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Chapter 2: ECONOMICS The Framework for Business © 2009 South-Western, a division of Cengage Learning WHY ECONOMICS MATTER • Economics represent the flow of resources • Forces that impact your business and personal life – Better Decisions – More Money © 2009 South-Western, a division of Cengage Learning • The economy is financial and social system • Represents flow of resources through society (from production to consumption) • Economics is about choices © 2009 South-Western, a division of Cengage Learning CONSUMER CHOICES AND ECONOMICS What choices have you made because of increasing gas costs? What would you do differently if the price now doubled? How would your choices impact various businesses? © 2009 South-Western, a division of Cengage Learning MACROECONOMICS VS. MICROECONOMICS Same Scene, Different Take Macroeconomics Country’s Overall Economy Microeconomics Consumers Families Businesses © 2009 South-Western, a division of Cengage Learning ALLOCATING RESOURCES Free Market Planned Economies Capitalism Socialism Mixed Economies © 2009 South-Western, a division of Cengage Learning Communism CAPITALISM • The Free Market: – Private Ownership – Economic Freedom – Fair Competition – Innovation and Hard Work • Businesses offer Value to: – Customers – Employees – Suppliers © 2009 South-Western, a division of Cengage Learning PLANNED ECONOMIES • Communism – Public Ownership of Enterprise – Strong Central Government • Socialism – Government Control Key Enterprises – Higher Taxes © 2009 South-Western, a division of Cengage Learning MIXED ECONOMIES • Market and Planned Economies don’t meet all needs – Under pure market economies, the old, young, sick and the environment could suffer – Planned Economies will not create enough value • As a market dominant economy, the US government still owns/supports enterprises – Postal Service – Universities – Parks – Libraries © 2009 South-Western, a division of Cengage Learning MIXED ECONOMIES “ What industries should be regulated? Why? © 2009 South-Western, a division of Cengage Learning P.J. O’Rourke, political satirist, journalist, writer “ As Mixed Economies become The Story of the Future, how much government intervention is too much? When buying and selling are controlled by legislation, the first things to be bought and sold are legislators. RIGHTS OF CAPITALISM • The right to own a business and keep after-tax profits. • The right to private property • The right to free choice • The right to fair competition © 2009 South-Western, a division of Cengage Learning DEGREES OF COMPETITION • Pure Competition • Monopolistic Competition • Oligopoly • Monopoly © 2009 South-Western, a division of Cengage Learning • Pure – many competitors with identical product where consumers have all power • Monopolistic Competition – many competitors who have control over price because brand loyalty • Oligopoly – handful of competitors selling similar products • Monopoly – single producer controls industry © 2009 South-Western, a division of Cengage Learning FREE MARKET FUNDAMENTALS • Supply and Demand • 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 – Entrance of competition © 2009 South-Western, a division of Cengage Learning SUPPLY: HOW MUCH TO PRODUCE? CHARGE? • Supply: the relationship between the price of a good and the quantity sellers are willing and able to offer for sale. – Sellers tend to supply a greater quantity as the price rises • Supply curve: a graph of the supply relationship. – The supply curve slopes upward to the right showing that quantity supplied increases as price rises © 2009 South-Western, a division of Cengage Learning DEMAND: HOW MUCH WILL BUYERS PURCHASE? • Demand: the relationship between the price of a good and the quantity buyers are willing and can afford to buy. – When price falls, consumers tend to buy more • Demand curve: a graph of the demand relationship – The demand curve slopes downward showing that quantity demanded increases as price falls © 2009 South-Western, a division of Cengage Learning EQUILIBRIUM PRICE • Forces of supply and demand drive equilibrium price • The point where supply and demand intersect • Equilibrium price is the market price. © 2009 South-Western, a division of Cengage Learning COST OF AN ICE COLD COKE • Coke took supply and demand too far.... • …install thermometers in their vending machines • Consumers balked at paying more for a cold Coke on a hot day. © 2009 South-Western, a division of Cengage Learning EVALUATING THE ECONOMY Gross Domestic Product Unemployment Rate Consumer Price Index Producer Price Index Productivity © 2009 South-Western, a division of Cengage Learning Unemployment • Frictional – job changes • Structural – unemployment because skills are not needed • Seasonal – time of year • Cyclical – economic cycle layoffs and hires © 2009 South-Western, a division of Cengage Learning GOVERNMENT PLAYS A ROLE IN MANAGING THE ECONOMY The goal is to find: – The right mix of freedom and control – The right balance between taxing and spending – And the right growth rate for the supply of money © 2009 South-Western, a division of Cengage Learning MANAGING THE ECONOMY • Fiscal Policy – Taxation – Government Spending – Controlled by Congress/Budget Process • Monetary Policy – Supply & Demand of Money • Cost of Credit – Controlled by the Federal Reserve (FED) • Seven Member Board • Chairman © 2009 South-Western, a division of Cengage Learning FEDERAL GOVERNMENT REVENUE & EXPENSES © 2009 South-Western, a division of Cengage Learning MONEY: M1 AND M2 M1 Money Supply - all currency—paper bills and metal coins—plus checking accounts and traveler’s checks. M2 Money Supply - all M1 plus most savings accounts, money market accounts, and certificates of deposit (low risk savings vehicles with a fixed term). © 2009 South-Western, a division of Cengage Learning BANKS MULTIPLYING MONEY The bank must hold 10% of your deposit based on You deposit $5,000 Federal Reserve Requirements. The bank loans Anne $4,500 Anne buys a car from Jake for $4,500 Jake deposits the $4,500 Although you still have $5,000, the money supply has increased to $9,500 © 2009 South-Western, a division of Cengage Learning FEDERAL RESERVE • Conduct Monetary Policy: – Changes in the Discount Rate – Changes in Reserve Requirement – Open Market Operations • Participates in Check Clearing Process • Banking Services for Government and other banks © 2009 South-Western, a division of Cengage Learning More on the Fed GOVERNMENT’S ROLE? “ For a free market to function humanely, it must find a way to provide a decent standard of living for everyone, including the desperately poor, the very young, the very old, and the sick. “ © 2009 South-Western, a division of Cengage Learning What do you think? Country Corporate Personal Sweden 28%[ 28.89%59.09% United States 15-39% (federal income) 0-12% (state income) Canada[5] 29.5-35.5% Payroll 32.42%[ VAT/GST/Sal es 25%. 12% and 6% for some goods. 0-35% (federal 0-10.25% income) 15.3%(federal (state and 0-10.3% payroll) local sales (state income) tax) 15-29% (federal) 417.95% (provincial) United Kingdom [23] 21-28% 0,20,40% India 30-40% 10-30% 5% (GST) 010% (provincial sales taxes) 23.8% (National Insurance) 17.5% 12.5% US ECONOMIC GROWTH Housing Statistics: 1950 2003 Average size of new homes 983 2,330 New homes with 4 bedrooms 1% 37% New homes with 2.5 or more baths 1% 56% © 2009 South-Western, a division of Cengage Learning Source: Home Big Home, Carleton College Voice, Winter 2006 THE BUSINESS CYCLE © 2009 South-Western, a division of Cengage Learning LOOKING BACK • Why is supply and demand the driving force in a free-market system? • What is the difference between planned economies and a free-market system? • Why is there a trend toward mixed economies? • How is the economy measured and controlled? • What is the role of the Federal Reserve? © 2009 South-Western, a division of Cengage Learning