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INTRODUCTION TO
BUSINESS
University of Management and Technology
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MGT100
Chapter 1:
Understanding the U.S.
Business System
Griffin, R. W. & Ebert, R. J.
Business (7th ed.)
© 2004 Prentice Hall.
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Learning Objectives
Upon successful completion, the student will be able to:
Describe The Concept of Business and the Concept of Profit
Identify Economic Systems Around the World
Explain The Economics of a Market System
Understand A Short History of Business in the U.S.
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The Concept of Business and
the Concept of Profit
XP
Why study business?
Business affects you many times a day in a variety of ways. As
you progress through this course, you will begin to look at
businesses with the eye of an employee or a manager instead
of a consumer.
You’ll develop fundamental business vocabulary and skills, as
well as learning about a variety of jobs in fields such as
accounting, economics, human resources, management, and
finance.
Business is an organization that provides goods or services
to earn profits.
Profits represent the difference between a business’s
revenues and its expenses.
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The Concept of Business and
the Concept of Profit
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For example,
Jerry Yang and David Filo of Yahoo! chose to start a new
business—a profit-seeking activity that provides goods and
services that consumers want.
The driving force behind most businesses is the prospect of
earning a profit, what remains after all expenses have been
deducted from business revenue.
While some businesses can weather short-term losses,
successful businesses must earn long-term profits in order to
survive.
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The Concept of Business and
the Concept of Profit
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Businesses provide society with necessities:
They provide people with jobs and a means to prosper.
They pay taxes that are used by the government to provide
services for citizens.
They reinvest their profits in the economy, thereby increasing a
nation’s standard of living and quality of life for society as a
whole.
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The Concept of Business and
the Concept of Profit
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Organizations such as schools, museums, public
universities, and symphonies exist to provide society with a
social or educational service and are known as nonprofit or
not-for-profit enterprises.
It is just as important for them to run effectively and efficiently to
achieve their goals.
Nonprofit corporations are nonprofit by design, not by accident!
They serve a charitable purpose or a defined disadvantaged
group.
But they must make money to stay in business.
Their advantage is they don’t get taxed on their “excess
revenues” 
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The Concept of Business and
the Concept of Profit
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Whom do for-profit and nonprofit organizations enrich?
In other words, if they are both successful in their endeavors,
who shares in that wealth creation.
For-profit organizations enrich their owners (sole proprietors,
partners, stockholders).
Maximizing shareholder value is the key.
Sometimes profit-sharing enriches the employees.
Nonprofits enrich their beneficiaries by providing goods or
services where none were available before, or at a lower
price, etc.
Nonprofits can retain their earnings to a point.
Nonprofits cannot have shareholders and cannot offer profit
sharing.
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Economic Systems Around
the World
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How a business operates depends largely on the economic
system of its home country.
An economic system is essentially how a country chooses to
allocate the resources that it uses to produce goods and
services.
These resources are referred to as the factors of production.
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What Are Factors of Production?
A basic difference between economic systems is the way in
which a system manages its factors of production
These are the resources that a country’s businesses use to
produce goods and services.
Economics have long focused on four factors of production:
Labor
Capital
Entrepreneurs
Physical resources
In addition to the classic four, information resources are
now considered a factor of production as well.
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Factors of Production
Labor—People who work for businesses provide labor.
Sometimes called human resources.
Labor includes the physical and intellectual contributions
people make while engaged in economic production.
AOL Time Warner www.aoltimewarner.com, for example,
employs 88,000 people.
Such large operations require highly skilled workforces that
span a wide range of knowledge areas, ranging from software
engineers and media experts to financial analysts.
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Factors of Production
Capital—Obtaining and using labor and other resources
requires capita.
Capital describes the financial resources needed to operate
an enterprise.
AOL Time Warner needs millions of dollars in cash (and
millions more in equipment and other assets) to run its
operations.
A major source of capital for small businesses is personal
investment by the owners.
Capital can also include the market value of corporate stock.
When American Online acquired Time Warner for $106 billion in
2001, the deal involved very little cash.
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Factors of Production
Entrepreneurs—An entrepreneur is an individual who
accepts the risks and opportunities entailed by creating and
operating a new business.
AOL was started by James Kimsey, who had the technical
skills to understand how the Internet works, the conceptual
skills to see its huge future potential, and the risk-taking
acumen to bet his own career and capital on the idea of
AOL.
Both Time Inc. and Warner Brothers Studios, two older
companies that later merged into Time Warner, were also
started (both in 1922) by entrepreneurs who risked personal
fortunes on the success of their new ventures.
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Factors of Production
Physical Resources—are the tangible things that
organizations use to conduct their business.
These include natural resources and raw materials, offices,
storage, production facilities, parts and supplies, computers
and peripherals, and a variety of other equipment.
AOL Time Warner, for example, needs land, buildings, and
computers. The CDs on which it distributes its software and
music and the videotapes and DVDs on which it distributes
movies are supplied by other manufacturers; forest products
are used for packaging. Etc.
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Factors of Production
Information Resources—The production of tangible goods
once dominated most economic systems, but today
information resources play a major role.
Businesses rely on market forecasts, on the specialized
knowledge of people, and on economic data for much their
work.
AOL Time Warner produces few tangible products.
America Online provides online services for millions of
subscribers who pay monthly access fees.
Time Warner Entertainment produces movies and television
programming.
AOL Time Warner essentially is in the information business.
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Factors of Production
Not all countries share the same combination of resources.
Let us compare three specific country’s available factors of
production: Russia, Japan, and the USA.
Russia has abundant physical resources and labor markets,
developing entrepreneurship, information resources, and
capital markets.
Japan and the USA share similar strengths across all
factors with one major exception: Japan has limited domestic
physical resources.
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Factors of Production
Do these countries share similar outputs (GDP)? Why are
their outputs so dramatically different? What appears to be
the critical factor?
Japan’s GDP is roughly 70% of USA’s; and it is double the size
of Germany’s GDP.
Russia’s output is just a small fraction of Japan’s.
One of the critical factors is that the USA and Japan have
established capital markets for both equity and debt.
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Types of Economic Systems
Different types of economic systems manage the factors of
production in different ways.
Regardless of how they operate, all economic systems must
answer the same basic questions:
How should resources be used to satisfy society’s needs?
What goods and services should be produced?
Who should produce them?
How should these goods and services be divided among the
population?
The three major categories are planned economies, market
economies, and mixed economies.
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Planned economies
Planned economies—There are two basic forms of planned
economies: communism and socialism.
Communism is a planned system that allows individuals the
least degree of economic freedom.
The degree to which communism is practiced varies from one
country to another.
During the 1990s communism was renounced as both an
economic and political system by most countries that practiced
it.
The only remaining communist systems are North Korea, the
People’s Republic of China, Cuba, and Vietnam.
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Planned economies
The idea behind communism was that each citizen would
contribute according to his or her abilities, and would gain
benefits according to his or her needs.
Why didn’t this work?
A major reason are the gross inefficiencies of huge, state-owned
organizations.
Also in competitive economic markets only the strongest
companies survive.
They do so by producing goods and services that people want at a
price that people can pay and which still earns a profit.
What was missing?
The profit motive is an incentive for hard work by individuals.
Free markets encourage economic growth through competition.
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Market economy
Market economy—An economic system in which buyers and
sellers interact based on freedom of choice.
In a free-market, or capitalist system, individuals are free to
choose where to work, what to buy, and how much to pay.
Producers are free to choose who to hire, what to produce,
and how much to charge.
According to Adam Smith, the father of economics:
The market serves as a self-correcting mechanism, an
“invisible hand,” that ensures the production of goods that
society wants, in the quantities wanted, without regulation of
any kind.
Examples of other countries with capitalist economies are
Canada, Germany, and Japan.
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Input and Output Markets
Input and Output Markets—One way of understanding a
pure market economy is through the idea of input and output
markets.
Input market: Market in which resources flow to firms from
supplier households.
Resources include labor and capital.
People are paid for their labor.
They save some money, which banks can lend to businesses
(deft financing).
They invest in stocks, investment banks can exchange with
companies for shares.
Output market: Market in which firms supply goods and
services in response to demand from households.
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Circular Flow in a Market
Economy
XP
The figure, shows a more
complete model for better
understanding how factors of
production work in a pure market
economy.
According to this view, businesses
and households interact in two
different market relationships.
In the input market, firms buy
resources from households, which
are thus resources suppliers.
In the output market, firms supply
goods and services in response to
household demand.
The activities of these two markets
create a circular flow.
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Capitalism
Capitalism—Market economy that provides for private
ownership of production and encourages entrepreneurship
by offering profits as an incentive.
For example,
Consumers, of course are free to buy their next car from Ford
or Toyota or BMW.
This process contrasts markedly with that of a planned
economy, in which individuals may be told where they can
and cannot work, companies may be told what they can and
cannot make, and consumers may have little or no choice in
what they purchase or how much they pay.
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Mixed Market Economies
Capitalism is a fundamentally
market-based economy in
which the government
supports private ownership,
and encourages
entrepreneurship by offering
after-tax profits as an
incentive.
In the real world, most
economies are neither fully
planned nor fully market, but
rather they include elements
of each—a mixed market
economy.
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Mixed Market Economies
Socialism—The worldwide trend continues to be toward the
market end of the spectrum and away from state control.
Countries in the mid-range of the spectrum are typically
socialist, embracing an economic system in which the
government owns and operates only selected sources of
production.
As in a communist system, there is a high level of government
planning and ownership of vital industries such as
transportation, utilities, and steel.
The government provides such social services as medical care,
education, and subsidized housing. As in capitalist systems,
socialism allows private ownership in industries not considered
vital, and individuals may benefit from their own efforts.
Examples of socialist countries are Great Britain, France, and
India.
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Mixed Market Economies
Privatization—Like communism, socialism has been
embracing elements of capitalism in the past decade.
Private ownership of basic industries is on the rise.
For instance, Mexico and Chile are selling off state-owned
enterprises such as national airlines and telephone companies.
As many of these countries have moved more towards a
market economy, they have engaged in privatization, the
process of converting government enterprises into privately
owned companies.
However, many planned systems are finding that moving
toward a free-market system and converting state-owned
enterprises into world-class corporations is a formidable
task.
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The Economics of a Market
System
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Understanding the complex nature of the U.S. economic
system is essential to understanding the environment in
which U.S. business operate.
In this section, we describe the workings of the U.S. market
economy. Specially, we examine markets, the nature of
demand and supply, private enterprise, and degrees of
competition.
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Demand and Supply in a Market XP
Economy
In each of these markets, businesses decide what inputs to
buy, what to make and in what quantities, and what prices to
charge.
Likewise, customers decide what to buy and how much they
want to pay. Literally billions of such exchanges take place
every day between businesses and individuals; between
businesses; and among individuals, businesses, and
governments.
Moreover, exchanges conducted in one area often affect
exchange elsewhere.
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Demand and Supply in a Market XP
Economy
For example,
As U.S. demand dropped, firms like Dell and IBM cut prices to keep
sales from slumping too far, and lower prices mean lower profit per
unit.
At the same time, however, demand in other parts of the world,
notably in China and India, has continued to rise. Lower prices make
U.S. good more affordable, so international shipments increase.
But the lower prices overall cannot be offset by international sales,
which often are lower than U.S. and have higher shipping costs that
further reduce profits.
Finally, lower profits generate expectations of even lower profits, so
shareholders begin to sell their holdings.
The increased selling leads to the price being “beaten down” by
buyers who will only buy if it’s a bargain – since the profits are falling.
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The Laws of Supply and Demand
The forces of supply and demand combine with the profit
motive in a free-market system to regulate what is produced
and in what amounts.
Demand refers to the quantity of a good or service that
consumers will buy at a given time at various prices.
Supply refers to the quantities of a good or service that
producers will provide on a particular date at various prices.
The Laws of Demand and Supply
The law of supply states that the higher the price, the more
producers are willing to supply.
The law of demand says that the lower the price, the more
consumers are willing to buy.
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Demand and Supply Schedule
To appreciate these laws in action, consider
the market for pizza in your town (or
neighborhood).
Price
If everyone is willing to pay $25 for a pizza,
the town’s only pizzeria will be willing to
produce a large supply.
But if everyone is willing to pay only $5,
then the pizzaria will only be interested in
making a few pizzas..
Through careful analysis, we can determine
how many pizzas will be sold at different
prices.
Supply
These results, called a demand and supply
schedule—Assessment of the relationships
among different levels of demand and supply
at different price levels.
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Demand
Qty
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A demand curve is a graph showing how
many units of a product will be
demanded (bought) at different prices.
Price
Demand and Supply Curves
A supply curve is a graph showing how
many units of a product will be supplied
(offered for sale) at different prices.
Price
Quantity
Quantity
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Demand &
Supply
Curves
The demand and supply schedule
can be used to construct demand
and supply curves for pizza in
your town.
A demand curve shows how
many products—in this case,
pizza—will be demanded
(bought) at different prices.
A supply curve shows how many
pizzas will be supplied (offered
for sale) at different prices.
The figure shows demand and
supply curves for pizzas.
As you can see, demand
increases as price decreases;
supply increases as the price
increases.
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When the price of pizza
is high, fewer people are
willing to pay for it. But
when the price goes
down, more people are
willing to buy pizza. At
the lower price, in other
words, more people
“demand” the product.
XP
When the price of the is low, more
people are willing to buy pizza. Pizza
makers, however, do not have the
money to invest in making pizzas and
so they make fewer. Supply, therefore,
is limited, and only when the price goes
up will pizza makers be willing and
able to increase supply.
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When pizza makers increase supply in order
to satisfy demand, there will ultimately be a
point at which the price that they can charge
is the same as the price that a maximum
number of customers is willing to pay. That
point is the market price, or equilibrium
price.
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Equilibrium Price
When demand and supply curves are plotted on the same
graph, the point at which they intersect is the market price or
equilibrium price—the price at which the quality of goods
demands and the quantity of goods supplied are equal.
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Surpluses and Shortages
If the actual price of a good were below
the market price, demand would be
higher than supply, creating a
shortage. Producers would be leaving
"money on the table" that they could be
collecting if they simply increased the
supply.
If the actual price of a good were
above the market price, supply would
be higher than demand, creating a
surplus. Producers would need to sell
excess goods at a steep discount,
dramatically reducing profitability.
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Surplus
Shortage
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Surpluses and Shortages
For Example:
When PT Cruisers were introduced to the U.S. market, demand
far outstripped supply.
Poor sales projections cost DaimlerChrysler the opportunity to
earn profits on all the additional PT Cruisers that it could have
sold, if it had them to sell.
However, in real life it is more complicated than that. To a
large degree, it depends on the type of product being sold.
For instance,
When the price of gasoline or milk goes up, consumers won’t
stop buying, although they may cut back.
In broad terms, the theory of supply and demand regulates a
free-market system by determining what is produced and in
what amounts.
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Private Enterprise and Competition
in a Market Economy
Private enterprise is an economic system that allows
individuals to pursue their own interests with minimal
government restricts.
It requires the presence of four elements:
1. Private property rights—Ownership of the resources used to
create wealth is in the hands of individuals. Private property
rights include both real and intellectual property.
2. Freedom of choice—You can sell your labor to any employer
you choose. You can also choose which products to buy, and
producers can usually choose whom to hire and what to
produce.
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Private Enterprise and Competition
in a Market Economy
3. Profits—The lure of profits (and freedom) leads some people
to abandon the security of working for someone else and to
assume the risks of entrepreneurship. Anticipated profits also
influence individual’s choice of which goods services to
produce.
4. Competition—Occurs when two or more businesses vie for the
same resources or customers.
To gain an advantage over competitors, a business must produce
its goods and services efficiently and be able to sell at a
reasonable profit.
To achieve these goals, it must convince customers that its
produces are either better or less expensive than those of its
competitors.
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Private Enterprise and Competition
in a Market Economy
Are there any restrictions or constraints on these rights? In
other words, do these four elements have any limits?
Private property rights might encounter eminent domain.
The government steps in claims the property for the benefit of
public.
Laws and regulations might limit our freedom of choice.
Taxes might reduce profits.
Anti-trust laws try to preserve competition.
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Degrees of Competition
Competition motivates businesses to produce their products
better or cheaper.
Companies that don’t compete effectively will be forced out
of business. While competition is a fundamental element of
free enterprise, not all industries are equally competitive.
Economists have identified four basic degrees of competition
within a private enterprise system:
Perfect competition
Monopolistic competition
Oligopoly
Monopoly
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Perfect Competition
Perfect competition is characterized by
many competitors
with virtually identical products, and
few barriers to entry.
No single firm has control over prices.
The agricultural industry is a classic example of perfect
competition.
However, some groups of farmers within this industry have
managed to differentiate their products, which has allowed
them to exercise some control over price (e.g. California
cheese, Chiquita bananas, Dole pineapples, Sunkist
oranges).
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Monopolistic Competition
Monopolistic competition is characterized by fewer
competitors than with full and open competition.
Products may be somewhat differentiated.
And there may be some, perhaps modest, barriers to entry.
Individual firms have limited control over prices.
Examples include fast food, detergent, clothing
manufacturers, etc.
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Oligopoly
Oligopoly is characterized by very few competitors in the
market, often just a handful.
Typically there are high barriers to entry.
The product can be either similar or differentiated.
Each firm has some control over prices.
Examples include the automobile industry, the airline
industry, the steel industry, etc.
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Monopoly
Monopoly is characterized by one producer dominating the
industry to the point of completely controlling prices.
Monopolies are illegal in the U.S. because they undermine the
competition that drives our economy.
In the past, the government has sanctioned and closely
regulated some natural monopolies, industries in which one
producer can most efficiently supply all needed goods or
services (e.g. natural gas, electricity, local phone service).
But even these natural monopolies are gradually being
deregulated to allow for competition.
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Degrees of Competition
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A Short History of Business in
the U.S.
XP
The landscape of U.S. business has evolved over the course
of many decades.
Specially, a look at the history of U.S. business shows a
steady development from sole proprietorships to today’s
intricate corporate structure.
We can gain a more detailed understanding of this
development by tracing its history.
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The Factory System and the
Industrial Revolution
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The Factory System and the Industrial Revolution, which
began during the middle of the eighteenth century, forced
hundreds of cottage workers to enter a centralized factory
environment, and launched an era of mass production.
This form of production reduced duplication of equipment
and allowed firms to purchase raw materials at better prices.
It also encouraged specialization of labor.
A number of developments made possible the transportation
of products to distant markets. Among the most important of
these developments was improved financing through the
U.S. banking system, and improved transportation through
the opening of the Erie Canal and the development of the
railroads.
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Laissez-Faire and the
Entrepreneurial Era
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Also contributing to the rise in entrepreneurship in this
country was the Laissez-Faire principle.
This principle states that the government should not interfere
in the economy but should let business function without
interference.
A number of laws were passed during this era that helped
improve business practices.
These included the Sherman Antitrust Act and the Clayton
Act.
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The Production Era
Mass production and the assembly line are ascribed to the
genius of Henry Ford (1863-1946).
In the early 1900s, Ford used the principles of mass production
to build the Model T, and used an army of workers to keep up
with the moving assembly line.
Mass production and specialization continued into the twentieth
century. These factors, along with the focus on scientific
management and the moving assembly line, helped usher in
the Production Era
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The Production Era
The management thinker behind scientific management is
Frederick Winslow Taylor.
Beginning in 1881, he used a stopwatch to break down every
step in the production process. He wrote: “In the past the man
was first. In the future the system must be first.”
The Concept of Countervailing Powers
The Production era also saw the rise of labor unions and
collective bargaining, referred to as countervailing powers.
In addition, the Great Depression of the 1930's and World War
II prompted the government to intervene in commerce more so
than it had done in the past.
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The Marketing Era
After World War II, the 1950's and 1960's were prosperous
times.
Production increase, technology advanced, and the standard of
living rose.
A new philosophy called the marketing concept emerged
during this marketing era.
This concept states that a business must focus on identifying
and satisfying consumer wants in order to be profitable.
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The Global Era
In the 1980s, the continuation of technological advances in
production, computer technology, information systems, and
communications capabilities created the emergence of a
global economy.
The global economy emerged during this era, as more
Americans began to purchase foreign products, and
American firms sold their products in more and more
countries.
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The Internet Era
The beginning of the twenty-first century marked what
experts call the Internet Era.
Approximately 450 of 1,000 people in the year 2000 used the
Internet.
Projections estimate that by the year 2005 that figure will
increase to 750 users per 1000 people.
The growth of the Internet has affected businesses in at
least three different ways:
Giving a dramatic boost to trade in all economic sectors
Leveling the playing field between larger and smaller
enterprises
Building a networking mechanism among businesses
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Summary
Businesses are organizations that produce or sell goods or
services to make a profit.
Profits are the difference between revenues and expenses. The
prospect of earning profits encourages individuals and organizations to
open and expand businesses, whose benefits also extend to wages
paid to workers and to taxes that support government functions.
An economic system is a nation’s system for allocating its
resources among citizens. Economic systems differ in terms
of who owns or controls the five basic factors of production:
Labor
Capital
Entrepreneurs
Physical resources
Information resources
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Summary
In planned economies, the government controls all or most
factors.
In market economies, individuals and businesses control the
factors and exchange them through input and output
markets.
Most countries today have mixed market economies that are
dominated by one of these systems but include elements of
the other.
Privatization is an important means by which many planned
economies are moving toward mixed market systems.
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Summary
The U.S. is a market economy, based on the principles of
capitalism, and propelled by the forces of demand and
supply.
Demand is the willingness and ability of buyers to purchase a
good or service.
Supply is the willingness and ability of producers to offer goods
or services for sale.
Demand and supply work together to set a market or
equilibrium price at which the quantity of goods demand and
supplied are equal.
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Summary
Fundamentally, the U.S. economy is a private enterprise
system, incorporating four key elements:
private property rights
freedom of choice
profits
competition
Degrees of competition vary because not all industries are
equally competitive.
In pure competition, numerous small firms compete in a market
governed entirely by demand and supply.
An oligopoly involves a handful of sellers only.
A monopoly has only one seller.
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Summary
The rise of the factory system during the Industrial Revolution
brought with it mass production and specialization of labor.
During the entrepreneurial era in the 19th century, huge corporations
and monopolies emerged.
During the production era of the early 20th century, companies grew
by emphasizing output and production.
During the marketing era of the 1950s and 1960s, businesses began
focusing on sales staff, advertising, and the need to produce what
consumers wanted.
The global perspective of business emerged in the 1980s and
continues today. The most recent developments are pointing toward
an Internet era as perhaps the next major period in the evolution of
business.
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