Download LO 2-2

CHAPTER 2
Understanding
Economics
and
How it Affects
Business
McGraw-Hill/Irwin
Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
The MAJOR BRANCHES of
ECONOMICS
LO 2-1
• Economics -- The study of how society employs resources
to produce goods and services for consumption among
various groups and individuals.
• Macroeconomics -- Concentrates on the operation of a
nation’s economy as a whole.
• Microeconomics -- Concentrates on the behavior of
people and organizations in markets for particular
products or services.
2-2
RESOURCE DEVELOPMENT
LO 2-1
Some economists believe economics is the
study of the allocation of SCARCE resources, and
that resources should be DIVIDED among people
with either people, the gov’t or some
combination thereof determining:
•Who gets what?
•What gets produced?
•When does it get produced?
•How many gets produced?
However the concept of Resource Development
suggests that scarce resources should be
increased to the benefit of society as a whole.
•
Resource Development -- The study of how
to increase resources and create conditions
that will make better use of them.
2-3
EXAMPLES of WAYS to
INCREASE RESOURCES
LO 2-1
• New energy sources
– Hydrogen fuel
• New ways of growing
foods
– Hydroponics
• New ways of creating
goods and services
– Aquaculture
– Nanotechnology
2-4
THOMAS MALTHUS and
the DISMAL SCIENCE
LO 2-1
• 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.
2-5
POPULATION as a RESOURCE
•
LO 2-1
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.
Economics can be expressed as:
•
•
“Give a man a fish and you feed for him for a day,
but teach a man to fish and you feed him for a
lifetime.”
The SECRET to creating a Wealthy Economy
can be expressed as:
•
“TEACH A PERSON TO START A FISH FARM,
AND HE OR SHE WILL BE ABLE TO FEED A
VILLAGE FOR A LIFETIME.”
2-6
TWO MAJOR
ECONOMIC SYSTEMS
LO 2-4
Economic system – the financial and social system through which a country
allocated its resources (factors of production) – aka the structure for how
resources are used to meet the needs of society
Types of economic systems:
1. Free-Market Economy: The market largely determines what goods
and services are produced, who gets them, and how the economy
grows
• Capitalism
2. Command Economy: The government largely determines what
goods and services are produced, who gets them, and how the
economy will grow.
• Socialism
• Communism
2-7
UNDERSTANDING CAPITALISM
•
LO 2-1
Capitalism
– An economic system in which individuals own and
operate the majority of businesses that provide goods
and services
– Commonly referred to as a FREE ENTERPISE (MARKET)
SYSTEM or PURE CAPITALISM or LAISSEZ-FAIRE
CAPITALISM
• System in which individuals are free to decide what
to produce, how to produce it, and at what price to
sell it
– Derived from Adam Smith’s laissez-faire capitalism
(“Wealth of Nations,” 1776) in which a society’s best
interests are served by individuals pursuing their own
self-interest (called “Invisible Hand”)
– Pure or Laissez-faire capitalism doesn’t exist anywhere;
it’s just a theory
– United States is best example of a Capitalistic Economy
2-8
The INVISIBLE HAND THEORY
•
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.
LO 2-1
EXAMPLE OF THE INVISIBLE HAND THEORY IN ACTION:
• 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.
2-9
CAPITALISM’S
FOUR BASIC RIGHTS
LO 2-2
1. The right to own private
property.
2. The right to own a business and
keep all that business’s profits.
3. The right to freedom of
competition.
4. The right to freedom of choice.
2-10
CAPITALISM
LO 2-2
• 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
2-11
FREE MARKET BENEFITS
and LIMITATIONS
LO 2-2
Benefits:
• It uses resources effectively and
efficiently.
• Provides FREEDOM of choice.
• It allows for open competition among
companies.
• Provides opportunities for poor people
to work their way out of poverty.
• Provides incentive and motivation to
owners and workers (profit retention,
income retention, etc.)
• Provides for LOWER taxes.
Limitations:
• People may start to let greed drive them.
2-12
The GOVERNMENT NEEDS…
LO 2-2
Individual Tax Rates from Around the World
Source: Worldwide Tax, www.worldwide-tax.com, accessed October 2014.
2-13
SOCIALISM
•
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.
Benefits of Socialism:
•
Entrepreneurs run
smaller businesses.
•Few incentives for businesspeople to take
risks.
•
Citizens are highly
taxed.
•
Government is more
involved in protecting
the environment and
the poor.
•
Social equality
•
Free education
•
Free healthcare
•
Free childcare
•
Longer vacations
•
Shorter work weeks
•
Generous sick leave
LO 2-3
Drawbacks of Socialism:
•Brain Drain: Some of a country’s best and
brightest workers (i.e. doctors, lawyers and
business owners) move to capitalistic
countries.
•Fewer inventions and innovations because
the reward is not as great as in capitalistic
countries.
2-14
COMMUNISM
•
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.
•
Most communist countries today suffer severe economic
depression and citizens fear the government.
•
Father of Communism=Karl Marx
•
Examples of Communistic Economies:
•
LO 2-3
Old USSR, North Korea, Cuba
2-15
MIXED ECONOMIES
LO 2-4
• Mixed Economies -- Some allocation of resources is made by the market
and some by the government.
• Neither free-market nor command economies have created sound
economic conditions so countries use a mix of the two economic systems.
US=Mixed Economy?*
•
In what ways does our government “interfere” with private interests and
individual freedoms?
*US is best described as Capitalistic; however many economists will argue we
are actually a Mixed Economy with major elements of capitalism
2-16
TRENDING TOWARD MIXED
ECONOMIES
LO 2-4
• 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.
2-17
UNDERSTANDING HOW FREE
MARKETS WORK
• Free Market -- Decisions about
what and how much to produce
are made by the market.
• Consumers send signals about
what they like and how they like it.
• 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.
LO 2-2
The Foundation of the Free
Market
 How much can we
make/sell?
 How much will consumers
buy?
 At what price?
Interaction of buyers & sellers
 Impact prices
 Competition
• Concept of Supply & Demand
2-18
CIRCULAR FLOW MODEL
LO 2-2
2-19
UNDERSTANDING SUPPLY &
DEMAND: PRICING
LO 2-2
• 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.
2-20
UNDERSTANDING SUPPY & DEMAND:
DETERMING MARKET PRICE
Supply -- The quantities of
products businesses are
willing to sell at different
prices.
Demand -- The quantities
of products consumers are
willing to buy at different
prices.
LO 2-2
Market Price (Equilibrium
Point) -- Determined by
supply and demand, this is
the negotiated price.
2-21
BUGS BUG ORANGE FARMERS
and DRIVE PRICES UP
• The 2013 Florida orange crop
experienced a major disruption
because of bugs.
• As a result, orange prices rose as
much as 16%!
• With circumstances out of their
control, farmers have to hope that
nothing else harms their crops.
2-22
FOUR DEGREES
of COMPETITION
LO 2-2
1. Perfect Competition
A) a market situation in which there are A LOT of buyers along with a relatively large number of sellers; B)
Sellers have NO control over price (market determines price, Supply and Demand); C) Identical products
with NO differentiation (cotton, wheat?)
2. Monopolistic Competition
A) a market situation in which there are many buyers along with a relatively large number of sellers; B)
Sellers look for a COMPETITIVE ADVANTAGE by promoting PRODUCT DIFFERENTIAION (real or perceived
differences by consumers with sellers’ products); C) Seller retains some control over price
3. Oligopoly
A) a market (or industry) situation in which there are FEW sellers; B) Strong barriers to entry (for seller,
it’s hard to enter into market); C) Similar products (cereal, cars, airlines); D) relatively higher prices for
consumers
4. Monopoly
A) a market (or industry) with only one seller, and there are barriers to keep other firms from entering the
industry; B) Seller has complete control over price; C) Illegal; D) Some legal exceptions – NATURAL
MONOPOLY and LIMITED MONOPOLY
2-23
KEY ECONOMIC INDICATORS:
MEASURING ECONOMIC
PERFORMANCE
LO 2-5
Gross domestic product (GDP)
• The total dollar value of all goods & services
produced within a country’s borders during a
one-year period
• Real GDP (RGDP) – GDP that adjusts for inflation
• Nominal GDP (NGDP) – GDP measured in
current year’s prices
Inflation
• A general rise in the level of prices
Productivity
• The average level of output per worker per hour
Unemployment rate
• The percentage of a nation’s labor force
unemployed at any time
2-24
UNDERSTANDING RGDP VS. NGDP
Year
2012
2013
Product
Chips
Chips
$1
$2
Q
5
10
2012
2013
Beer
Beer
$3
$4
4
6
•NGDP2012? NGDP2013?
• RGDP2012? RGDP2013?
Price
LO 2-5
The UNITED STATES GDP
Source: World Bank , www.worldbank.org, accessed October 2014.
LO 2-5
2-26
PLAYING CATCH-UP
LO 2-5
Countries Challenging the U.S. in GDP
Source: World Bank, www.worldbank.org, accessed October 2014
.
2-27
UNEMPLOYMENT
LO 2-5
• Unemployment Rate -- 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.
2.
3.
4.
Frictional
Structural
Cyclical
Seasonal
2-28
U.S. UNEMPLOYMENT RATE
LO 2-5
* As of October 2014
2-29
BEST and WORST CITIES
for a JOB SEARCH
Best
Worst
Washington, D.C.
St. Louis, MO
San Jose, CA
Detroit, MI
New York, NY
Miami, FL
Source: Money Magazine, accessed October 2014.
LO 2-5
2-30
PRODUCTIVITY
LO 2-5
• 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.
2-31
PRODUCTIVITY in the
SERVICE SECTOR
LO 2-5
• 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.
2-32
BUSINESS CYCLES
LO 2-5
• Business Cycles -- Periodic rises and
falls that occur in economies over
time.
• Four Phases of Long-Term Business
Cycles:
1. Economic Boom
2.
Recession – Two or more
consecutive quarters of decline
in the GDP.
3.
Depression – A severe recession.
4.
Recovery – When the economy
stabilizes and starts to grow. This
leads to an Economic Boom.
2-33
FISCAL POLICY
Fiscal Policy – Government efforts to influence the economy:
 Taxation
  Taxes,  Economy
 Government Spending
  Gov’t Spending,  Economy
 Controlled by Congress/Budget Process
Monetary Policy – Federal Reserve actions to shape the economy:
 Supply of Money
  Money Supply,  Economy
 Influencing Interest Rates
  Interest Rates,  Economy
 Controlled by Fed
LO 2-6
FISCAL POLICY
LO 2-6
• Fiscal Policy -- The federal
government’s efforts to keep
the economy stable by
increasing or decreasing taxes
or government spending.
• Tools of Fiscal Policy:
-
Taxation
Government Spending
2-35
NATIONAL DEFICITS, DEBT
and SURPLUS
LO 2-6
• National Deficit -- The amount of money the federal
government spends beyond what it gathers in taxes.
• Gov’t Spending > Tax Revenues
• National Debt -- The sum of government deficits over
time.
• National Surplus -- When government takes in more than
it spends.
• Tax Revenues > Gov’t Spending
2-36
WHAT’S OUR NATIONAL DEBT?
LO 2-6
• The National Debt has reached nearly $18 trillion.
• If $1 bills were stacked, the National Debt would
would stretch over 1,000,000 miles. The moon is
only 238,857 miles away.
• Follow the U.S. National Debt Clock here.
2-37
MONETARY POLICY
LO 2-6
• Monetary Policy -- The management of the money
supply and interest rates by the Federal Reserve Bank (the
Fed).
• The Fed’s most visible role is increasing and lowering
interest rates.
• The FED is the central banking system in the US
• Who is Chairman (woman) of the FED?
• When the economy is booming, the Fed tends to
increase interest rates.
• When the economy is in a recession, the Fed tends to
decrease the interest rates.
2-38