1-1 copyright © 2010 by the mcgraw-hill companies, inc. all rights reserved. mcgraw-hill/irwin...

1-1Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

Introduction to Business

Dr. H. Ronald Moser

Cumberland University

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Understanding Economics

and How It Affects

Business

Chapter 02

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

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JOHN MAYNARD KEYNES

• Had great influence on U.S. economic policy.

• Believed if the economy was in a recession, the government should increase spending and cut taxes to stimulate the economy for a short term.

• Wrote The General Theory of Employment, Interest and Money in 1936.

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PROFILE

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HOW ECONOMIC CONDITIONS AFFECT BUSINESSES

A major part of the United States business success is due to an economic and social climate

that allows most businesses to operate freely.

People are free to start a business anywhere, and just as free to fail and start again. Most fail

the first five years (about 52% in the nation, but about 75% in Tennessee).

• “Where did I go wrong?”

Global economics and global politics also have a major influence on businesses in the United

States. Therefore, to understand business, you must also understand

basic economics and politics.

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What is Economics? 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. There are two major branches of economics:Macroeconomics looks at the operation of a

nation’s economy as a whole ( the whole United States). United States

Microeconomics looks at the behavior of people and organizations in markets for particular products or

services. It also looks at how market conditions determine the price of a specific product.

Tennessee

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• Resource Development -- The study of how to

increase resources and create conditions that will make better use of them.

Businesses can contribute to an economic system by

inventing products that greatly increase available

resources.

Resource Development

What is Economics?


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• New energy sources– Hydrogen fuel for autos.

• New ways of growing foods– Hydroponics.

• New ways of creating goods and services– Mariculture- Raising fish in pens

– Nanotechnology-New ways of creating needed goods and services.


What is Economics?

Examples of Ways to Increase Resources

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• The public’s concern with global warming contributed to the success of the Toyota

Prius.• Farmers are growing more

corn and other crops to use for biofuels.

• What can you do to help lower carbon emissions?

More Profits from the Green Revolution(Thinking Green)

Resource Development


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• Malthus believed that if the rich had most of the wealth and the poor had most of the population, resources would run out.

• This belief led the writer Thomas Carlyle to call economics “The Dismal Science.”

• Neo-Malthusians believe there are too many people in the world and believe the answer is radical birth control.

Thomas Malthus and the Dismal Science

The Secret to Creating a Wealthy Economy


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• Contrary to Malthus, some economists believe a large population can be a resource.

- An educated population is highly valuable.

- Business owners provide jobs and economic growth for their employees and communities as well as for themselves.

Population as a Resource

The Secret to Creating a Wealthy Economy


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Smith believed that:

• Freedom was vital to any economy’s survival.

• Freedom to own land or property and the right to keep the profits of a business

is essential.

• People will work hard if they believe

they will be rewarded.

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Adam Smith and the Creation of WealthAdam Smith, the Father of Economics

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• In Adam Smith’s view, business people don’t necessarily deliberately set out to help. They work primarily for their own prosperity and growth.

• As people improve their own situation in life, they help the economy prosper through the production of goods, services and ideas.

• Invisible Hand -- When self-directed gain leads to social and economic benefits for the whole community.

The Invisible Hand TheoryHow Businesses Benefit the Community


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• A farmer earns money by selling his crops.

• To earn more, the farmer hires farmhands to produce

more crops.• When the farmer produces more, there is plenty of food

for the community.• The farmer helped his

employees and his community while helping

himself.

Understand the Invisible Hand TheoryHow Businesses Benefit the Community


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UNDERSTANDING FREE- MARKET CAPITALISM Basing their ideas on free-market principles such as

those of Adam Smith, business people in the United States, Europe, Japan, Canada, and other countries

began to create more wealth than ever before.

They hired others to work on their farms and in their factories, and their nations

began to prosper as a result.

Business people soon became the wealthiest people in society.

The economic system that has led to wealth creation in much of the world is known as

Capitalism.

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*• Capitalism -- All or most of the land, factories

and stores are owned by individuals, not the government, and operated for profit.

• Countries with capitalist foundations:- United States- England- Australia- Canada

Capitalism

UNDERSTANDING FREE- MARKET CAPITALISM

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1. The right to own private property. The most fundamental of all rights under

capitalism.

The Foundations of CapitalismUnder free market capitalism people have four basic rights:

2. The right to own a business and keep all that business’ profits. Profits act as important

incentives for business owners.

3. The right to freedom of competition. With certain guidelines established by the government, individuals are free to compete with other

individuals or businesses in selling and promoting goods and services.

4. The right to freedom of choice. People are free to choose where they want to work and what career they want to follow.

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*1. Freedom of speech and

expression.

2. Freedom to worship in your own way.

3. Freedom from want.

4. Freedom from fear.

Roosevelt’s Four Additional Rights

The Foundations of Capitalism

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• Free Market -- A free market is one in which decisions about what and how much is

produced are made by buyers and seller negotiating prices for goods and services. Decisions about what and how

much to produce are made by the market.

Free MarketsHow Free Markets Work

• Price tells companies how much of a product they should produce. If something is wanted

but hard to get, the price will rise until more products are available.

• Consumers send signals about what they like and how they like it.

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• A seller may want to sell shirts for $50, but only a few people may buy them at that price.

• If the seller lowers the price to $30, more people buy the

shirts.

• The seller establishes a price of $30 based on what

consumers are willing to pay.

PricingHow Prices Are Determined

UNDERSTANDING FREE- MARKET CAPITALISM

• Price is determined by what the customer is willing to pay.

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• Supply -- The quantities of products businesses are willing to sell at different prices. Generally

speaking, the amount supplied will increase as the price increases, because sellers can make more

money with a high price.

Supply CurvesThe Economic Concept of Supply

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• Demand -- The quantities of products consumers are willing to buy at different prices. Generally

speaking, the quantity demanded will increase as the price decreases.

Demand CurvesThe Economic Concept of Demand

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*• Market Price (Equilibrium Point) -- Determined by supply and demand, this is the negotiated price. In the long run, the point on a graph where the supply for a product or services equals the demand for the

product or service is the equilibrium price.

Equilibrium

The Equilibrium Point, or Market Price

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1. Perfect Competition- exists when there are many sellers in a market and none is large enough to

dictate the price of a product. Maybe farming is an example.

Four Degrees of CompetitionCompetition within Free Markets

2. Monopolistic Competition- a large number of sellers produce very similar products that buyers nevertheless perceive as different, such as hot dogs, sodas, personal computers, and T-shirts.

3. Oligopoly- is a degree of competition in which just a few firms dominate an industry, such as in the tobacco, gasoline, automobiles, U.S. Steel, Inc. and aircraft industries. Not a lot of price wars here.

4. Monopoly- Occurs when one seller controls the total supply of a product or services, and sets the price. In the U.S. a monopoly is prohibited by law.

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UNDERSTANDING FREE- MARKET CAPITALISMCompetition within Free Markets

• Reality Entertainment, Inc is a major producer of reality TV programming. The

company faces fierce competition from three other major producers of similar shows.

Today, Reality Entertainment and its three rivals control almost the entire reality TV

programming. Their market environment is call an oligopoly.

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Benefits:• It allows for open competition among companies.

Business must provide customers with high-quality products at fair prices with good service.

Free Market Benefits and LimitationsBenefits and Limitations of Free Markets

• Provides opportunities for poor people to work their way out of poverty.• I am a

poor person. Limitations:

• People may start to let greed drive them. Criminal charges brought against some big businesses in

banking, oil, accounting, telecommunications, insurance, and pharmaceuticals indicate the scope

of the potential problem.

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• Socialism -- An economic system based on the premise that some basic businesses, like utilities, should be owned by the government in order to more evenly distribute profits among the people.• Entrepreneurs run smaller businesses.

• Citizens are highly taxed.• Government is more involved in protecting

the environment and the poor.• This economy promotes social equality.

Socialism

UNDERSTANDING SOCIALISM

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• Social equality- It comes about because the government takes income form wealthier people, in the form of taxes, and redistributes it to poorer people through various government programs.

• Free education.• Free healthcare.• Free childcare.• Longer vacations.• Shorter work weeks.• Generous sick leave.

Socialism BenefitsBenefits and Limitations of Free Markets

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• Few incentives for business people to take risks.

• Brain Drain: Because of the high tax rates in some nations are so high, (some reach 85%),

some of a country’s best and brightest workers (i.e. doctors, lawyers and business owners) move to capitalistic country’s. This loss of the best and

brightest people to other countries is called a Brain Drain.

• Fewer inventions and innovations because the reward is not as great as in capitalistic

countries.

The Negative of SocialismThe Negative Consequences of Socialism

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• While touring Greece last year, Angela landed in the hospital for five days

when she was run-over by a careless motorcyclist. To no avail, her son and

daughter who were also on the trip tried frantically to pay for the medical care

required to set her broken bones. There she lay with no casts, limbs hanging until the state’s doctor deemed it her turn for attention. In nations where

medicine is socialized, individuals often wait for several years for proper medical

attention.

Socialism

UNDERSTANDING SOCIALISM

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• Socialism is an economic and political system where major industries are owned

and operated by the government. Although it provides wider coverage of medical services for persons who may not normally be able to afford medical

care, there are often complaints by persons who wait a long time for service.

SocialismUNDERSTANDING SOCIALISM

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• Communism -- An economic and political system in which the government makes almost all economic decisions and owns almost all

the major factors of production.

• Prices don’t reflect demand which may lead to shortages of items, including food and

clothing. The government must guess what the people need.

Communism

UNDERSTANDING COMMUNISM

• Most communist countries today suffer severe economic depression and citizens

fear the government.

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Two Major Economic SystemsTHE TREND TOWARD MIXED ECONOMIES

• The nations of the world have largely been divided between those that followed the concepts of

capitalism and those that adopted the concept of communism or socialism. We can now contrast the two major

economic systems as follows:

• Free-Market Economies -- The market largely determines what goods and services are produced, who gets them, and how the economy grows.

• Command Economies -- The government largely determines what goods and services are produced,

who gets them, and how the economy will grow.

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• Mixed Economies -- Some allocation of resources is made by the market and some by the

government. Like most other nations of the world, the United States has a mixed economy. The U.S.

government has now become the largest employer in the country which means there are more

workers, in the public sector (government) than in any of the major businesses in the

United States.

• Neither free-market nor command economies have created sound economic conditions so

countries use a mix of the two economic systems.

Mixed EconomicsTHE TREND TOWARD MIXED ECONOMIES

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• Communist governments are disappearing.• Socialist governments

are cutting back on social programs,

lowering taxes and moving toward

capitalism.

• Capitalist countries are increasing social

programs and moving more toward socialism.

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THE TREND TOWARD MIXED ECONOMIES

Mixed Economics

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• China’s economy is growing two or three times faster than the U.S.

• China is worried about inflation and a possible housing crash.

CHINA’S CHANGING ECONOMY

(Reaching Beyond Our Borders)

• Though known for its socialist and communist

foundations, the adoption of capitalist principles is credited

for some of the growth.2-35

THE TREND TOWARD MIXED ECONOMIES

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• The following sections will introduce the terms and concepts that you, as an

informed citizen, will need to understand the issues facing government and

business leaders in the United States.

UNDERSTANDING THE U.S. ECONOMIC SYSTEM

United States

• Three major indicators of economic conditions are (1) the gross domestic product

(GDP), (2) the unemployment rate, and (3) price indices.

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• Gross Domestic Product (GDP) -- Total value of final goods and services produced in a

country in a given year. As long as a company is within a country’s border, their numbers go into

the country’s GDP (even if they are foreign-owned).

• When the GDP changes, businesses feel the effect.

• The high U.S. GDP (about $14 trillion) is what enables us to enjoy a high

standard of living.

Gross Domestic Product


United States

Mexico

Canada Ron’s Place

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• The next wave of marketable innovations may involve new ways to produce and conserve energy. If we can turn new technology into

marketable products and services that produce energy to run our businesses and homes, the U.S. could see a surge in output of goods and

services. The Department of Economic Development would document this surge by

measuring the Gross Domestic Product.

Gross Domestic ProductUNDERSTANDING THE U.S. ECONOMIC SYSTEM

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Unemployment Rate – Refers to the percentage of civilians at least 16-years-old who are unemployed and tried to find a job within the prior four weeks.

Four Types of Unemployment

1. Frictional- refers to those people who have quit work because they didn’t like the job, the boss, or the

working conditions and who have not found a new job.

2. Structural- caused by the restructuring of the firms.

3. Cyclical- caused by recession or a similar downturn in the business cycle.

4. Seasonal- occurs where demand for labor varies over the year as with the harvesting of crops.

Unemployment


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Source: U.S. Bureau of Labor Statistics, www.bls.gov, June 2011.

U.S. Unemployment Rate

* As of June 20119.1%

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• Inflation -- The general rise in the prices of goods and services over time.

• Disinflation -- When the price increases are slowing (inflation rate declining). Occurred throughout the United States in the 1990s.

• Deflation -- Prices are declining because too few dollars are chasing too many goods. People cannot buy all the products.

• Stagflation -- Economy is slowing but prices are going up. Some economists fear the United States may face stagflation in the near future.

InflationUNDERSTANDING THE U.S. ECONOMIC SYSTEM

• Price indices help gauge the health of the economy by measuring the levels of inflation, disinflation,

deflation, and stagflation.

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• Consumer Price Index (CPI) -- Monthly statistics that measure the pace

of inflation or deflation.• The government computes the costs of goods and

services (housing, food, apparel, medical care, etc.) to see if they are going up or down.

• The wages, rent/leases, tax brackets, government benefits and interest rates of some citizens are

based upon the CPI.• A decrease in the CPI indicates that an economy is

experiencing deflation.• The Producer Price Index (PPI) – Measures price at

the wholesale level.

The Consumer Price IndexUNDERSTANDING THE U.S. ECONOMIC SYSTEM

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• Productivity in the U.S. has risen due to the technological advances that have

made production faster and easier.

• Productivity in the service sector grows more

slowly because of fewer

technologies.

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Productivity on the United States

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• The higher the productivity, the lower the costs of producing goods and services. This helps

lower prices.

• New technology adds to the quality of the services provided but not to the worker’s

output.

• A new form of measurement needs to be created to account for the quality as well as the

quantity of output.

Productivity in the Service SectorUNDERSTANDING THE U.S. ECONOMIC SYSTEM

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• Four Phases of Long-Term Business Cycles:1. Economic Boom – Business is

booming.

2. Recession – Two or more consecutive quarters of decline in the GDP. Brings high unemployment, increased business failure, and an overall drop in living standards.

3. Depression – A severe recession in the 1930s.

4. Recovery – When the economy stabilizes and starts to grow. This leads to an Economic Boom.

The Business CyclesUNDERSTANDING THE U.S. ECONOMIC SYSTEM

• Business Cycles -- Periodic rises and falls that occur in economies over time.

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• Fiscal Policy -- The federal government’s efforts to keep the economy stable by increasing or decreasing

taxes or government spending.

Fiscal Policy

UNDERSTANDING THE U.S. ECONOMIC SYSTEMStabilizing the Economy through Fiscal Policy

• Tools of Fiscal Policy:- Taxation- High tax rates tend to slow the

economy because they draw money away from the private sector and put it into the government. High

tax rates may discourage small-business ownership because they decrease the profits businesses can

earn and make the effort less rewarding.- Government Spending- On highways,

social programs, education, defense, and so on.

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• Fiscal Policy – Senator Gong Lee is alarmed at the state of the economy.

Unemployment is high and GDP is low. Senator Lee wants Congress to take

action to increase its expenditures and cut taxes in order to stimulate the

economy. The actions called for by Senator Lee are examples of Fiscal

Policy.

Fiscal Policy


Stabilizing the Economy through Fiscal Policy

May I help you, please?

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• National Deficit -- The amount of money the federal government spends beyond what it gathers in taxes. The 2008 federal budget, had a projected deficit of

$407 billion. The deficit is expected to rise to over $1 trillion for several years. Such deficits

increase the national debt.

• National Debt -- The sum of government deficits over time. Recently, the national debt was about $10

trillion and was growing at a rate of abut a $1.78 billion a day. Medicare and the unfunded debt of

Social security are on the top of the list.

• National Surplus -- When government takes in more than it spends.

National Deficits, Debt and Surplus UNDERSTANDING THE U.S. ECONOMIC SYSTEM

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• National Debt – While scanning the movies section in your local

online newspaper, you click on the business section by mistake. While you’re there, you quickly scan a report

that says government spending will again exceed tax revenues in the

current year. This means that the total national debt is likely to increase.

National Deficits, Debt and Surplus


Stabilizing the Economy through Fiscal Policy

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• Monetary Policy -- The management of the money supply and interest rates by the Federal Reserve Bank (the Fed). The Federal Reserve System operates as a semi-private organization not under

the direct control of the government.

• The Fed’s most visible role is increasing and decreasing or lowering interest rates.

- When the economy is booming, the Fed tends to increase interest rates. This makes money more expensive to borrow.

Businesses thus borrow less, and the economy slows ad business people spend less money on everything

they to need grow, including labor and machinery.

UNDERSTANDING THE U.S. ECONOMIC SYSTEMUsing Monetary Policy to Keep the Economy Growing

Monetary Policy

- When the economy is in a recession, the Fed tends to decrease the interest rates

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The End!

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