Understanding Economic Understanding Economic Systems and CompetitionSystems and CompetitionUnderstanding Economic Understanding Economic Systems and CompetitionSystems 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 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 1Learning 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.

BusinessBusiness::

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

Standard of livingStandard 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. 821-827)

Factors of ProductionFactors of Production

1.1. Natural resources

2. 2. Labor

3. 3. Capital

4. 4. Entrepreneurship

5. 5. Knowledge

Learning Goal 2Learning 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

EconomicsEconomics::

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

2 Subareas of Economics2 Subareas of Economics

1.1. MacroMacroeconomics– focus on economy as a whole; considers

aggregate data from large groups of people, companies, or products

2. 2. MicroMicroeconomics– focus on individual parts of economy,

such as households or firms

materialsmaterials

Circular Flow BetweenCircular Flow Between3 Sectors of the Economy3 Sectors of the Economy

Government

Households

Businesses

incomeincome

laborlabor

costscosts

revenuesrevenues

goodsgoods

spendingspending

taxes, revenues,inputs, outputs,

public goods and services

Learning Goal 3Learning 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 Goals3 Main Macroeconomic Goals

1.1. Economic growth– increased output of a nation’s goods and

services

2. 2. Full employment– all who want to work have jobs

3. 3. Price Stability– avoiding rapid inflation

The Goal of Economic GrowthThe Goal of Economic Growth

Benefits:Benefits:

• Increased standard of living

• Increased employment

• Increased income

Drawbacks:Drawbacks:

• 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 GrowthPolicy Concerning Economic Growth

Source: The Arizona Republic, Nov. 25, 1999, p. D1.

Learning Goal 4Learning 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 PricesThe Goal of Steady Prices

Inflation:Inflation:increase in the average price of goods and services

Demand-pull inflation:Demand-pull inflation:caused by demand exceeding supply

Cost-push inflation: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:1979 13.3%

1987 4.4%

1998 2.0%

The Goal of Steady PricesThe Goal of Steady Prices

Source: Fortune, Sept. 28, 1998, p. 64.

Learning Goal 5Learning 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 Reach2 Tools to ReachMacroeconomic GoalsMacroeconomic Goals

1. Monetary PolicyMonetary Policy– government’s programs for controlling

the amount of money circulating in the economy and interest rates

2. Fiscal Policy Fiscal Policy– government’s use of taxation and

spending to affect the economy

Revenues and ExpensesRevenues and Expensesfor the Federal Budgetfor the Federal Budget

Individual income taxes

Social insurance

payroll taxes

Corporate income taxesExcise taxesOther

Social security

National defenseN

on-defense

discretionary

Net

inte

rest

Medicare

MedicaidReserve pending social security reform

Other

Revenues Expenses

Learning Goal 6Learning 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 CurveDemand Curve::A graph showing the quantity of a good or service that can be sold at various prices

Changes in demandChanges 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:Supply Curve:A graph showing the quantity of a good or service that a business will provide at various prices

Changes in supply:Changes in supply:• new technology• change in price of resources• change in price of related products• change in number of producers• change in taxes

EquilibriumEquilibrium::

The point at which quantity demanded equals quantity supplied

Learning Goal 7Learning 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 StructureTypes of Market Structure

Market structure:Market structure:

number of suppliers in a market

1.1. Perfect competition

2. 2. Pure monopoly

3. 3. Monopolistic competition

4. 4. Oligopoly

Types of Market StructureTypes of Market StructurePerfect competition

Pure monopoly

Monopolistic competition

Oligopoly

Learning Goal 8Learning 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 EconomicsTrends in Economics

MicroeconomicMicroeconomic• delivering value & quality• creating long-term relationships• creating a competitive workforceMacroeconomicMacroeconomic• nations formerly with command

economies are becoming entrepreneurial

Strategic alliance:Strategic alliance:

A cooperative agreement between business firms; sometimes called a strategic partnership

Example: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)