Chapter 2 How Economic Issues Affect Business

Learning Objectives 1. Capitalism and free markets 2. Supply, demand and equilibrium 3. Socialism versus communism 4. Canada’s mixed economy 5. Canada’s economic system Economic indicators, productivity & business cycle

Economic Links to Business o Economic concepts are the basis for most major business decisions o Both the global economy and the Canadian economy have an effect on Canadian business o Economics is the study of how a country produces and distributes its goods and services

Four “What’s” of an Economic System o What is produced? o What amount is produced? o What is the method of output distribution? o What determines rate of economic growth? Adapted from: Adapted from: Edwin Mansfield Economics (New York: W.W. Norton, 1976), p.8

Economic Theory of Wealth Creation: Adam Smith  The Wealth of Nations in 1776 defined Capitalism as a system of rights and freedoms: Right to Make a Profit Right to Private Property Right to Buy or Sell Freedom to Compete Freedom from Government Interference

Keynesian Economics  Oxford economist John Maynard Keynes advocated government spending to stimulate the economy  He proposed that governments should borrow in bad times and spend to help the economy  He stated that governments should pay off debt in good times to reduce inflation and get ready for “bad times”

Three Economic Systems Communism Socialism Capitalism (Highly Controlled ) (Little Control ) Mixed

Different Economic Systems  Capitalism - individuals seeking profits produce goods and services Goods and services are sold in a free market to those who can pay for them  Communism - the government decides what will be produced and who will consume that production  Socialism - some free market and some government allocation  Most countries have Mixed Economy

The Foundations of Capitalism  How a free market works - many buyers and sellers trading freely determine prices at which they will exchange goods and services  How prices are determined - the constant interplay between supply and demand determines an equilibrium price at which a transaction will occur

Free-Market Competition Sellers OneMany Monopoly Oligopoly MonopolisticCompetition Perfect Competition

Supply Curve Quantity(S) High High Low Price(P) S

Demand Curve Price(P) Quantity(D) High HighLow D

Quantity High HighLow Price Equilibrium Point Market Equilibrium SD Surplus Shortage

Limits of Free-Markets  Inequality of Wealth- Causes National & World Tension  Greed Compromises Ethics  Potential Environmental Damage  Limitations Push Country towards Socialism = Government Regulation

Recent Economic Trends  Canada - we have a mixed economy, as the government has always played a major role in the economy  Communist countries - they have moved to capitalist forms of economies to improve their standards of living  Socialist countries - they have reduced government’s role in their economies

Economics and Business  Strong Economy - Business prospers  Weak Economy - Business declines  Gross Domestic Product (GDP) - this is the total of goods and services produced by the economy. This is how we measure how well the economy is doing!

Canadian Economy  Key Economic Indicators  Productivity  Business Cycles Recession Depression Recovery  Stabilization Fiscal Policy Monetary Policy National Debt

Key Economic Indicators  Gross Domestic Product (GDP)  Unemployment rate  Price Indexes Consumer Price Index(CPI) Producer Price Index(PPI)  Housing starts  Commodity prices  Stock markets

U.S. Unemployment (%) Source: U.S. Bureau of Labor Statistics

Industrialized Nations’ Tax Rate Source: Parade Magazine, Apr. 12, 1998.

Number of Workers per Social Security Recipient Source: Investors.com

Change in Labor Productivity- U.S. Source: U.S. Dept. of Commerce, Bureau of Labor Statistics

Distribution of GDP  Employees get their share of GDP via wages  Employers get their share of GDP via profits  Governments get their share of GDP via taxes  What is a fair “share of the pie” is a source for constant debate - it depends on one’s perspective

The Issue of Unemployment  Unemployment in Canada remained stubbornly high during the 1990s  Recession, globalization and technological change have contributed to the unemployment problem  There are different types of unemployment Cyclical Seasonal Structural

Inflation and the CPI  Consumer Price Index (CPI) is the index economists use to measure the effects of inflation. Inflation was high prior to the 1990s, but it has been about 2% per year in recent years  The Rule of 72 means that dividing 72 by the rate of inflation equals the number of years that prices will double due to inflation. Currently, it would take 36 years for prices to double due to inflation

What Makes Up The Consumer Price Index? SOURCE: SOURCE: U.S. Bureau of Labor Statistics

Consumer Price Index = 100 Source: U.S. Dept. of Labor, Bureau of Labor Statistics

The National Debt  Governments adopted Keynesian economics and deficit spending. They forgot the second part of Keynesian economics -- they did not pay down the debt in good times  By the 1990s many governments had accumulated large national debts  Canada has finally balanced its budget after 25 years of deficits and recently we have had budget surpluses. Tax cuts are possible?

Government Intervention  In 1929 the stock market crashed  The crash led to a severe, prolonged Depression  The hardship forced governments to abandon Adam Smith’s “laissez faire” approach to economics  Governments looked for ways to intervene in the economy to alleviate the suffering

The Outlook for our Economy  We are all painfully aware that unemployment has remained stubbornly high in the 1990s  The late 1990s saw improved economic activity and job prospects  Canada is in the early stages of long- term economic growth with excellent job prospects for those entering the workforce  Those with education and the ability to learn new skills will be successful