*

*Chapter Two

Understanding How Economics Affects Business

Economics: Use of scarce resources to produce

goods/services, distribute them among competing groups/individuals

• Land

• Labor

• Capital

• Entrepreneurship

• Knowledge

• Economics -- The study of how society employs resources to produce goods and services for consumption among various groups and individuals.

• Macroeconomics -- Concentrates on the operation of a nation’s economy as a whole.

For example: Why Interest rate changes? Why unemployment goes up?

• Microeconomics -- Concentrates on the behavior of people and organizations in markets for particular products or services.• For Example: Why people choose to use Gas (CNG conversion)

rather than oil.

• Why people more buy more of a product at reduced price?

The MAJOR BRANCHES of ECONOMICS

*

• Economics is the study of the allocation of scarce resources which emphasizes on Resource Development.

• Businesses can contribute to an economic system by

inventing products that greatly increase the available resources.

• For example: By discovering new energy sources (hydrogen fuel for autos), new ways of growing foods (hydroponics, organics), new ways producing goods and services (nanotechnology).

What is ECONOMICS?

DIFFERENCE BETWEEN MICRO AND MACRO ECONOMICS :          MICRO ECONOMICS:-1.Evolution of micro economics took place earlier than macro economics.2.It is branch of economics, which studies individual economic variables like demand, supply, price etc.3.It has a very narrow scope i.e. an individual, a market etc.4.Demand,supply,market forms etc. related to micro economics.5.It is helpful in analysis of an individual economics unit like firm.6.Theory of demand, theory of production, price determination theory etc develop from micro economics.

MACRO ECONOMICS:-1.It evolved only after the publication of Keynes‘ book, General theory of employment interest and money.2.It is a branch of economics which studies aggregate economic variables, like aggregate demand, aggregate supply, price level etc.3.It has a very wide scope i.e. a country.4.Aggregate demand aggregate supply, national income etc. related to macro economics.5.It is helpful for analyzing the level of employment, income, economic growth etc.6.Theory of national income, theory of employment theory of money, theory of general price level etc. develop from macro economics.

Economic Theory

• Thomas Malthus (Early 1800s)– “Dismal Science”– Too many people

• Adam Smith (1776)– Freedom is vital– “Invisible Hand”

• 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.

• Nations like Japan, Germany, Italy, Russia, Canada, and USA suffer from low population growth (Story of Canada…..having children is a gift!) with more old people less of young generation (Story of USA….Olds are being a major burden for the nation but it makes joke by offering senior citizens status).

THOMAS MALTHUS and the DISMAL SCIENCE

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*Adam Smith & the Creation of Wealth

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 will be rewarded.

He is considered as the father of modern economics!

ADAM SMITH the FATHER of ECONOMICS

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Four “What’s” of an Economic System

$ What (how it) is produced

$ What amount is produced

$ What method of output distribution

$ What rate of economic growth

Adapted from:Adapted from: Edwin Mansfield Economics (New York: W.W. Norton, 1976), p.8

Three Economic Systems

CommunismCommunism

SocialismSocialism

CapitalismCapitalism

(Highly Controlled(Highly Controlled)) (Little Control(Little Control))

MixedMixed

*

*Understanding Free-Market 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

CAPITALISM/ Market economy

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Capitalism

• Private PropertyIndividuals can buy, sell and properties.

• Profit/OwnershipProfit acts as incentive for taking risk and initiative.

• Freedom of CompetitionPossesses right to compete each other.

• Freedom of ChoiceFree to choose what to do and what not.

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 EQUILIBRIUM POINTPOINT

Market EquilibriumMarket Equilibrium

SS DD

SurplusSurplus

ShortageShortage

Degrees of Competition

SellersSellers

OneOne ManyMany

MonopolyMonopoly

OligopolyOligopoly

Monopolistic Monopolistic

CompetitionCompetition

Pure CompetitionPure Competition

Monopoly = One Seller• Diamonds

– South-Africa

• Utilities– WASA– DESA

Oligopoly = Few Sellers• Tobacco

– Gold-Leaf -Banson– Pall Mall -Sheikh– More -Garam -Pine

• Automobiles– Toyota -Ford– Porshe -Nissan

Monopolistic Competition =Many Sellers With Perceived Differences

• Fast Food– McDonald’s -KFC– Pizza Hut -Subway

• University/College– Harvard– Stanford– Orford

Pure Competition

BuyerBuyer

SellersSellers

Limitations of Free-Market

• Inequality of Wealth- Causes National & World Tension

• Potential Environmental Damage

• Limitations Push Country towards Socialism = Government Regulation

• 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

• Citizens are highly taxed almost 60% usually.

• Government is more involved in protecting the environment and the poor

SOCIALISM

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Brain-drain: The loss of best and brightest people to other countries

Socialism

• Private & Public Ownership• Some Choices are Limited• Creates Social Equality• Reduces Individual Incentive

• 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.

• Some countries even don’t allow its citizens to practice different religions, change jobs, or move to a different town they prefer.

• Example: North Korea, Cuba, Venezuela practice Socialism. China also practices Communism but it is rapidly being open.

COMMUNISM

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Communism• Public Ownership

– Productive Capacity– Capital

• Central Planning/Controlled Economy

• Managers = Mandatory Party Membership

Comparison of the main economic systems

• 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.

• Bangladesh is a vibrant example of Mixed Economy!

MIXED ECONOMIES

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Mixed Economies

• Free-Market Economy = Capitalism• Command Economy

– Socialism– Communism

• Trend Results in Blend– Capitalism > Socialism– Socialism > Capitalism

Understanding Economic System

Key Economic Indicators Gross Domestic Product (GDP)

Unemployment Rate

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

• 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).

• Gross national product (GNP) is the total income earned by a country’s factors of production in a year or a given time period, regardless of where assets are located (nations' output).

• Net national product (NNP) is the total market value of all final goods and services produced by residents in a country during a given time period.

GDP, GNP and NNP

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What Makes Up the Consumer Price Index

Transportation18%

Other5%

Medical Care6%

Food & Beverage

16%

Housing & Util.39%

Recreation6%

Medical Care/ Insurance

7%

Apparel5%

SOURCE:SOURCE: U.S. Bureau of Labor Statistics

Inflation: A general rise in the prices of goods and services over time.

Disinflation: A situation in which price increases are slowing (the inflation rate is decreasing).

Deflation: A situation in which prices are declining.

Stagflation: A situation when the economy is slowing but prices are going up anyhow.

Consumer price Index (CPI): Monthly statistics that measure the pace of inflation or deflation.

Economic Scenarios

*

*The Business Cycle

• 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 leads to an Economic Boom.

BUSINESS CYCLES

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Government Economic Tools• Monetary Policy- (management of money supply)

– Expansionary Monetary Policy– Contractionery Monetary Policy

• Fiscal Policy- management of taxes and government

expenditures

• National Debt- Refers total debt/loan owed by a nation

– Internal Debt -External Debt

Government’s Role in Economics

• Enforces Rules/Regulations• Provides Public Goods• Transfers Payments• Fosters Competition• Contributes to Economic Stability

*

*Stabilizing the Economy Through 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

FISCAL POLICY

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Industrialized Nations Tax Rate

0% 10% 20% 30% 40% 50% 60% 70%

Denmark

Finland

France

Spain/Sweden

Germany

Canada

Italy

Austria/Japan

U.S.

Source: Parade Magazine, Apr. 12, 1998.

*

*Using Monetary Policy to Keep the Economy Growing

• 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.

MONETARY POLICY

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