Chapter Two: Understanding How Economic Effects Business

LEARNING GOAL 1 *

Explain basic economics.

HOW ECONOMIC CONDITIONS AFFECT BUSINESSES

Compared to, say, Mexico, the United States is a relatively wealthy

country.
Why? Why is South Korea comparatively wealthy and North Korea
suffering economically, with many of its people starving?

What Is Economics?

Economics is the study of how society chooses to employ resources to

produce goods and services and distribute them for consumption among
various competing groups and individuals. There are two major branches
of economics: macroeconomics looks at the operation of a nation's
economy as a whole.

• The two branches of economics

There are two major branches of economics: macroeconomics studies the

operation of a nation's economy as a whole, and microeconomics studies
the behaviour of people and organizations in particular markets (e.g., why
people buy smaller cars when gas prices go up).

• The assured of having enough resources

Resource development is the study of how to increase resources and

create the conditions that will make better use of them.

• The capitalism that create a climate for economic growth

Under capitalism, businesspeople don't often deliberately set out to help

others; they work mostly for their prosperity and growth. Yet people's
efforts to improve their situation in life act like an invisible hand to help
the economy grow and prosper through the production of needed goods,
services, and ideas.

LEARNING GOAL 2

Explain what capitalism is and how free markets work

UNDERSTANDING FREE-MARKET CAPITALISM

Basing their ideas on free-market principles such as those of Adam Smith,

Businesspeople in the United States, Europe, Japan, Canada, and other countries-
Tries began to create more wealth than ever before. They hired others to work
On their farms and in their factories, and their nations began to prosper as a
Result. Businesspeople soon became the wealthiest people in society.

Adam Smith and the Creation of Wealth

Rather than believing fixed resources had to be divided among competing

Groups and individuals, Scottish economist Adam Smith envisioned creating more resources
so that everyone could become wealthier.

How Businesses Benefit the Community

In Adam Smith’s view, businesspeople don’t necessarily deliberately set out to

Help others. They work primarily for their prosperity and growth.

Resource development is the study of how to increase resources (say by getting-

Ting oil from shale and tar sands) and create conditions that will make better
Of them (like recycling and conservation).

Businesses can contribute to an economic system by inventing products

That greatly increase available resources. For example, they can discover new
Energy sources (hydrogen fuel for autos), new ways of growing food (hydroponic-
Ices), and new ways of creating needed goods and services (nanotechnology).
Mari culture, or raising fish in pens out in the ocean, could lead to more food for
Everyone and more employment. The Thinking Green bois x on. 32 explores
Some new ventures that have been created to help lessen climate change.

The Secret to Creating a Wealthy Economy

Imagine a world where kings and other rich landowners had most of the
Wealth, and the majority of the people were peasants. The peasants had many
Children, and it may have seemed a natural conclusion that if things went on
As usual there would soon be too many people and not enough food and other
Resources. Economist Thomas Malthus made this argument in the late 1700s.
The Foundations of Capitalism

Under free-market capitalism, people have four basic rights:

1. The right to own private property. This is the most fundamental of all
Rights under capitalism. Private ownership means that individuals can
Buy, sell, and use land, buildings, machinery, inventions, and other
Forms of property. They can also pass the property on to their children.
Would farmers work as hard if they didn’t own the land and couldn’t
Keep the profits from what they earned?

2. The right to own a business and keep all that business’s profits. Recall
From Chapter 1 that profits equal revenues minus expenses (salaries,
Materials, taxes). Profits act as important incentives for
Business owners.

3. The right type of competition. Within certain

Guidelines established by the government, individuals
Are free to compete with other individuals or businesses
In selling and promoting goods and services.

4. The right to freedom of choice. People are free to choose

Where they want to work and what career they want to
Follow. Other choices people are free to make include
Where to live and what to buy or sell.

Competition within Free Markets

Economists generally agree there are four different degrees of competition:

(1) perfect competition, (2) monopolistic competition, (3) oligopoly, and
(4) monopoly.

Perfect competition exists when there are many sellers in a market and
None is large enough to dictate the price of a product.

Under monopolistic competition, a large number of sellers produce very

Similar products that buyers nevertheless perceive as different, such as hot
Dogs, sodas, personal computers, and T-shirts.

An oligopoly is a degree of competition in which just a few sellers dome-

Nate a market, as we see in tobacco, gasoline, automobiles, aluminium, and
Aircraft.

In an oligopoly, products from different companies tend to be priced about

The same. The reason is simple: Intense price competition would lower profits
For everyone since a price cut by one producer would most likely be matched
By the others.
A monopoly occurs when. One seller controls the total supply of a product
Or service, and sets the price. In the United States, laws prohibit the creation of
Monopolies.

The Economic Concept of Supply

Supply refers to the quantities of products manufacturers or owners are will-

Ingo to sell at different prices at a specific time. Generally speaking, the amount
Supplied will increase as the price increases, because sellers can make more
Money with a higher price.

The Economic Concept of Demand

Demand refers to the quantity of Products that People are willing to buy at different
pricesbusinesspeopletime.

Explain what capitalism is and how free markets work.

• What is capitalism?

Capitalism is an economic system in which all or most of the means of

Production and distribution are privately owned and operated for profit.

Decision to produce under capitalism

In capitalist countries, businesspeople decide what to produce, how much

To pay workers, and how much to charge for goods and services. They also
Decide whether to produce certain goods in their own countries, import
Those goods, or have them made in other countries.

• T he basic rights people have under capitalism

The four basic rights under capitalism are (1) the right to private property,
(2) the right to own a business and to keep all of that business’s profits after
Taxes, (3) the right to freedom of competition, and (4) the right to freedom
Of choice. President Franklin D. Roosevelt felt that other economic free—
Doms were also important: the right to freedom of speech and expression,
The right to worship in your way, and freedom from want and fear.
• How does the free market work?

The free market is one in which buyers and sellers negotiating prices for
Goods and services influence the decisions about what gets produced and
In what quantities. Buyers’ decisions in the marketplace tell sellers what
To produce and in what quantity. When buyers demand more goods, the
Price goes up, signalling suppliers to produce more. The higher the price,
The more goods and services suppliers are willing to produce. Price is the
Mechanism that allows free markets to work.
LEARNING goal 3 *

UNDERSTANDING SOCIALISM

Socialism is an economic system based on the premise that some, if not most,
basic businesses (e.g, steel mills, coal mines, and utilities) should be owned
by the government so that profits can be more evenly distributed among the
people.

Compare socialism and communism.

• Socialism

Socialism is an economic system based on the premise that some busi-

nesses should be owned by the government.

• The advantages and disadvantages of socialism

Socialism intends to create more social equity. Workers in socialist coun-
tries usually receive more education, health care, and other benefits and

also work fewer hours, with longer vacations. The major disadvantage of
socialism is that it lowers the incentive to start a business or to work hard.
Socialist economies tend to have a higher unemployment rate and a slower
growth rate than capitalist economies.

• socialism differences from communism

Under conmunism, the government owns almost all major production

facilities and dictates what gets produced and by whom. Communism is
also moe restrictive when it comes to personal freedoms, such as reli-
gious freedom.
LEARNING goal 4

THE TREND TOWARD MIXED ECONOMIES

1. Free-market economies exist when the market largely determines

what goods and services get produced, who gets them, and how the
economy grows. Capitalism is the popular term for this economic
system.

2. Command economies exist when the government largely

decides what goods and services will be produced, who
gets them,systemw the economy will grow. Socialism and
communism are variations on this economic systemn.

The Benefits of Socialism

The major benefit of socialism is supposed to be social equality. Ideally it

comes about because the government take the system from wealthier people, in
the form of taxes, and redistributes it to poorer people through various gov-
ernment programs.

The Negative Consequences of Socialism

Socialism may create more equality than capitalism, but it takes away some per people’s
government-government example, tax rates in some nations once
reached 83 and per cent.!7 Today, doctors, lawyers, business owners, and others
who earn a lot of money pay very high tax rates.
UNDERSTANDING COMMUNISM

Communism is an economic and political system in which the government

makes almost all economic decisions and owns almost all the major factors of
production. It intrudes further into the lives of people than socialism does. For
example, some communist countries have not allowed their citizens to practice-
tice certain religions.
Analyze the trend toward mixed economies.
• What is a mixed economy?
A mixed economy is part capitalist and part socialist. Some businesses
are privately owned, but taxes tend to be high to distribute income more
evenly among the population.
• Countries that have mixed economies
The United States has a mixed economy, as do most other developed
countries.
• benefits of mixed economies
A mixed economy has most of the benefits of wealth creation that free
markets bring plus the benefits of greater social equality and concern for
the environment that socialism promises.

LEARNING goal 5

UNDERSTANDING THE U.S. ECONOMIC SYSTEM

Key Economic Indicators

Three major indicators of economic conditions are (1) the gross domestics
product (GDP), (2) the unemployment rate, and (3) price indexes. Another
important statistic is the increase or decrease in productivity.
Gross Domestic Product Gross domestic product (GDP) is the total value of final goods and
services pro-
deuced in a country in a given year.
The Unemployment Rate The unemployment rate refers to the percentage
of civilians at least 16 years old who are unemployed and tried to find a job
within the prior four weeks.
A recession brings high unemployment, increased
business failures.
A depression is a severe recession, usually accompanied by deflation.
Business cycles racy go through a depression phase.
A recovery occurs when the cconomy stabilizes and starts to grow.

Describe the economic system of the United States, including

the significance of key economic indicators (especially GDP), productivity,
and the business cycle.
• What are the key economic indicators in the United States?

Gross domestic product (GDP) is the total value of final goods and services
produced in a country in a given year. The unemployment rate refers to the
percentage of civilians at least 16 years old who are unemployed and tried
to find a job within the most recent four weeks. The consumer price index
(CPI) measures changes in the prices of about 400 goods and services that
consumers buy.

the four phases of business cycles

In an economic boom, businesses do well. A recession occurs when two or
more quarters show declines in the GDP, prices fall, people purchase fewer
products, and businesses fail. A depression is a severe recession. Recovery
occurs when the economy stabilizes and starts to grow.

LEARNING goal 6
Contrast fiscal policy and monetary policy, and explain how each affects
the economy.
Fiscal policy refers to the federal government's efforts to keep the economy
stable by increasing or decreasing taxes or government spending.
Productivity in the United States
An increase in productivity means a worker can produce more
goods and services than before in the same time period, us-
ally thanks to machinery or other equipment. Productivity in the
United States has risen because computers and other technol.
fogy have made production faster and easier: The higher produced-
tidily, the lower the costs of producing goods and services, and
the lower prices can be. Therefore, businesspeople are eager to
increase productivity. Remember, however, that high productiv.
its can lead to high unemployment.

Productivity in the Service Sector

One problem with the service industry is that an influx of machinery may
add to the quality of the service provided but not to the output per worker. For
example, you've probably noticed how many computers there are on college
campuses. They add to the quality of education but don’t necessarily boost
professors' productivity. The same is true of some equipment in hospitals, such
as CAT scanners, PET scanners, and MRI scanners. They improve patient care
but don't necessarily increase the number of patients doctors can see. In other
words, today's productivity measures in the service industry fail to capture the
increase in quality caused by new technology.
The Business Cycle
Business cycles are the periodic rises and falls that occur in economies over
time. Economists look at several business cycles, from seasonal cycles
that occur within a year to cycles that occur every 48-60 years.
Economist Joseph Schumpeter identified the four phases of long-term
business cycles as boom-recession-depression-recovery.

Critical Thinking Answers

1. I understand the importance of competition in both private and public sectors. It plays
a crucial role in driving efficiency, fostering innovation, and ultimately leading to
 better outcomes. While private companies strive for market dominance and profits,
public organizations compete for funding and public support. It's important to
recognize the differences in goals and constraints between the two sectors. Finding the
right balance is key to effectively leveraging competition in both areas, ensuring that
it contributes positively to the overall welfare of stakeholders.
2. There are several public functions that could potentially benefit from increased
competition, including competition from private firms in some cases. Healthcare is
one such area, where introducing more competition between public and private
providers, as well as between different private insurance plans, could spur innovation,
improve service quality, and provide more consumer choice. Similarly, in the field of
education, while primary/secondary education is often publicly provided, there may
be opportunities to introduce competition through charter schools, voucher programs,
or public-private partnerships, incentivizing public schools to improve and giving
families more schooling options. Additionally, there may be scope for private firms to
compete for contracts in the infrastructure sector, traditionally dominated by public
monopolies, such as roads, bridges, and utilities. Social services, including welfare
and job training programs, are often government-run, but contracting some of these
services out to private and non-profit providers could foster competition and
potentially lead to better outcomes. Moreover, in public transit, private companies
could potentially compete to provide bus, rail, or ride-sharing services, improving
efficiency and responsiveness. It’s crucial to find the right balance and scope for
competition based on the specific public service, whether it’s a fully competitive
market, a hybrid public-private model, or regulated competition. The goal should be
to harness the benefits of competition while ensuring universal access, equity, and the
provision of public goods. Careful analysis, experimentation, and stakeholder
engagement would be required to determine where increased competition could be
most beneficial for public services. Nonetheless, the potential rewards in terms of
innovation, efficiency, and responsiveness to citizen needs make it a worthwhile area
to explore further.
A. The issue at hand is complex, with valid arguments on both sides. To find a middle
ground, it is suggested to recognize the contributions of both the private and nonprofit
sectors. Businesses provide employment, generate wealth, and fund social initiatives,
while nonprofit organizations play a crucial role in addressing neglected issues.
Emphasizing complementarity and collaboration is essential, as both sectors can
 partner to achieve greater societal impact. Encouraging social entrepreneurship and
hybrid models, as well as facilitating cross-sector dialogue and partnerships, can
further this collaboration. Additionally, government support is crucial in creating an
enabling environment for effective cross-sector collaboration and social impact
initiatives. Ultimately, by acknowledging the unique contributions of both sectors and
promoting complementarity and collaboration, a more integrated and synergistic
approach to addressing societal challenges can be achieved.
B. The ideas of Adam Smith can be applied to show how businesses and nonprofits can
work together to achieve greater social impact. Smith's concepts, such as the
"invisible hand" and the division of labor, can help illustrate the complementary roles
of these sectors. This, combined with appropriate government support, can lead to a
more effective approach to improving people's lives.