1. The Economic Environments Facing Businesses
Chapter 4
The Economic Environments Facing Businesses
Chapter 4: The Economic Environments Facing Business

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Learning Objectives
Communicate the importance of economic analysis
Discuss the idea of economic freedom
Profile the characteristics of the types of economic systems
Introduce the notion of state capitalism
Profile leading indicators of economic development, performance, and potential
The learning objectives for this chapter are
To communicate the importance of economic analysis
To discuss the idea of economic freedom
To profile the characteristics of the types of economic systems
To introduce the notion of state capitalism
To profile indicators of economic development, performance, and potential
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Gross National Income
Gross national income (GNI)
Value of all productions in domestic countries plus the net flows of factor income from abroad.
Gross national product (GNP)
the total value of all final goods and services produced within a nation in a particular year, plus income earned from citizens abroad minus income earned by foreigners from domestic production.
Gross domestic product (GDP)
the total market value of goods and services produced by workers and capital within a nation’s borders
One way managers can assess markets is by looking at gross national income or GNI which measures the value of all production in the domestic economy together with the income the country receives from other countries, less similar payments it has made to other countries.
Managers can also look at gross national product or GNP. Conceptually, world GNI and world GNP are the same.
Gross domestic product or GDP allows managers to assess countries in which the output of multinationals represents a significant share of activity.
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Improving Analysis
GNI data should be adjusted for
the growth rate of the economy
the number of people in a country
the local cost of living
The degree of economic sustainability
To measure a country’s relative performance:
GNI is converted to per capita estimate
It’s important to be careful when using GNI data because it can be misleading. To improve the usefulness of GNI managers should adjust for the growth rate of the economy, the number of people in a country, and the local cost of living.
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5. Purchasing Power Parity (PPP)
GNI Per Capita fails to account the differences in cost of living across different countries.
Assumes people around the world has the same “purchasing power” of a dollar of income everywhere.
PPP adjusts the exchange rate so two identical goods would cost the same in two different countries.
The Big Mac Index published by The Economist is a popular estimate for PPP
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6. Purchasing Power Parity (Big Mac Index)
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Economic Analysis
Managers should also consider
Inflation
Unemployment
Debt
Income distribution
Poverty
Balance of payments
Managers can also study other features of an economy including inflation, unemployment, debt, income distribution, poverty, and its balance of payments.
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Inflation
Inflation
a measure of the increase in the cost of living
Aggregate Demand growing faster than aggregate supplies- thus creating demand that pushes price level faster than growth in income.
Deflation
when prices for products go down not up
Rising deflation calls for increasing unemployment.
Chronic inflation usually plagues countries where prices have been rising for prolonged periods of time.
Deflation occurs when the general price level of goods and services falls. It’s often caused by a reduction in the money supply or a reduction in credit.
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Unemployment
Unemployment rate
Share of unemployed workers seeking employment for pay relative to the total civilian labor force
Indicates how well a country is productively using its human resources.
Misery index
The sum of a country’s inflation and unemployment rates
The unemployment rate measures the number of workers who want to work but do not have jobs. High unemployment is a warning sign for managers because it symbolizes a government’s ineptitude in managing domestic affairs.
Underemployment occurs when people work fewer hours per day than they would prefer or when they work below the level for which they have been trained.
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Debt
Debt
the total of a government’s financial obligations
internal debt
external debt
Growing public debt signals
tax increases
reduced growth
rising inflation
increasing austerity
Managers can look at a country’s debt to gauge how much a country borrows from its citizens, foreign organizations, foreign governments, and international institutions. When total debt is high the more uncertain an economy’s performance and potential.
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Income Distribution
Income distribution
estimates the proportion of the population that earns various levels of income
Gini coefficient
measures the extent to which the distribution of resources deviates from a perfectly equal distribution
Managers should also look at income distribution to better understand a market’s performance and potential. One trend that is affecting markets across the globe is the growing gap between rich and poor. Managers can estimate inequalities in income distribution using a Gini coefficient. A score of one indicates that one person has all the income. Most countries range between 25 and 60 percent.
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Poverty
Poverty the state of having little or no money and few or no material possessions
extreme poverty
less than $1.25 per day
moderate poverty
less than $2.00 per day
Today the world population is 80% poor, 10% middle income, and 10% rich
Base of the Pyramid
Next market frontier for the global economy.
Poverty shapes economic environments. While the number of people in extreme poverty in the world has fallen, this figure is misleading because much of the drop has been in a single country, China. Poverty continues to be a problem with as many as 1.2 billion people in poverty.
The growth of business and economic progress is dependent on ending poverty. Keep in mind though, that despite being poor, there may still be a market for goods. Some 80 percent of Indians live on less than $2 per day for example, yet there are 700 million cell phone subscribers in the country.
The Base of the Pyramid is the largest, but poorest, socioeconomic group in the world who live on less than $2.50 per day. This group may in fact be the future of the global economy prompting the development of frugal engineering which focuses on the needs of poor consumers as a starting point for developing functional, economic products.
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Balance of Payments
Balance of payments
reports a country’s trade and financial transactions with the rest of the world
Current account
tracks merchandise trade
Capital account
tracks loans given to foreigners and loans received by citizens
A country’s balance of payments is a system of monitoring all of a country’s economic transactions with the rest of the world.
It reports the country’s trade and financial transactions with the rest of the world. A current account surplus occurs when exports exceed imports, while a current account deficit occurs when imports exceed exports.
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14. Balance of Payments Components of a Country’s Balance of Payments
This Table shows the various components of each account in the balance of payments.
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15. Balance of Payments Current Account Balances: The Top and Bottom Five
This Table shows the countries with the largest current account surpluses and those with the largest current account deficits.
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16. Types of Economic Systems
An economic system refers to the mechanism that deals with the production, distribution, and consumption of goods and services
Types
Market economy
Command economy
Mixed economy
Managers can explore a country’s economic system to understand how the host government regulates the economy, protects property rights, sets fiscal and monetary policies, and enforces antitrust regulation.
There are three main types of economic systems: market, command, and mixed economies.
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17. Types of Economic Systems
This Figure shows the different types of economic systems.
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Market Economy
In a market economy individuals rather than governments make most economic decisions
Capitalism
private ownership of capital
Laissez-faire
governmental noninterference in economic affairs
In market economies private interests own resources, and prices determine supply and demand. While there is generally an attitude of laissez-faire the invisible hand does become more visible at times because of the need to provide public goods and protect society. Market economies maximize economic freedom.
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Command Economy
In a command economy the visible hand of the state supersedes the invisible hand of individuals
Government
owns and controls resources
determines prices
Communism
In a command economy, governments plan what goods and services will be produced, the quantity in which they are produced, and the price at which they are sold. Command economies constrain economic freedom.
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Mixed Economy
Most economies are mixed economies
fall between market and command economies
Socialism
regulate economic activity with a focus on social equality and a fair distribution of wealth
In a mixed economy, both government and private enterprise influence production, consumption, and savings. This type of economy supports socialism and the notion that the partly visible hand of the government commands and controls some factors of production. Therefore, economic freedom in a mixed economy is regulated.
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21. Economic Development, Performance, and Potential
Broad classes of countries include
developing countries
largest number of countries
low per capita income
emerging economies
fast growing, relatively prosperous
BRICs – Brazil, Russia, India, and China
developed countries
high per capita income and standard of living
like the U.S., Japan, France, Australia
Managers need to assess a country’s level of economic development, performance, and potential. Countries can be classified as developing countries, emerging economies, and developed countries.
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Standard of Living
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