Market-oriented Economic Systems

& Free Enterprise

Chapter 5(2006 Edition)

The Free Enterprise System

Encourages individuals to start

and operate their own

businesses without government

involvement.

Basic Principles of Free Enterprise

Freedom of Ownership

Competition

Risk

Profit

Intellectual Property Rights

• Are protected in a free enterprise system

• Patents – If you patent an invention, you alone own the rights to that item or idea.

• Trademark – A word, name, symbol, sound, or color that identifies a good or service and that cannot be used by anyone but the owner.

• Copyright – Involves anything that is authored by an individual, such as writings, music, and artwork.

Basic Principles of Free Enterprise

• Freedom of Ownership – We can own just

about anything. The system encourages

individuals to own businesses.

• You can buy anything you want, as long as

it’s not illegal.

Competition

• Competition : The struggle between companies for customers.

Two kinds:

– Price Competition: Focuses on the price

– Nonprice Competition: Factors not related to price such as quality, service, location, reputation.

Monopolies

• When there is no COMPETITION and one

firm controls the whole market.

• U.S. Government allows only a few

monopolies, such as utility companies.

Called a natural monopoly.

Business Risk

• Risk – The potential for loss or failure

As the potential for earnings gets greater, so

does the risk.

One of every three businesses in the U.S. fails

after one year.

Introducing new products is also risky. Up to

85% of new products fail in the first year.

Business Profit

• Profit – The money earned from conducting

business after all costs and expenses are

paid.

Profit is the motivation for taking a risk.

Profits are high when sales are high and costs

are low.

As the

potential for

PROFIT

increases, the

RISK also

INCREASES.

Economic Cost of Unprofitable

Firms:

• Laying off of employees

• Investors can lose money

• Fewer resources with which to conduct

business

• Cut backs on research and development for

new products

• Cut backs on purchase of goods and

services needed for operation

Unprofitable firms (cont.)

• Affects profitability of suppliers

• Government suffers. Less tax collected,

rise in unemployment.

Economic Benefits of Successful

Firms:

• Hire more people and pay them well

• Employees have better benefits and higher

morale

• Investors earn money, which they spend or

invest

• Vendors and suppliers make more money

• Government makes more money in taxes

Supply and Demand

• In a market-oriented economy, supply and

demand determine the prices and quantities

of goods and services produced.

Supply

• The amount of goods producers are

willing to make and sell

Demand

– The amount of goods consumers are

willing to buy

Law of Supply

• As prices rise, so will the quantity

supplied.

• Price and quantity supplied move in

the same direction.

PriceQuantity

Supplied

Look at Law of Supply through the eyes of the “Supplier”

Law of Demand

• As prices increase, the quantity demanded

decreases.

• Price and quantity demanded move in the

opposite direction.

PriceQuantity

Demanded

Look at Law of Demand through the eyes of the “Consumer”

Supply & Demand

Surpluses: Occur when supply

exceeds demand

Shortages: Occur when demand

exceeds supply

Equilibrium: The amount being

supplied is equal to the

amount being demanded.

Supply & demand are

balanced.

All of the activities involved in

producing and marketing goods/services.

Consumer Market: Sells products/services to

individuals.

Industrial Market: Sells products/services to

businesses (B2B)

What is Business?

Business Classifications

• Size & Scope

• Purpose

• Industry & Markets

Business Classifications

Size and Scope

– Large vs. Small Size

• Small businesses have less than 100 employees.

• 95% of all businesses are classified as small

businesses.

– Domestic vs. Global

• Domestic market is a single country… global is

among nations.

Business Classifications

Purpose

Profit vs. Nonprofit

• Profit (Microsoft/McDonald’s)

• Nonprofit: Functions like a business but uses

money it makes to fund it’s identified cause.

(YMCA, Boys/Girls Clubs of America)

Public vs. Private

Public organizations provide a non-profit service or are

associated with the government.

(Military, Schools, Social Security Administration)

Business Classifications

• Industry and Markets

Industry: Consists of a group of establishments primarily engaged in producing or handling the same product or service

• U.S, Canada, & Mexico created NAIC…A six-digit coding system to classify all economic activity into 20 industry sectors.

Industry & Consumers are

Interrelated

• Derived Demand

As consumer demand increases, it positively effects the industries associated in supplying that product.

• Industries will study consumer trends to look for opportunities to increase business.

Example:

Consumers start buying more automobiles →

Dealers need more cars to sell →

Manufacturers need increased supply of tires, radios, batteries, electronic parts, etc.

4 Functions of Business

• Regardless of the type of business, there are

four main function involved in an

organization’s operation

Marketing

Management

Finance/Accounting

Production

“My Mother Fixes Awesome Pancakes”

• Marketing: All activities from the time a

product leaves the producer or manufacturer

until it reaches the final consumer.

4 Functions of Business

• Management: The process of achieving

company goals by effective use of resources

4 Functions of Business

4 Functions of Business

• Finance and Accounting:

– Finance involves money management

– Accounting keeps track of a company’s

financial situation

4 Functions of Business

• Production: The process of creating,

growing, manufacturing, or improving

goods and services.

– Procurement: Involves buying and reselling

goods that have already been produced.