CHAPTER 2

Understandi
ng
Economics
and
How it
Affects
Business

McGraw-Hill/Irwin Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
 ECONOMICS…What Is It?

Economics -- The study of how society

employs resources to produce goods and
services for consumption among various
groups and individuals.

2-4
 The MAJOR BRANCHES of
ECONOMICS

• 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.

2-5
 RESOURCE DEVELOPMENT

• Resource
Development -- The
study of how to
increase resources
and create
conditions that will
make better use of
them.

2-6
Economic Theories

2-7
 Economic Theories

Thomas Malthus
• “Dismal Science”
• Too many people

2-8
 THOMAS MALTHUS and
the DISMAL SCIENCE

• 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.
2-9
 Economic Theories
Adam Smith (1776)
• Advocated creating
• wealth through
• entrepreneurship
• Freedom is vital
• “Invisible Hand”

2-10
 ADAM SMITH the
FATHER of ECONOMICS

Smith believed that:

• Freedom was vital to
any economy’s
survival.
• Freedom to own land
or property and the
right to keep the
profits of a business
is essential.
• People will work hard
if they believe they 2-11
will be rewarded.
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.

2-12
 UNDERSTANDING the LO 2-1

INVISIBLE HAND THEORY

• 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. 2-13
 TEST PREP

• What is the difference between

macroeconomics and microeconomics?

• What is better for an economy than

teaching a man to fish?

• What does Adam Smith’s term invisible

hand mean? How does the invisible hand
create wealth for a country?

2-15
 Three Economic
Systems

2-16
 Three Economic Systems

Socialism

(Highly Controlled) (Little Control)

Communism Capitalism

2-17
 Capitalism

2-18
 CAPITALISM

• 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
2-19
 STATE CAPITALISM

• State Capitalism -- When the state, rather

than private owners, run some businesses.

• Well-known countries practicing state

capitalism:
- China
- Russia

• These countries have experienced some

success using capitalistic principles, but
the future is still uncertain.
2-20
 CAPITALISM’S
FOUR BASIC RIGHTS

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.
2-21
 FREE MARKETS

• 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 2-22
 Supply and Demand

2-23
 Supply Curve
Supply -- The quantities of products
businesses are willing to sell at different
prices.
High

Price(P)

Low Quantity(S) High

2-24
 Demand Curve
• Demand -- The quantities of products
consumers are willing to buy at different
prices.
High

Price(P)

D
Low Quantity(D) High
2-25
 Equilibrium Point
• Market Price (Equilibrium Point) --
Determined by supply and demand, this is
the negotiated price.
Surplus
High

Market Equilibrium
Price

S Shortage D
Low Quantity High
2-26
 Competition

2-31
Free-Market Competition
Monopolistic
Oligopoly Competition

One Many

Monopoly Perfect
Competition

Sellers

2-32
Free-Market Capitalism
Although Capitalism…
• Allows for open
competition among
companies,
• Provides opportunities for
poor people to work their
way out of poverty,

It has limitations…
2-37
 FREE MARKET BENEFITS
and LIMITATIONS

Benefits:
• It allows for open
competition among
companies.
• Provides opportunities
for poor people to
work their way out of
poverty.

Limitations:
• People may start to
let greed drive them. 2-38
 TEST PREP

• What are the four basic rights that

people have under free-market
capitalism?

• How do businesspeople know what to

produce and in what quantity?

• How are prices determined?

• What are the four degrees of

competition and what are some 2-41
 Socialism

2-42
 LO 2-3
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.

• Entrepreneurs run smaller businesses.

• Government is more involved in
protecting the environment and the
poor.
2-43
 LO 2-3
BENEFITS of SOCIALISM

• Social equality
• Free education
• Free healthcare
• Free childcare
• Longer vacations
• Shorter work weeks
• Generous sick leave

2-44
 LO 2-3
NEGATIVES of SOCIALISM

• Few incentives for businesspeople to

take risks.

• 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.
2-45
 Communism

2-47
 LO 2-3
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. 2-48
 TWO MAJOR LO 2-4

ECONOMIC SYSTEMS

• Free-Market Economies -- The market

largely determines what goods and
services are produced, who gets them,
and how the economy grows.

• Command Economies -- The government

largely determines what goods and
services are produced, who gets them,
and how the economy will grow.

2-49
 LO 2-4
MIXED ECONOMIES

• 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.

2-50
 TRENDING TOWARD MIXED
ECONOMIES
Mixed
Socialism

(Highly Controlled) (Little Control)

Communism Capitalism

2-51
 TRENDING TOWARD MIXED LO 2-4

ECONOMIES

• 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. 2-52
1.3. The business environment
1.3. External forces that influence business activities
 Vietnam overview

Vietnam’s development over the past 30 years

has been remarkable.
Vietnam is experiencing rapid demographic and
social change
Over the last thirty years, the provision of basic
services has significantly improved

Vietnam’s economic outlook is positive, despite signs

of cyclical moderation in growth
In Vietnam, rapid growth and industrialization have not
been friendly to the environment and natural assets.
 Global overview 2020

Economic shock: global GDP went down by

3.5%, developed countries by 4.9%, developing
and emerging by 2.4%
International investment reduced tremendously.
Global Fix asset investment down by 13%, FDI
by 29.8% (UN, UNCTAD reports 2021)
Global trade went down by 9.5% due to cut
down of manufacturing and borders closed
Bright side in 2020: AfCFTA, RCEP (Regional
Comprehensive Economic Partnership)
Oil price reluctant to bounce back even in medium
term. Metal price had steep downturn and still there.
Food price increase by 4%.
 TEST PREP

• What led to the emergence of socialism?

• What are the benefits and drawbacks of

socialism?

• What countries still practice

communism?

• What are the characteristics of a mixed

economy? 2-58
 Economy
I. Key Economic Indicators
– Gross Domestic Product
– Unemployment Rate
– Price Indexes
II. Business Cycles
– Economic Boom
– Recession
– Depression
– Recovery
III.Stabilization
– Fiscal Policy
– Monetary Policy
– National Debt

2-61
I. Key Economic Indicators
• Gross Domestic Product (GDP)

• Unemployment Rate

• Price Indexes
• Consumer Price Index(CPI)
• Producer Price Index(PPI)

2-62
 LO 2-5
GROSS DOMESTIC PRODUCT

• Gross Domestic Product (GDP) -- Total

value of final goods and services produced
in a country in a given year. As long as a
company is within a country’s border, their
numbers go into the country’s GDP (even if
they are foreign-owned).

• When the GDP changes, businesses feel

the effect.
• Gross Output (GO) -- A measure of total
sales volume at all stages of production. 2-63
 LO 2-5
INFLATION

• Inflation -- The general rise in the prices of

goods and services over time.

• Disinflation -- When the price increases

are slowing (inflation rate declining).

• Deflation -- Prices are declining because

too few dollars are chasing too many
goods.

• Stagflation -- Economy is slowing, but

prices are going up.
2-66
 LO 2-5
UNEMPLOYMENT

• 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. Frictional
2. Structural
3. Cyclical
4. Seasonal
2-67
Key Economic Indicators, cont.
• Price Indexes

Help measure health of the economy

2-70
 LO 2-5
CONSUMER PRICE INDEX

• Consumer Price Index (CPI) -- Monthly

statistics that measure the pace of
inflation or deflation.

• The government computes the costs of

goods and services (housing, food,
apparel, medical care, etc.) to see if
they are going up or down.

• The wages, rent/leases, tax brackets,

government benefits and interest rates
of some citizens are based upon the
2-71
 What Makes Up The
Consumer Price Index?
Recreation Apparel Other
6% 5% 5%

Medical Care/
Insurance
7%
Housing & Util.
Medical Care
39%
6%

Food &
Beverage
16%
Transportation
SOURCE: U.S. Bureau of Labor Statistics 18%
2-72
 LO 2-5
PRODUCER PRICE INDEX

• Producer Price Index (PPI) -- An index

that measures prices at the wholesale
level.

2-74
 LO 2-5
PRODUCTIVITY

• 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.
2-75
 PRODUCTIVITY in the LO 2-5

SERVICE SECTOR

• 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.
2-76
 U.S. Economy
• Key Economic Indicators
– Gross Domestic Product
– Unemployment Rate
– Price Indexes
• Business Cycles
– Economic Boom
– Recession
– Depression
– Recovery
• Stabilization
– Fiscal Policy
– Monetary Policy
– National Debt

2-77
 LO 2-5
BUSINESS CYCLES

• 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 leads2-78
 U.S. Economy
• Key Economic Indicators
– Gross Domestic Product
– Unemployment Rate
– Price Indexes
• Business Cycles
– Economic Boom
– Recession
– Depression
– Recovery
• Stabilization
– Monetary Policy
– Fiscal Policy
– National Debt

2-79
 Stabilization
• Monetary Policy
• Federal Reserve (Fed)
• Interest Rates
• Money Supply

2-80
 LO 2-6
MONETARY POLICY

• 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.
- 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.
2-81
 Stabilization, cont.
• Fiscal Policy
• Executive & Legislative
• Taxes
• Spending
• National deficit
• National debt

2-82
 LO 2-6
FISCAL POLICY

• 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
2-83
 NATIONAL DEFICITS, DEBT LO 2-6

and SURPLUS

• National Deficit -- The amount of money

the federal government spends beyond
what it gathers in taxes.

• National Debt -- The sum of government

deficits over time.

• National Surplus -- When government

takes in more than it spends.

2-84
 TEST PREP

• Name the three economic indicators and

describe how well the U.S. is doing
based on each indicator.

• What is the difference between a

recession and a depression?

• How does the government manage the

economy using fiscal policy?

• What does the term monetary policy

mean? What organization is responsible
for monetary policy? 2-85