various government programs. Free education, free health care, and free child care are some of the benefits socialist governments distribute to their people using the money from taxes. Workers in socialist countries usually get longer vacations than workers in capitalist countries. They also tend to work fewer hours per week and have more employee benefits, such as generous sick leave. The Negative Consequences of Socialism Socialism may create more equality than capitalism, but it takes away some of business people's incentives and enthusiasm to start work early and leave work late. It can also take away the incentive to start new businesses or market new ideas. As a consequence, many people leave socialist countries for more capitalistic countries with lower taxes, such as the United States. This loss of the best and brightest people to other countries is called brain drain. Capitalism results in freedom of opportunity, which is the freedom to keep whatever you earn. In contrast, socialism strives for equality of outcomes. Socialist systems, therefore, tend to discourage the best from working as hard as they can. As a result, people may or may not be motivated to try new ideas.

Socialism and Communism Definition Karl Marx Lack of incentive for workers to produce Countries – severe economic depression The Trend toward Mixed Economies Free market Command Neither are best Mixed economies See Learning Objective 4: Understand the differences between socialism and communism. See text pages: 52-54 Communism Communism is an economic and political system in which the state makes almost all economic decisions and owns almost all the major factors of production, including housing for its people. The 19th-century German political philosopher Karl Marx saw the wealth created by capitalism, but he also noted the poor working and living conditions of laborers in his time. It intrudes further into the lives of people than socialism does. One problem with communism is that the government has no way of knowing what to produce because prices don’t reflect supply and demand as they do in free markets. Another problem with communism is that it doesn’t inspire businesspeople to work hard because the government takes most of their earnings. Most communist countries today are suffering severe economic depression, and some people are starving. The Trend toward Mixed Economies The nations of the world have largely divided historically between those that have followed the concepts of capitalism and those that have adopted concepts of communism or socialism. Free market economies exist when the market largely determines what goods and services get produced, who gets them, and how the economy grows. Capitalism is the popular term used to describe this economic system. Command economies exist when the government largely decides what goods and services get produced, who gets them, and how the economy grows. Socialism and Capitalism are the popular terms used to describe variations of this economic system. The experience of the world, however, has been that neither free market nor command economies have resulted in optimum economic conditions. Free market economies haven't been responsive enough to the needs of individuals who are poor, elderly, and disabled. On the other hand, socialism and communism, or command economies, haven't always created enough jobs or wealth to keep growing fast enough. The trend has been for traditionally capitalist countries to move towards a more socialist system, that is, to provide programs to take care of poor or disadvantaged people and to safeguard the environment, while some of the socialist and communist countries have adopted elements of capitalism to a greater or lesser degree. Mixed economies exist where some allocation of resources is made by the market and some by the government. Most countries with mixed economies don’t refer to themselves by such a name, however. Like most other nations of the world, the United States has a mixed economy. Many people believe the government should be more involved, many believe it should be less involved, while other believe the government should not be involved in these issues at all.

Economic Indicators Gross Domestic Product GDP and GNP Unemployment Unemployment rate Price Indexes Inflation and hyperinflation Stagflation and deflation CPI PPI See Learning Objective 5: Discuss the three major indicators of economic conditions. See text pages: 56-60 Economic Indicators This section will discuss how a government determined how well the economy is doing. The three major indicators of economic conditions are The gross domestic product The unemployment rate The price indexes Gross Domestic Product Gross Domestic Product (GDP) is the total value of final goods and services produced in a country in a given year within the United States. Either a domestic company or a foreign-owned company may produce the goods and services included in the GDP as long as the companies are located within the country’s boundaries. Gross National Product (GNP) is a similar term, but refers to the value of goods and services produced in the United States by Americans only. If GDP growth slows or declines, there are often many negative effects on business. Unemployment Our second economic indicator is unemployment rate. The unemployment rate refers to the number of civilians at least 16 years old who are unemployed and who have tried to find a job within the prior four weeks. The United States tries to protect those who are unemployed because of recession, industry shifts, and other cyclical factors. Price Indexes Our third economic indicator is price indexes. The price indexes help to measure the health of the economy by measuring the levels of inflation, deflation, and stagflation. Inflation refers to a general rise in the prices of goods and services over time. Hyperinflation, on the other hand, is a phenomenon where the cost of goods is rising so quickly that it renders the currency virtually worthless. Although there is no set definition of where hyperinflation begins, many experts believe that inflation of over 50 percent is hyperinflation. Stagflation occurs when both inflation and unemployment are high and occurring at the same time. Obviously, stagflation is harmful to a country because it means that prices are rising while people are losing their jobs or do not have jobs. Deflation means that prices are actually declining. It occurs when countries produce so many goods that people cannot afford to buy them all. The consumer price index (CPI) consists of monthly statistics that measure the pace of inflation or deflation. The CPI is an important figure because some wages and salaries, rents and leases, tax brackets, government benefits, and interest rates are based on it. The producer price index (PPI) measures prices at the wholesale level. The PPI measures price change from the perspective of the seller whereas the CPI measures the price change from the purchaser’s perspective. These are all statistics that are announced regularly and can provide some insight into the overall health of an economy.

Fiscal and Monetary Policy Two halves of fiscal policy: Taxation and Government spending National debt Economic boom and recession Depression Recovery See Learning Objective 5: Discuss the three major indicators of economic conditions. See text pages: 60-62 Fiscal and Monetary Policy Fiscal policy refers to the federal government’s efforts to keep the economy stable by increasing or decreasing taxes or government spending. The first half of the fiscal policy involves taxation. It follows, then, that-theoretically-low tax rates would tend to give the economy a boost. The second half of fiscal policy involves government spending. The government spends money on highways, social programs, education, defense, and so on. The national debt is the amount of money that the federal government spends over and above the amount it gathers in taxes for a specific period of time. The national debt is the sum of government deficits over time. One way to lessen the annual deficits is to cut government spending. Some people believe that spending by the government helps the economy grown. In an economic boom, businesses do well. A recession occurs when two or more quarters show declines in the GDP, prices fall, people purchase fewer products, and businesses fail. A depression is a severe recession. A depression usually occurs during times of deflation and unemployment and is extremely serious. Recovery occurs when the economy stabilizes and starts to grow again.

Fiscal and Monetary Policy Controlled by Federal Reserve Raising and lowering of interest rates Controlling the money supply See Learning Objective 5: Discuss the three major indicators of economic conditions. See text pages: 62-64 Fiscal and Monetary Policy Monetary policy is ultimately what adds or subtracts money from the economy. Monetary policy is controlled buy the Federal Reserve system. The most obvious role of the Federal Reserve is the raising and lowering of interest rates. The Federal Reserve also controls the money supply. If the government printed more money, it would cost much more to buy the things we need, simply because there is more money available.