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1 & 3. Business and the Economy

Understanding Business and the Context in Which it Operates

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Why Study Business?

• To become a better-informed consumer and investor

• For help in choosing a career

• To be a successful employee

• To start your own business

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Business: A Definition

• Business consists of:– The profit-seeking activities of those engaged in

purchasing or selling goods and services to satisfy society’s needs and wants.

• Satisfying needs wants– Ultimate objective of every firm

• Business profit– What remains after business expenses are deducted

from sales revenue

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Economic Systems

• Economics: The study of how wealth is created & distributed

– Macroeconomics: national economic issues

– Microeconomics: consumers, individual businesses

• Factors of production: Four inputs to economic systems– Natural resources

– Human resources

– Capital

– Entrepreneurship

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Measuring Economic Performance

• Economic indicators

– Productivity measures

• Gross domestic product (GDP)

• Gross national product (GNP)

– Price indexes

• Consumer price index (CPI)

• Producer price index (PPI)

– Employment statistics

• Labor force, employment, unemployment

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More on Economic Systems

• Can be capitalistic, command/planned, or “mixed”

• Address four basic economic questions:– Which & how many goods & services will be

produced?– How will they be produced?– For whom will they be produced?– Who owns & controls the factors of production?

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Capitalism: The Private Enterprise System

• Theories of Adam Smith (Wealth of Nations, 1776)– Society’s interests are best served when the individuals

within society are allowed to pursue their own self-interest• Based on four principles:

– Creation of wealth is the concern of private individuals, not government

– Owners of resources should be free to determine how they are used

– Economic freedom ensures existence of competitive markets (market economy)

– Government should act only as rule-maker/umpire

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Capitalism: The Private Enterprise System (Cont.)

• Basic rights of capitalist system:– Right to private property– Right of business owners to the profits (after

taxes) generated by their activities– Freedom of choice (employment, purchases,

investments)– Public (i.e, government) sets rules to protect

competition

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Market Forces at Work in theCapitalist System

• Supply & demand– Prices influenced by competition– Prices usually respond to forces of supply &

demand

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Supply

• Quantities of good/service that producers will provide on particular date at various prices

• Law of supply:– Sellers supply more at higher price, less at

lower

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Demand

• Amount of good/service that consumers will buy on that date at various prices

• Law of demand:– Buyers buy more at lower price, less at higher

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Theory Of Supply & Demand

• Quantity supplied & quantity demanded interact continuously

• Balance between them is reflected by current price

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Supply, Demand, & Profit Motive

• Interact to regulate– What is produced– Amounts produced

• Consumers get what they want & producers earn a profit

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Relationship Between Supply And Demand

• Demand curve: relationship between price and quantity demanded

• Supply curve: relationship between price and quantity provided

• Equilibrium point: intersection of supply & demand curves

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Demand Curve

• Changes in quantity demanded– Movement along curve

• Changes in demand– Curve shifts to right (demand increased) or left

(demand decreased)– Influences: preferences, incomes, substitute

prices, no. buyers

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Supply Curve

• Changes in quantity supplied– Movement along curve– Independent of demand

• Changes in supply– Curve shifts to left (lowered supply) or right

(increased supply)– Influence: factors of production

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Equilibrium Point

• Point at which demand and supply curves intersect

• Identifies prevailing market price

• Discrepancies between market & equilibrium price are self- correcting

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Types of Competition in theCapitalist System

• Pure competition

• Monopolistic competition

• Oligopoly

• Monopoly

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Pure Competition

• Products identical

• Perfect information

• No entity large enough to influence prices

• E.g., markets for agricultural commodities

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Monopolistic Competition

• Products not identical– Product differentiation possible– Use of branding, etc.

• Many buyers & sellers

• Imperfect information

• Some government regulation

• E.g., consumer goods markets

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Oligopoly

• Products: similar or different

• Few, large sellers; many small buyers

• Sellers match rivals’ prices

• Market entry expensive

• Government watches closely

• E.g., steel, automobile markets

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Monopoly

• One seller; many small buyers

• Seller controls products & prices--no competition

• Seller keeps other firms from competing

• True monopolies illegal

• E.g., utilities (legal; regulated)

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Other Economic Systems: Command/Planned & Mixed

• Socialism

• Communism

• “Mixed” economies

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Socialism

• High degree government planning

• Government owns some of land & capital

• Government involvement limited

• Private ownership permitted

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Communism

• Allows least degree economic freedom

• Public ownership of factors of production

• Planned resource allocation

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Mixed Economies

• Many communist & socialist economies have capitalist elements– Some relaxing of central control– Increased privatization

• Capitalist economies often have socialist elements

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Business Cycle

• Pattern of expansion and contraction through which our economy flows

• Characterized by:– Prosperity– Inflation: Recession– Depression– Recovery

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Employment Act of 1946

• First formal statement of economic goals & federal government’s responsibility for economic progress

• Brought about by concerns following depression and WWII

• Effort to “flatten” the effects of the business cycle

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Federal Economic Responsibilities

• Promote maximum employment

• Promote maximum production

• Promote maximum purchasing power

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Maximum Employment

• Goal:full employment of able, willing, & seeking

• Full employment does not equal 0% unemployment– Worker mobility– Worker layoffs & retraining– Unrealistic worker hopes

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Four Categories Of Unemployment

• Frictional

• Seasonal

• Cyclical

• Structural

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Maximum Production (Economic Growth)

• Generally understood to be 4% production growth per year

• Increased efficiency– Increased production– Conservation of input resources

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Maximum Purchasing Power (Stable Prices)

• Control of inflation– Demand-pull– Cost-push– Hyperinflation

• Goal historically considered attained when prices rise at 2-3% per year

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Monetary Policy

• Increase/decrease money supply– Expansionary– Restrictive

• Controlled by “The Fed”– Adjusts % deposits of member banks– Adjusts interest rates

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Fiscal Policy

• Government influences economic activity through– Taxation– Spending

• Policy manifested in federal budget