Understanding Economic Systems and Competition Chapter 1

Chapter 1 Learning Goals How do businesses and not-for-profit organizations help create our standard of living? What is economics, and how are the three sectors of the economy linked? How do economic growth, full employment, and price stability indicate a nation’s economic health? What is inflation, how is it measured, and what causes it? How does the government use monetary policy and fiscal policy to achieve its macroeconomic growth?

Chapter 1 Learning Goals What are the basic microeconomic concepts of demand and supply, and how do they establish prices? What are the four types of market structure? Which trends are reshaping micro- and macroeconomic environments?

Learning Goal 1 How do businesses and not-for-profit organizations help create our standard of living? –Standard of living is measured by the output of goods and services delivered by businesses and not-for-profit organizations. –Our quality of life is not simply the amount of goods and services available but also society’s general level of happiness.

Business: An organization that strives for a profit by providing goods and services desired by its customers

Standard of living: A country’s output of goods and services that people can buy Although there is a positive relationship between a nation’s wealth & people’s happiness, the relationship is far from perfect –Germany & Japan’s gross national products are two times higher than Ireland’s, yet Irish people are more happy overall than German & Japanese (Source: American Psychologist, 54, 1999, p )

Factors of Production Natural resources Labor Capital Entrepreneurship Knowledge

Learning Goal 2 What is economics, and how are the three sectors of the economy linked? –Economics is the study of how individuals, businesses, and governments use scarce resources to produce and distribute goods and services. –Three sectors are linked by a series of two-way flows Government provides public goods and services for the other two sectors Government receives income in the form of taxes Changes in one flow affect the other sectors

Economics : The study of how a society uses scarce resources to produce and distribute goods and services

2 Subareas of Economics 1.Macro 1. Macroeconomics –focus on economy as a whole; considers aggregate data from large groups of people, companies, or products 2. Micro 2. Microeconomics –focus on individual parts of economy, such as households or firms

materials Circular Flow Between 3 Sectors of the Economy Government Households Businesses income labor costs revenues goods spending taxes, revenues, inputs, outputs, public goods and services

Learning Goal 3 How do economic growth, full employment, and price stability indicate a nation’s economic health? –A nation’s economy is growing when the level of business activity, as measured by GDP, is rising. –A nation’s employment goals are measured by the unemployment rate.

3 Main Macroeconomic Goals Economic growth –increased output of a nation’s goods and services Full employment –all who want to work have jobs Price Stability –avoiding rapid inflation

The Goal of Economic Growth Benefits: Increased standard of living Increased employment Increased incomeDrawbacks: Pollution Strain on facilities

When growth is too fast, the Federal Reserve may raise interest rates to prevent inflation by slowing down the economy A real GDP of 3% is the Federal Reserve’s preferred rate of growth Policy Concerning Economic Growth Source: The Arizona Republic, Nov. 25, 1999, p. D1.

Learning Goal 4 What is inflation, how is it measured, and what causes it? –Inflation is the general upward movement of prices. –Rate of inflation is measured by changes in the consumer price index (CPI) and the producer price index (PPI). –Causes Demand-pull Cost-push

The Goal of Steady Prices Inflation: increase in the average price of goods and services Demand-pull inflation: caused by demand exceeding supply Cost-push inflation: caused by increase in production cost leading to increased price

Inflation is measured by the consumer price index Inflation rates in the US: % % % The Goal of Steady Prices Source: Fortune, Sept. 28, 1998, p. 64.

Learning Goal 5 How does the government use monetary policy and fiscal policy to achieve its macroeconomic goals? –Fed restricts the money supply to slow growth and expands the money supply to stimulate growth –Government reduces taxes or increases spending to stimulate the economy; raises taxes or decreases spending to slow economy

2 Tools to Reach Macroeconomic Goals Monetary Policy 1. Monetary Policy –government’s programs for controlling the amount of money circulating in the economy and interest rates Fiscal Policy 2. Fiscal Policy –government’s use of taxation and spending to affect the economy

Revenues and Expenses for the Federal Budget Individual income taxes Social insurance payroll taxes Corporate income taxes Excise taxes Other Social security National defense Non-defense discretionary Net interest Medicare Medicaid Reserve pending social security reform Other Revenues Expenses

Learning Goal 6 What are the basic microeconomic concepts of demand and supply, and how do they establish prices? –Demand Quantity of a good or service that people buy at a given price –Supply Quantity of a good or service that firms will make available at a given price –Balance of demand and supply is achieved by market adjustments of quantity and price

Demand Curve : A graph showing the quantity of a good or service that can be sold at various prices Changes in demand Changes in demand: change in customer income changes in fashion or taste change in price of related products expectations about future prices change in number of buyers

Supply Curve: A graph showing the quantity of a good or service that a business will provide at various prices Changes in supply: new technology change in price of resources change in price of related products change in number of producers change in taxes

Equilibrium : The point at which quantity demanded equals quantity supplied

Learning Goal 7 What are the four types of market structure? –Perfect competition Large number of buyers and sellers, similar products, good market information for buyers and sellers, ease of entry and exit into the market –Pure monopoly Single seller in a market –Monopolistic competition Many firms sell close substitutes in market that is easy to enter –Oligopoly Few firms produce most or all of the industry’s output, is difficult to enter, and what one firm does will influence others

Types of Market Structure Market structure: number of suppliers in a market Perfect competition Pure monopoly Monopolistic competition Oligopoly

Types of Market Structure Perfect competition Pure monopoly Monopolistic competition Oligopoly

Learning Goal 8 Which trends are reshaping the micro- and macroeconomic environments? –Firms are placing more emphasis on delivering value and quality to the customer –Companies are establishing long-term relationships with both customers and suppliers –Entrepreneurial spirit is sparking wealth among individual business owners and fueling the growth of capitalism

Trends in Economics Microeconomic delivering value & quality creating long-term relationships creating a competitive workforceMacroeconomic nations formerly with command economies are becoming entrepreneurial

Strategic alliance: A cooperative agreement between business firms; sometimes called a strategic partnership Example: Sony Corporation formed a strategic alliance with Palm Computing to provide the operating system for Sony’s handheld devices (Source: Newsweek, Nov. 29, 1999, p. 12)