Download How Economic conditions affect business

How Economic Conditions Affect Business
To understand the underlying situation and conditions in which Canadian businesses
operate, you must have (1) some grasp of economics, (2) be aware of the impact of the
global environment, and (3) understand the role of the federal and provincial
governments in Canada.
The Canadian economy is an integral part of the world economy. Business firms use
labor from the other countries, export to and import from other countries, buy land in the
other countries for their facilities, and receive money from foreign investors. To
understand the Canadian economy, one needs to understand the World economy.
A major part of business success is due to an economic and social climate that allows
business to operate freely. Foreign investors like Canada because we have a stable
economic and political environment – investing is risky enough without having to worry
about unpredictable governments, massive corruption and weak laws. Any change in our
economic or political system can have a major influence on business.
Economics
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is the study of how society chooses to employ resources to produce goods and
services and distribute them for consumption among various competing groups.
Remember these resources (land, labor, capital, entrepreneurship and knowledge)
were all outlined in chapter 1 and are called factors of productions.
There are two major branches of economics: MACROECONOMICS looks ate the
operation of a nation’s economy as a whole, and MICROECONOMICS looks at
the behavior of people and organizations in a particular market. While
macroeconomics looks at how many jobs exist in the whole economy,
microeconomics examines how many people will be hired in a particular industry
or a particular region of the country.
Some economists define economics as the allocation of “scarce” resources. They
believe that resources are scarce and that they need to be carefully divided among
people. There’s no way to maintain peace and prosperity in the world by merely
dividing the resources we have today among the existing nations. There aren’t
enough known resources available to do that. RESOURCE DEVELOPMENT is
the study of how to increase resources and to create the conditions that will make
better use of those resources (eg. recycling and oil conservation). Outside of
government, businesses may contribute to an economic system by inventing
products that greatly increase available resources. For example, businesses may
discover new energy sources, new ways of growing food, and new ways of
creating needed goods and services.
Adam Smith was one of the first people to imagine a system for creating wealth and
improving the lives of everyone. Rather than believing that fixed resources had to be
divided among competing groups and individuals, Smith envisioned creating more
resources so that everyone could become wealthier. Smith’s book The Wealth of Nations
was later considered the foundation of the study and understanding of the newly
developing capitalist industrial society. Smith believed that freedom was vital to the
survival of an economy, especially the freedom to own land or property and the freedom
to keep profits from working the land or owning a business. He believed that as long as
farmers, laborers, and business people (entrepreneurs) could see economic rewards for
their efforts (receive enough money in the form of profits to support their families), they
would work long hard hours. As a result of these efforts, our economy would prosper.
Under Smith’s theory, people primarily worked for their own prosperity and growth. Yet
as people improve their own situation in life, Smith thought that their efforts would serve
as an “invisible hand” that would help the economy grow and prosper. Therefore, the
“invisible hand” serves to turn self-directed gain into social and economic benefits for
all.
Free-Market Capitalism
With ideas such as Smith’s, business people began creating more wealth than had ever
been created before. They began hiring others to work within their businesses – leading
to factories and nations prospering.
The economic system that has led to wealth creation in much of the world is known as
capitalism. Capitalism is an economic system in which all or most of the factors of the
production and distribution (eg. Land, factories, railroads, and stores) are privately owned
and are operated for profit. In capitalist countries, business people decide what to
produce, how much to pay workers, how much to charge for goods and services, where to
sell these goods and services, and so on. Capitalism is the popular term used to describe
free-market economies.
No country is truly capitalist. Often governments get involved in issues which determine
minimum wages and subsidizing certain sectors as the federal government does in
Canada for the agriculture sector. Capitalism is the foundation for the economies of
Canada, England, Australia, the United States and most other developed nations.
The free market is one in which decisions about what to produce and in what quantities
are made by the market – by buyers and sellers negotiating prices for goods and services.
Consumers determine what the producers make, how many to make, in what colors and
so on. We do that by choosing what to buy or what not to buy when it comes to good and
services.
In a free market, prices are not determined by sellers; they are determined by buyers and
sellers negotiating in the marketplace. A seller may want to receive $50 for a t-shirt, but
the quantity demanded at that price may be quite low. If the seller lowers the price, the
quantity demanded is likely to increase. How is a price that is acceptable to both buyers
and sellers determined? The answer is found in the microeconomic concepts of supply
and demand.
SUPPLY refers to the quantity of products that manufacturers of owners are willing to
sell at different prices at a specific time. The amount supplied will increase as the price
increases because sellers can make more money with a higher price.
Economists show this relationship between quantity supplied and price on a graph. The
graph below shows a simple supply curve for t-shirts. The price of the shirts in dollars is
shown vertically on the left of the graph. The quantity of shirts that sellers are willing to
supply is shown horizontally at the bottom of the graph. The various points on the curve
indicate how any t-shirts sellers would provide at different prices. At a price of $5 per
shirt, a vendor would provide only five t-shirts, but at $50 a shirt the vendor would
supply 50 shirts. The supply curve indicates that relationship between the price and the
quantity supplied. All things being equal, the higher the price, the more the vendor will
be willing to supply. See page 48 of the textbook.
The supply curve rises from left
to right. Think it through – the
higher the price of t-shirts goes
(the left margin), the more sellers
will be willing to supply.
Price
Quantity for t-shirts
DEMAND refers to the quantity of products that people are willing to buy at different
prices at a specific time. The quantity demanded will increase as the price decreases.
Again, the relationship between price and quantity demanded can be shown in a graph.
This is a simple demand curve
showing the quantity of T-shirts
demanded at different prices. The
demand curve falls from left to
right. The lower the price of Tshirts, the higher the quantity
demanded.
Price
Quantity of T-Shirts
The graph above shows a simple demand curve for T-shirts. The various points on the
graph indicate the quantity demanded at various prices. For example, at a price of $45,
the quantity demanded is just five T-shirts; but if the price were $5, the quantity
demanded would increase to 35 shirts. The line is called the demand curve. It shows the
relationship between quantity demanded and price.
Read Dealing with Change – Adapting to Swings in Demand on page 49.
The Equilibrium Point or Market Price
It should be clear now that the key factor in determining the quantity supplied and the
quantity demanded is PRICE. Sellers prefer a high price and buyers prefer a low price.
If you were to lay one of the two graphs on top of the other, the supply curve and the
demand curve would cross (see page 49). At that crossing point, the quantity demanded
and the quantity supplied are equal. At a price of $15, the quantity of t-shirts demanded
and the quantity supplied are equal (25 shirts). That crossing point is known as the
equilibrium point or the equilibrium price. In the long run, that price would become the
market price. Market price, then, is determined by supply and demand.
Read page 50 – second paragraph
Supporters of a free market would argue that, because supply and demand interactions
determine prices, there is no need for government involvement or planning. If surpluses
develop (quantity supplied exceeds quantity demanded), a signal is sent to sellers to
lower the price. If shortages develop (quantity supplied is less than quantity demanded),
a signal is sent to sellers to increase the price. Eventually, supply will again equal
demand if nothing interferes with market forces. Such price swings were evident when
the oil supply was cut because of Hurricane Katrina. When supplies were low because of
the hurricane, the price of gasoline went up (dramatically). When supplies were again
plentiful, the price of gas fell.
In countries without free markets, there is no mechanism to tell businesses what to
produce and in what amounts, so there are often shortages or surpluses. In such
countries, governments decide what to produce and in what quantity, but the government
has no way of knowing what the proper quantities are. When governments interfere in
free markets, such as when it subsidizes farm goods, there may also be shortages and
surpluses.
Competition within Free Markets
Economists generally agree that four different degrees of competition exist:
Perfect Competition
Monopolistic Competition
Oligopoly
Monopoly
(read pages 50-51)
Benefits and Limitations of Free Markets
The free market – with it competition and incentives – was a major factor in creating
the wealth that industrialized countries now enjoy. Free market capitalism, more than
any other economic system, provides opportunities for poor people to work their way
out of poverty.
The free market allows open competition among companies. Businesses must
provide customers with quality products at fair prices with good service. Otherwise,
they will lose customers to those businesses that do provide good products, good
prices and good service.
Free market capitalism has brought prosperity yet it has also brought inequality as
well. Business owners and managers make more money and have more wealth than
workers. There is much poverty, unemployment, and homelessness. People who are
old, disabled, or sick may not be able to support themselves.
Smith assumed that as people became wealthier, they would naturally reach out and
help the less fortunate in the community. While this had not always happened, many
business people are becoming more concerned about the social issues and their
obligations to return to society some of what they have earned.
Do questions on page 52 – Progress Assessment.
Write your own notes based on pages 52-55 – including copying the chart on page 55
in your notebooks.
Do questions on page 55 – Progress Assessment
Canada’s Mixed Economy
Like other nations of the world, Canada has a mixed economy. The Government has
involvement in our economy in such areas as health care. The perceived goal is to
grow the economy while maintaining some measure of social equality. The goal is
very hard to attain. Nonetheless, the basic principles of freedom and opportunity
should lead to economic growth that is sustainable.
Several features have played a major role in Canada becoming an independent
economic entity with a high percentage of government involvement in the economy.
Firstly, we are one of the largest countries in the world geographically, but we have a
small population (in perspective with other countries). We have one of the lowest
population densities in the world.
Our neighbour to the south has ten that population and an economy even greater than
that proportion, speaks our language, is very aggressive economically, and is the most
powerful country in the world. The United States exerts a very powerful influence on
Canada as our largest trading partner. To control our destiny, Canadian governments
have passed many laws and regulations to ensure that significant economic and
cultural institutions, such as banks, insurance companies, and radio and TV stations,
remain under Canadian control.
All these factors led to the Canadian capitalist system taking on many characteristics
of a mixed economy. Massive government support was necessary to build our first
national rail line, the CPR, in the 1880s. When air transport was beginning in the
1930s no company wanted to risk investing heavily in such a large country with only
10 million people spread thinly across the land. So the government set up Air Canada
to transport mail, people, and freight. There are many such examples of government
action to protect the national interest.
The strength of the economy has a tremendous effect on business. When the
economy is strong and growing, most businesses prosper and almost everyone
benefits through plentiful jobs, reasonably good wages and sufficient revenues for the
government to provide needed goods and services. When the economy is weak,
however, businesses are weakened, employment and wages fall, and government
revenues decline as a result.
Because business and the economy are so closely linked, business literature is full of
terms and concepts. It is virtually impossible to read such business reports with much
understanding unless you are familiar with the economic concepts and terms being
used.
Three major indicators of economic conditions are (1) the gross domestic product
(GDP) and productivity, (2) the unemployment rate, and (3) the price indexes.
Another important statistic is the increase or decrease in productivity. When you read
business literature, you’ll see these terms again and again.
GROSS DOMESTIC PRODUCT (GDP) is the total value of the final goods and
services produced in a country in a given year. Ether a domestic company or a
foreign-owned company may produce the goods and services included in the FDP as
long as the companies are located within the country’s boundaries. Cambridge,
Ontario, would be included in the Canadian GDP. Revenue generated by the Ford car
factory in Mexico would be included in Mexico’s GDP, even though Ford is a U.S.
Company.
If GDP growth slows or declines, there are often many negative effects on business.
This has not been the case in recent years. Table 2.1 on page 57 of your textbook
shows Canada’s real GDP growth since 2000. The growth rate in 2005 was primarily
driven by strong personal expenditures on good and services, investment in
residential and non residential structures, investment in machinery and equipment,
and net exports.
What accounts for increases in GDP? A major influence on the growth of GDP is
how productive the workforce is – that is, how much output workers create with a
given amount of input. This is linked to the combination of creating jobs, working
longer hours, or working smarter. Working smarter means being more productive
through the use of better technology and processes and a more educated and efficient
workforce. Over the past few years, GDP growth has been affected by rising
employment, low inflation, and low interest rates. The more you produce, the higher
the GDP and vice versa.
The economy benefits from a strong GDP. Monet that is earned from producing good
and services goes to the employees that produce them in the form of wages. People
who own the business generate a return on their investment, and government benefits
from tax collection. A strong economy usually leads to a high standard of living for
Canadians. The term standard of living refers to the amount of good and services
people can buy with the money they have. This includes homes, cars, trips and the
like. Standard of living is different from quality of life – which refers to the general
well-being of a society in terms of political freedom, education, health care, safety
and anything else that leads to satisfaction and joy.
Productivity is measured by dividing the total output of goods and services of a given
period by the total hours of labour required to produce them. An increase in
productivity means that a worker can produce more goods and services in the same
period of time than before, usually through the use of machinery or other equipment.
Labour cost measures the same equation in dollars. The dollar value of outputs is
divided by the dollar value of the work hours to arrive at the labour cost per unit.
Anything that increases productivity or reduces labour costs make a business, and a
country, more competitive because prices can be lower. Productivity has gone up in
recent years because computers and other technology have made the process of
production faster and easier for many workers. The higher productivity is, the lower
costs are in producing products and the lower prices can be. Therefore, business
people are eager to increase productivity.