Chapter 2

How Economic Issues Affect Business

Economic Links to Business

o Economic concepts are the basis for most major business decisions.

o Both the global economy and the Canadian economy have an effect on Canadian business.

o Economics is “the study of how society chooses to employ resources to produce its goods and services and distribute them for consumption among various competing groups and individuals”.

Economic Theory of Wealth Creation: Adam Smith

The Wealth of Nations in 1776 defined Capitalism as a system of rights and freedoms:– Right to Make a Profit– Right to Private Property– Right to Buy or Sell– Freedom to Compete– Freedom from Government Interference

Three Economic Systems

CommunismCommunism

SocialismSocialism

CapitalismCapitalism

(Highly Controlled (Highly Controlled by Governmentby Government))

(Little Control by Government)

MixedMixed

Economic Systems Capitalism - individuals seeking profits

produce goods and services.

– Goods and services are sold in a free market to those who can pay for them.

Communism - the government decides what will be produced and who will consume that production.

Socialism - some free market and some government allocation.

Most countries have a Mixed Economy

The Foundations of Capitalism

How a free market works - many buyers and sellers trading freely determine prices at which they will exchange goods and services

How prices are determined - the constant interplay between supply and demand determines an equilibrium price at which a transaction will occur

Benefits and Limitations of Free-Markets

Inequality of wealth - causes national and world tension.

Greed may compromise ethics. There is a potential for

environmental damage. Limitations push country towards

Socialism = government regulation.

Free-Market Competition

Monopolistic Monopolistic

CompetitionCompetition

OligopolyOligopoly

OneOne

SellersSellers

ManyMany

MonopolyMonopoly Perfect CompetitionPerfect Competition

COMMUNISM

All citizens are supposed to be equal Government controls all business practices

and decides how money is distributed Karl Marx was the father of communism. He

wrote the famous book “The Communist Manifesto”

Supply Curve

Quantity(S)Quantity(S)

HighHigh

HighHighLowLow

Price(P)Price(P)

SS

Demand Curve

Price(P)Price(P)

Quantity(D)Quantity(D)

HighHigh

HighHighLowLow

DD

QuantityQuantity

HighHigh

HighHighLowLow

PricePrice

Equilibrium Point

Market EquilibriumMarket Equilibrium

SS DD

SurplusSurplus

ShortageShortage

Progress Assessment

How do business people know what to produce and in what quantity?

How are prices determined? Describe the four degrees of competition.

What are some of the limitations of free markets?

What are some limitations of free markets?

Recent Economic Trends

Canada - we have a mixed economy, as the government has always played a major role in the economy

Communist countries - they have moved to capitalist forms of economies to improve their standards of living

Socialist countries - they have reduced government’s role in their economies

Canadian Economy

Key Economic Indicators:1. The gross domestic product (GDP) and

the importance of productivity2. The unemployment rate: frictional,

structural cyclical and seasonal3. The price indexes: inflation, disinflation,

deflation, consumer price index (CPI), industrial product price index (IPPI), and raw materials price index (RMPI)

Economics and Business

Strong Economy - Business prospers

Weak Economy - Business declines

Gross Domestic Product (GDP) - this is the total of goods and services produced by the economy. This is how we measure how well the economy is doing!

Distribution of GDP

Employees get their share of GDP via wages

Employers get their share of GDP via profits

Governments get their share of GDP via taxes

What is a fair “share of the pie” is a source for constant debate - it depends on one’s perspective

Inflation & the Components of the CPIConsumer Price Index (CPI) is the index economists use to measure the effects of inflation

Food 18.5%

Housing 38.0%

Clothing 5.0%

Transportation 21.5%

Medical Care 6.5%

Entertainment 5.0%Other Goods and Personal Services 5.5%

Government Intervention

In 1929 the stock market crashed The crash led to a severe, prolonged

Depression The hardship forced governments to

abandon Adam Smith’s “laissez faire” approach to economics

Governments looked for ways to intervene in the economy to alleviate the suffering

The National DebtThe National Debt

Governments adopted Keynesian economics and deficit spending

Governments forgot the second part of Keynesian economics -- they did not pay down the debt in good times

By the 1990s many governments had accumulated large national debts

Canada is currently $600 billion in debt (pop. 37 million = citizen share of debt

is approx. $16 000) The US is currently $9.6 trillion in debt

(pop. 300 million = citizen share of debt is between $31 000-$32 000)

France

Germany

Italy

Canada

Britain

Japan

U.S.

Who Pays the Least Taxes?

0 25 30 35 40 45 50

Total Receipts Alllevels of government

Business Cycles

oRecession

oDepression

oRecovery

oBoom