bmgt110f understanding business 10th ed

7/23/2019 BMGT110F Understanding Business 10th Ed

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2L E A R N I N G

goals 1 Explain basic economics.

2 Explain what capitalism is andhow free markets work.

3

Compare socialism and

communism.

4 Analyze the trend toward mixedeconomies.

5 Describe the econof the United Statthe significance of

economic indicato

(especially GDP), p

and the business c

6 Contrast fiscal polmonetary policy, ahow each affects t

A f t e r y o u h a v e r e a d a n d s t u d i e d t h i s c h a p t e r , y o u s h o u l d b

UnderstandingECONOMICS and How ItAFFECTS Business

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economists/

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p

If you listened to much of the recent debates about thestate of the nations economy and what to do about it,

youve probably heard people mention Keynes or Keynesian

economics and wondered what they were talking about. JohnMaynard Keynes (pronounced Canes) was one of the econo-mists who had a great influence on U.S. economic policy. Itwas Keynes who advocated stabilizing the economy by theuse of fiscal policy (policy related to taxes and spending). Hebelieved that if the economy was in a recession, the govern-ment should increase spending (e.g., on infrastructureroads, bridges, schools, and utilities) and cut taxes in order tostimulate the economy. The goal of cutting taxes would be to

increase consumer spending to revive businesses. Conversely,when the economy seems to be growing too fast and inflationresults, Keynesian theory suggests cutting back on govern-ment spending and increasing taxes. Such govern-ment intervention is supposed tobe a short-term solution to wideswings in the business cycle.Once the economy was stabi-lized, Keynes believed, free

economic principles could berestored.Keynes published his most

famous book, The General Theory ofEmployment, Interest and Money,in 1936.Until that time U.S. economic thinking was dominated

by Adam Smiths classic economics.Smith believed that the economywould automatically function at full

employment if there was minimalgovernment intervention. Thedepression of the 1930s changedthat view, and Keynesian eco-nomics took over.

While Keynesian economicshas been in and out of favor sincethe 1930s, it was Keynesian theory

that Presidents Bush and Obamahad in mind when theyattempted to stimulatethe economy by spend-ing money. While thereare signs that the econ-omy is now on the roadto recovery, the $787 bil-lion stimulus package

did not lead to the jobgrowth expected, and unemployment sThe economic environment is cri

business. That is what thiYou will learn to

nomic systeand the

You wmarke

Stateslearn msome co

countries pochapter, you sh

direct effect economic systemand happiness of communities through

Sources: Paul Johnson, There Is No Keynesian2010; Daniel Fisher, Keynes Who? Forbes,AuThe Keynes Solution, Bloomberg Businesswe7, 2010; and Peter Coy, Keynes vs. Alesina; AleBusinessweeek,July 5July 11, 2010.

Getting to Know

John Maynard KeynesEconomist

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This organization lends small amounts of money to people in poor

For example, it loaned a woman in Uganda enough to buy a refrige

was able to sell fresh food from the refrigerator and make enough

her family to succeed. Name this organization. (The answer is in th

LEARNING goal 1EARNING oa

Explain basic economics.

HOW ECONOMIC CONDITIONSAFFECT BUSINESSES

Compared to, say, Mexico, the United States is a relatively wealWhy? Why is South Korea comparatively wealthy and North Koreconomically, with many of its people starving?1Such questionsthe subject of economics. In this chapter, we explore the variou

systems of the world and how they either promote or hinder busithe creation of wealth, and a higher quality of life for all.A major part of the United States business success in the pas

an economic and social climate that allowed most businesses to opPeople were free to start a business anywhere, and just as free to fagain. That freedom motivated people to try until they succeededrewards were often so great.2

Any change in the U.S. economic or political system has a majon the success of the business system. For example, the recent inc

ernment involvement in business will have an economic effect.effect will be in the long run, however, remains to be seen.Global economics and global politics also have a major influe

nesses in the United States. Therefore, to understand business, younderstand basic economics and politics.

economicsThe study of how societychooses to employ

resources to produce goodsand services and distributethem for consumptionamong various competinggroups and individuals.

microeconomics

N A M E T H A T

company

Understanding Economics and How It Affects Business CHAPTER 2


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domestic product (GDP), the unemployment rate, and price indexes. A ques-tion in microeconomics might be: Why do people buy smaller cars when gas

prices go up?Some economists define economics as the study of the allocation ofscarceresources. They believe resources need to be carefully divided among people,usually by the government. However, theres no way to maintain peace andprosperity in the world by merely dividing the resources we have today amongthe existing nations. There arent enough known resources to do that. Resourcedevelopment is the study of how to increase resources (say, by getting oilfrom shale and tar sands) and create conditions that will make better use ofthem (like recycling and conservation).5

Businesses can contribute to an economic system by inventing productsthat greatly increase available resources. For example, they can discover newenergy sources (hydrogen fuel for autos), new ways of growing food (hydropon-ics), and new ways of creating needed goods and services (nanotechnology).Mariculture, or raising fish in pens out in the ocean, could lead to more foodfor everyone and more employment. It is believed that the United States couldmonopolize the shrimp industry using aquaculture 6 Now we import about a res


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resources. Economist Thomas Malthus made this argument in thand early 1800s, leading the writer Thomas Carlyle to call ecodismal science.

Followers of Malthus today (who are called neo-Malthusiansthere are too many people in the world and that the solution to po

cal birth control, including forced abortions and sterilization. Thestatistics, however, show population growing more slowly than some industrial countrieslike Japan, Germany, Italy, Russia, anStatespopulation growth may be so slow that eventually theremany old people and too few young people to care for them.8In thworld, on the other hand, population will climb relatively quicklead to greater poverty and more unrest. Studies about the effecttion growth on the economy are part of macroeconomics.

Some macroeconomists believe that a large population, espec

cated one, can be a valuable resource. Youve probably heard the a man a fish and you feed him for a day, but teach a man to fish ahim for a lifetime. You can add to thperson to start a fish farm, and he orable to feed a village for a lifetime. T

economic development is contained in thment Business owners provide jobs an

greenTHINKING

Bringing in the Green with Green Products

Adjusting to climate changes creates as many opportunitiesas it does challenges. Companies that help lower carbonemissions can prosper as people become more concernedabout climate change. Toyota has had success selling itshybrid Prius, and most automakers now offer similar hybrids,which get better mileage with less pollution than gas-only

vehicles. Some all-electric cars are now available. And severalfirms are offering cars half the size of regular carsto getbetter fuel economy.

Farmers are growing more corn and other crops for useas biofuels. That creates more demand for tractors and otherfarm equipment, and helps the economy grow. It also causes

food prices to skyrocket. Given these outcomrecommend an increase in the use of biofuels?

Its amazing what you find when you begreener businesses There are now green tegreen jeans. Have you ever seen hot-dog wraround the ballpark? In the future, theyll be re

Reuse. Recycle.These have become the tenetmore environmentally responsive lifestyle.

Sources: Christina Binkley, How Green Is My Sneaker?Journal, July 22, 2010; Jason B. White, The Confusing Cars, The Wall Street Journal,October 13, 2010; and PWhy Is the Gulf Cleanup So Slow? The Wall Street Jou

New ways of producinggoods and services add

resources to theeconomy and create

more employment. Fishfarms, for instance,

create both food andjobs. Can you think ofother innovations that

can help increase

economic development?



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Adam Smith and the Creation of WealthRather than believing fixed resources had to be divided among competinggroups and individuals, Scottish economist Adam Smith envisioned creating

more resources so that everyone could become wealthier. Smiths book AnInquiry into the Nature and Causes of the Wealth of Nations(often called simplyThe Wealth of Nations) was published in 1776.

Smith believedfreedomwas vital to the survival of any economy, especiallythe freedom to own land or property and to keep the profits from working theland or running a business.9He believed people will work long and hard ifthey have incentives for doing sothat is, if they know theyll be rewarded. Asa result of those efforts, the economy will prosper, with plenty of food and allkinds of products available to everyone.10Smiths ideas were later challenged

by Malthus and others who believed economic conditions would only getworse, but Smith, not Malthus, is considered thefather of modern economics.

How Businesses Benefit the CommunityIn Adam Smiths view, businesspeople dont necessarily deliberately set out tohelp others. They work primarily for their own prosperity and growth. Yet aspeople try to improve their own situation in life, Smith said, their efforts serveas an invisible hand that helps the economy grow and prosper through the

production of needed goods, services, and ideas. Thus, the phrase invisiblehand is used to describe the process that turns self-directed gain into socialand economic benefits for all.

How do people working in their own self-interest produce goods, services,and wealth for others? The only way farmers can become wealthy is to sellsome of their crops to others. To become even wealthier, they have to hireworkers to produce more food. So the farmers self-centered efforts to becomewealthy lead to jobs for some and food for almost all. Think about that processfor a minute, because it is critical to understanding economic growth in the

United States and other free countries. The same principles apply to every-thing from clothing to houses to iPads.

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Smith assumed that as people became wealthier, they woureach out to help the less fortunate in the community. That hashappened. Today, however, many businesspeople are becomingcerned about social issues and their obligation to return to socwhat theyve earned.11As we mentioned in Chapter 1, it is importnesses to be ethical as well as generous. Unethical practices unwhole economic system. The nearby Making Ethical Decisions bwhat universities are now doing about this.

progress assess

What is the difference between macroeconomics and microeco

What is better for an economy than teaching a man to fish?

What does Adam Smiths term invisible handmean? How does thand create wealth for a country?

LEARNING goal 2LEARNING oaExplain what capitalism is and how free markets work.

ethical decisions

MAKING

Corruptions Effect on the Economy

There are numerous forces in poor countries that hinder eco-nomic growth and development. One of those forces is cor-ruption. In many countries, a businessperson must bribegovernment officials to get permission to own land, build onit, and conduct normal business operations.

The United States has seen much corruption among

businesspeople, such as use of prostitutes, illegal drug use,alcohol addiction, and gambling. Imagine you need a permit toadd liquor to your restaurant menu to increase your profit.

You have tried for years to get one, with no rea friend in the government who offers to help ya large contribution to his or her reelection ca

you be tempted to make a campaign contribuyour alternatives? What are the consequences

Sources: Alina Dizik, Social Concerns Gain New UrgencStreet Journal,March 4, 2010; and Carol Loomis, The $Challenge, Fortune,July 5, 2010.



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lived in humble surroundings. Nonetheless, there was always the promise ofbetter times. One way to be really wealthy was to start a successful business ofyour own. Of course, it wasnt that easyit never has been. Then and now, youhave to accumulate some money to buy or start a business, and you have towork long hours to make it grow. But the opportunities are there.12

The economic system that has led to wealth creation in much of the worldis known as capitalism.13Under capitalism all or most of the factors of pro-duction and distributionsuch as land, factories, railroads, and storesareowned by individuals. They are operated for profit, and businesspeople, notgovernment officials, decide what to produce and how much, what to charge,and how much to pay workers. They also decide whether to produce goods intheir own countries or have them made in other countries. No country ispurely capitalist, however. Often the government gets involved in issues suchas determining minimum wages, setting farm prices, and lending money tosome failing businessesas it does in the United States. But capitalism is the

foundationof the U.S. economic system, and of the economies of England,Australia, Canada, and most other industrialized nations. There have beenmany suggestions as to how the United States could improve its capitalist sys-tem, especially given the recession that began on 2008.14

Some countries are practicing state capitalism. State capitalismis wherethe state runs some businesses instead of private owners. The most obviousexample is China, but the same concepts are being used in Russia and some ofthe Arab nations of the Middle East.15These countries have experienced somesuccess using capitalist principles, but the future is still uncertain.16

The root word ofcapitalismis capital. The Spotlight on Small Businessbox on p.36 shows how a little capital can help small businesses grow in thepoorest countries in the world.

The Foundations of CapitalismUnder free-market capitalism people have four basic rights:

1. The right to own private property.This is the most fundamental of allrights under capitalism. Private ownership means that individuals canbuy, sell, and use land, buildings, machinery, inventions, and otherforms of property. They can also pass property on to their children.Would farmers work as hard if they didnt own the land and couldntkeep the profits from what they earned? More than 90 percent ofEgyptians hold their property without legal title. This is one reasonthey cant build wealth and why they protested in the streets in 2011.17

2. The right to own a business and keep all thatbusinesss profits. Recall from Chapter 1that profits equal revenues minus expenses(salaries, materials, taxes). Profits act asimportant incentives for business owners.

3 The right to freedom of competition Within

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One benefit of the four basic rights of capitalism is that peoplto take more risks than they might otherwise. President Franklbelieved four additional freedoms were essential to economic sudom of speech and expression, freedom to worship in your own wfrom want, and freedom from fear. Do you see the benefits of thesfreedoms?

Now lets explore how the free market works. What role do conin the process? How do businesses learn what consumers needThese questions and more are answered next.

How Free Markets WorkA free market is one in which decisions about what and how muchare made by the marketby buyers and sellers negotiating pricand services. You and I and other consumers send signals to tewhat to make, how many, in what color, and so on. We do that bybuy (or not to buy) certain products and services

businessSPOTLIGHT ON SMA LL

A Small Loan Can Make a Big Difference

One way people in industrialized countries can help people indeveloping countries is to create a local bank that lendsmoney to budding entrepreneurs so they can begin or expandtheir business. The entrepreneurs must pay the money back,with interest, and often must keep some money in the bank.Such banks dont necessarily have to be in a bank building.

Village women often assume the role of banker and decidewhich women will get the loans. The bankers meet in a com-munity building of some sort.

Such banks are sponsored by the Foundation forInternational Community Assistance (FINCA). In its 10-yearhistory, FINCA has loaned more than $447 million to over600,000 small-scale entrepreneurs in some of the worldspoorest countries. Its borrowers have a 97.6 percent loanrepayment rate.

The story of one small entrepreneur will hstand the process. Pros Magaga lives in Kampahad a tiny shop in town, but it carried very lShe did not make enough to send her four chior to feed them more than once a day. FINCAshe used it to buy a refrigerator, which allowe

fresh foods and cold snacks. Later she added her children are all in school, and the family ena day. Magaga has built a small home with tplans to add another room soon. She can borrofrom FINCA because she has already paid back

Sources: Ruth David, In a Microfinance Boom, Echoes oBloomberg Businessweek, June 21June 27, 2010; and Bullish on Harare, Forbes, November 22, 2010.

www.villagebanking.org



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The same process occurs with most other products. Thepricetells produc-ers how much to produce. If something is wanted but isnt available, the pricetends to go up until someone begins making more of that product, sells theones already on hand, or makes a substitute. As a consequence, theres rarely along-term shortage of goods in the United States.

How Prices Are DeterminedIn a free market, prices are not determined by sellers; they are determined bybuyers and sellers negotiating in the marketplace. A seller may want to receive$50 for a T-shirt, but the quantity buyers demand at that high price may bequite low. If the seller lowers the price, the quantity demanded is likely toincrease. How is a price determined that is acceptable to both buyers and sell-ers? The answer is found in the microeconomic concepts of supply anddemand. We shall explore both next.

The Economic Concept of SupplySupply refers to the quantities of products manufacturers or owners are will-ing to sell at different prices at a specific time. Generally speaking, the amountsupplied will increase as the price increases, because sellers can make moremoney with a higher price.

Economists show this relationship between quantity supplied and priceon a graph. Figure 2.1 shows a simple supply curve for T-shirts. The price ofthe shirts in dollars is shown vertically on the left of the graph. The quantity ofshirts sellers are willing to supply is shown horizontally at the bottom of thegraph. The various points on the curve indicate how many T-shirts sellerswould provide at different prices. For example, at a price of $5 a shirt, a T-shirt

vendor would provide only 5 shirts, but at $50 a shirt the vendor would supply50 shirts. The supply curve indicates the relationship between the price andthe quantity supplied. All things being equal, the higher the price, the more the

vendor will be willing to supply.

The Economic Concept of DemandDemand refers to the quantity of products that people are willing to buy atdifferent prices at a specific time. Generally speaking, the quantity demandedwill increase as the price decreases. Again, we can show the relationshipbetween price and quantity demanded in a graph. Figure 2.2 shows a simple

demand curve for T-shirts. The various points on the graph indicate the quan-tity demanded at various prices. For example, at $45, buyers demand just 5shirts, but at $5, the quantity demanded would increase to 35 shirts. All thingsbeing equal, the lower the price, the more buyers are willing to buy.

The Equilibrium Point, or Market Price

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PART 1 Business Trends: Cultivating a Business in Diverse, Global Environments38


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Proponents of a free market argue that, bply and demand interactions determine pricesneed for the government to set prices. If quanexceeds quantity demanded, the resulting sursellers to lower the price. If shortages developquantity supplied is less than quantity demanals sellers to increase the price. Eventuallyagain equal demand if nothing interferes wforces.

When supplies of oil were lower because ospill, for instance, the price of gasoline wensupplies were again plentiful, the price of gasThe price of gas rose again when there was tuMiddle East (e.g., Libya) and the supply of oil Note, too, how many alternative fuel sources tar sands shale gas, etc.) were tried when the approached $4 a gallon.18

In countries without a free market, there inism to reveal to businesses (via price) what to

0

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Demand curve

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quantity of T-shirts demandprices. The demand curve falls froIt is easy to understand why. The lo

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Demand curve

Supply curve

figure 2.3THE EQUILIBRIUM POINT

The place where quantity demanded and quan-tity supplied meet is called the equilibrium point.

When we put both the supply and demandcurves on the same graph, we find that they

intersect at a price where the quantity suppliedand the quantity demanded are equal. In the

long run, the market price will tend toward theequilibrium point.

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5 10 15 20 25 30Quantity of T-Shirts

35 40 45 50

Supply curve

figure 2.1THE SUPPLY CURVE AT VARIOUS PRICES

The supply curve rises from left to right. Think

it through. The higher the price of T-shirtsgoes (the vertical axis), the more sellers will

be willing to supply.



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Competition within Free MarketsEconomists 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 andnone is large enough to dictate the price of a product. Sellers products appearto be identical, such as agricultural products like apples, corn, and potatoes.There are no true examples of perfect competition. Today, government pricesupports and drastic reductions in the number of farms make it hard to arguethat even farming represents perfect competition.

Under monopolistic competition a large number of sellers produce verysimilar products that buyers nevertheless perceive as different, such as hotdogs, sodas, personal computers, and T-shirts. Product differentiationtheattempt to make buyers think similar products are different in some wayis akey to success. Think about what that means. Through advertising, branding,and packaging, sellers try to convince buyers that their products are differentfrom competitors, though they may be very similar or even interchangeable.The fast-food industry, with its pricing battles among hamburger offeringsand the like, offers a good example of monopolistic competition.19

An oligopoly is a degree of competition in which just a few sellers domi-nate a market, as we see in tobacco, gasoline, automobiles, aluminum, andaircraft One reason some industries remain in the hands of a few sellers is

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Thus, advertising is a major factor determining which of the fbrands consumers buy, because often it is advertising that creaceived differences.20

A monopoly occurs when one seller controls the total supply

or service, and sets the price. In the United States, laws prohibit of monopolies. Nonetheless, the U.S. legal system has permitted in the markets for public utilities that sell natural gas, water, power. These companies prices and profits are usually controlleservice commissions to protect the interest of buyers. For examplePublic Service Commission is the administering agency over the Fland Light utility company. Legislation ended the monopoly statuin some areas, letting consumers choose among providers. The such deregulation is to increase competition among utility comultimately, lower prices for consumers.

Benefits and Limitations of Free MarketsOne benefit of the free market is that it allows open competition panies. Businesses must provide customers with high-quality proprices with good service. If they dont, they lose customers to busdo. Do government services have the same incentives?

The free marketwith its competition and incentiveswas a in creating the wealth that industrialized countries now enjoy. Seven talk of the free market as an economic miracle. Free-marketmore than any other economic system, provides opportunities forto work their way out of poverty. Capitalism also encourages busimore efficient so they can successfully compete on price and qual

Yet, even as free-market capitalism has brought prospeUnited States and to much of the rest of the world, it has brougity as well.21 Business owners and managers usually make m

and have more wealth than lower-level workers. Yet people wdisabled, or sick may not be able to start and manage a busineers may not have the talent or the drive. What should societsuch inequality? Not everyone in the United States is as geneGates, founder of Microsoft, who with his wife has established Melinda Gates Foundation to support world health and edufact, the desire to create as much wealth as possible has led sompeople throughout history, and still today, to exploit such practery and child labor.

One of the dangers of free markets is that some people let ghow they act. Criminal charges brought against some big businesing, oil, accounting, telecommunications, insurance, and pharindicate the scope of the potential problem. Some businesspdeceived the public about their products; others have deceived sabout the value of their stock, all in order to increase executiv

23

monopoly

A degree of competition inwhich only one sellercontrols the total supply ofa product or service, andsets the price.



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progress assessment

What are the four basic rights that people have under free-marketcapitalism?

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 examples ofeach?

LEARNING goal3

LEARNIN goaCompare socialism and communism.

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 ownedby the government so that profits can be more evenly distributed among thepeople. Entrepreneurs often own and run smaller businesses, and individualsare often taxed relatively steeply to pay for social programs. The top federalpersonal income tax rate in the United States, for example, was 35 percentrecently, but in some socialist countries the top rate can be as much as 60 per-cent. While U.S. shoppers pay sales taxes ranging from over 10 percent inChicago to zero in Delaware, socialist countries charge a similar value-addedtax of 15 to 20 percent or more. Socialists acknowledge the major benefit of

capitalismwealth creationbut believe that wealth should be more evenlydistributed than occurs in free-market capitalism. They believe the govern-ment should carry out the distribution and be much more involved in protect-ing the environment and providing for the poor.

The Benefits of SocialismThe major benefit of socialism is supposed to besocial equality.25Ideally it comes about because the

government takes income from wealthier people,in the form of taxes, and redistributes it to poorerpeople through various government programs.Free education through college, free health care,and free child care are some of the benefits social-ist governments, using the money from taxes, may

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The Negative Consequences of SocialismSocialism may create more equality than capitalism, but it takes abusinesspeoples incentives. For example, tax rates in some soci

once reached 83 percent. Today, doctors, lawyers, business ownerwho earn a lot of money pay very high tax rates. As a consequenthem leave socialist countries for capitalistic countries with loweas the United States. This loss of the best and brightest people to tries is called a brain drain.

Imagine an experiment in socialism in your own class. Imagithe first exam, those with grades of 90 and above have to give spoints to those who make 70 and below so that everyone ends upin the 80s. Would those who got 90s study as hard for the se

What about those who got 70s? Can you see why workers may hard or as well if they all get the same benefits regardless of howork?

Socialism also tends to result in fewer inventions and less because those who come up with new ideas usually dont recereward as they would in a capitalist system. Communism mayered a more intensive version of socialism. We shall explore next.

UNDERSTANDING COMMUNISM

Communism is an economic and political system in which the makes almost all economic decisions and owns almost all the mof production. It intrudes further into the lives of people thadoes. For example, some communist countries have not allowezens to practice certain religions, change jobs, or move to the tochoice.

One problem with communism is that the government hasknowing what to produce, because prices dont reflect supply andthey do in free markets. The government must guess what the peoa result, shortages of many items, including food and clothing, mAnother problem is that communism doesnt inspire businesspeohard because the incentives are not there. Therefore, communisdisappearing as an economic form.

Most communist countries today are suffering severe econosion. In North Korea, many people are starving. In Cuba, people of goods and services readily available in most other countries, anthe government. Even so, there seems to be a movement towardprinciples in Venezuela, following the Cuban model.

While some parts of the former Soviet Union remain underideals, Russia itself now has a flat tax of only 13 percent. Yet tincreased the governments tax revenues by nearly 30 percent b

brain drainThe loss of the best andbrightest people to othercountries.

communismAn economic and politicalsystem in which thegovernment makes almostall economic decisions andowns almost all the majorfactors of production.



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LEARNING goal 4LEARNING goa

Analyze the trend toward mixed economies.

THE TREND TOWARD MIXED ECONOMIES

The nations of the world have largely been divided between those that fol-lowed the concepts of capitalism and those that adopted the concepts of com-munism or socialism. We can now contrast the two major economic systemsas follows:

1. Free-market economies exist when the market largely determineswhat goods and services get produced, who gets them, and how theeconomy grows. Capitalism is the popular term for this economicsystem.

2. Command economies exist when the government largely decideswhat goods and services will be produced, who gets them, and how theeconomy will grow. Socialismandcommunismare variations on thiseconomic system.

Although all countries actually have some mix of the two systems, neitherfree-market nor command economies have resulted in optimal economic con-ditions. Free-market mechanisms dont seem to respond enough to the needsof the poor, the old, or the disabled. Some people also believe that businessesin free-market economies have not done enough to protect the environment.(We shall discuss that issue throughout the text.) Over time, voters in mostlyfree-market countries, such as the United States,have elected officials who have adopted manysocial and environmental programs such as SocialSecurity, welfare, unemployment compensation,and various clean air and water acts. What new orenhanced social policies do you know of that arebeing considered today?

Socialism and communism havent always cre-ated enough jobs or wealth to keep economiesgrowing fast enough. Thus, communist govern-ments are disappearing, and some socialist govern-ments have been cutting back on social programsand lowering taxes on businesses and workers togenerate more business growth and more reve-nue.27The Reaching Beyond Our Borders box dis-cusses how the economy of China has been growingdespite its communist base

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(more private businesses, lower taxes). All countries have some msystems. Thus, the long-term global trend is toward a blend of casocialism. This trend likely will increase with the opening of glomade easier by the Internet. The net effect is the emergence thrworld of mixed economies.

Mixed economies exist where some allocation of resourcesthe market and some by the government. Most countries dont havsuch a system. If free-market mechanisms allocate most resources

call their system capitalism. If the government allocates most releaders call it socialism. Figure 2.4 compares the various economLike most other nations of the world, the United States has a

omy. The U.S. government has now become the largest employer try, which means there are more workers in the public sector (gthan in any of the major businesses in the United States. Do you

mixed economiesEconomic systems in whichsome allocation ofresources is made by the

market and some by thegovernment.

our bordersREACHIN G B EYOND

Chinas Changing Economy

It is important, when studying economics, to look at countriesthroughout the world to see how they are doing economically.One country that has been in the news a lot lately is China.Chinas economy is growing two or three times faster than theUnited States. As a consequence of that rapid growth, Chinais worried about inflation and the possibility of a housing

crash and market drop much like the one experiencedrecently in the U.S.

China is now the worlds second largest economy, replac-ing Japan. Chinas GDP grew 10.3 percent in 2010, up from 9.2percent in 2009. The rapid rise in the Chinese economy cre-ates opportunities for companies that sell them goods andservices, but the rapid growth in Chinese manufacturing alsocreates problems for countries trying to compete. There ismuch discussion in the United States about losing jobs to

Chinese workers whose pay is much lower than in the UnitedStates.

Although it is known for its socialist and communistfoundations, one reason China is growing so rapidly is becauseit has adopted capitalist principles. This is an interesting time

to watch world economies to see what kind of to be the most beneficial to the most people.

Sources: Jason Dean and Aaron Back, China Growth Swith U.S., The Wall Street Journal,January 21, 2011; anWilliamson, The Other National Debt, National Review



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CAPITALISM*(United States)

SOCIALISM(Sweden)

COMMUNISM(North Korea)

M(G

Social andEconomicGoals

Private ownership ofland and business.Liberty and thepursuit of happiness.Free trade. Emphasison freedom and theprofit motive foreconomic growth.

Public ownership ofmajor businesses.Some privateownership of smallerbusinesses andshops. Governmentcontrol of education,health care, utilities,mining,transportation, andmedia. Very hightaxation. Emphasison equality.

Public ownership ofall businesses.Government-runeducation and healthcare. Emphasis onequality. Manylimitations onfreedom, includingfreedom to ownbusinesses and toassemble to protestgovernment actions.

PrlawireGoof(etaanweonbean

Motivation ofWorkers

Much incentive towork efficiently andhard because profitsare retained byowners. Workers arerewarded for high

productivity.

Capitalist incentivesexist in privatebusinesses.Government controlof wages in publicinstitutions limits

incentives.

Very little incentiveto work hard or toproduce qualitygoods or services.

Insimexgoenm

inControl overMarkets

Complete freedom oftrade within andamong nations. Somegovernment controlof markets.

Some markets arecontrolled by thegovernment andsome are free. Traderestrictions amongnations vary andinclude some free-trade agreements.

Total governmentcontrol over marketsexcept for illegaltransactions.

Socowinapr

Choices in theMarket

A wide variety ofgoods and services isavailable. Almost noscarcity oroversupply exists forlong because supplyand demand controlthe market.

Variety in themarketplace variesconsiderably fromcountry to country.Choice is directlyrelated togovernmentinvolvement inmarkets.

Very little choiceamong competinggoods.

Sibuovcagoinvmsu

SocialFreedoms Freedom of speech,press, assembly,religion, job choice,movement, andelections.

Similar to mixedeconomy.Governmentsmay restrict jobchoice, movementamong countries,and who may attend

Very limited freedomto protest thegovernment, practicereligion, or changehouses or jobs.

Sofreasspofmpr



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LEARNING goal 5LEARNING oa

Describe the economic system of the United States, including the

significance of key economic indicators (especially GDP), productithe business cycle.

UNDERSTANDING THE U.S. ECONOMIC SY

The following sections will introduce the terms and concepts thainformed citizen, will need to understand in order to grasp the i

government and business leaders in the United States.

Key Economic IndicatorsThree major indicators of economic conditions are (1) the groproduct (GDP), (2) the unemployment rate, and (3) price indeximportant statistic is the increase or decrease in productivity. Whbusiness literature, youll see these terms used again and again. Lwhat they mean.

Gross Domestic Product Gross domestic product (GDP), whitioned briefly in Chapter 1, is the total value of final goods and s

duced in a country in a given year. Boand foreign-owned companies can pgoods and services included in GDP, acompanies are located within the counaries. For example, production vJapanese automaker Hondas factory

included in U.S. GDP. Revenue generatfactory in Mexico is included in Mexicothough Ford is a U.S. company.

Almost every discussion about a naomy is based on GDP. If growth in Gdeclines, businesses may feel many negsuch as the slowdown in retail sales beginning on 2008. A major influence oof GDP is the productivity of the wor

is, how much output workers create wamount of input. The total U.S. GDP trillion. The level of U.S. economic actally larger than the GDP figures shothose figures dont take into account illisuch as sales of illegal drugs The high

gross domesticproduct (GDP)The total value of finalgoods and servicesproduced in a country in agiven year.

The overallunemployment rate in

the U.S. fluctuates.

Over the last decade, ithas been as low as lessthan 5 percent and as

high as more than 10percent.

Unemploymentinsurance goes only so

far to relieve the loss ofincome caused by

losing your job. How

high is theunemployment rate in

your area today?



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the rate had risen to over 9.5 percent (see Figure 2.5). The unemployment ratefell to below 9 percent in 2011, but many people had given up looking for jobs(people who are not actively look for work are not included in the unemploy-ment figures).

Figure 2.6 describes the four types of unemployment: frictional, struc-

tural, cyclical, and seasonal. The United States tries to protect those who areunemployed because of recessions (defined later in the chapter), industryshifts, and other cyclical factors. Nonetheless, the underemploymentfigure in2010 was about 17 percent (this includes those who are working part time andwant to work full time and those who stopped looking for work).28

If you worry about the U.S. unemployment rate, consider this: the unem-ployment rate in Zimbabwe is way over 80 percent, and the inflation rate isspectacular. You would enjoy cashing in your dollars in Zimbabwe; one dollarwill get you billions of Zimbabwean dollars. Actually, the situation is getting

much worse. Do you suppose Zimbabwe is a capitalist economy?

Inflation and Price Indexes Price indexes help gauge the health of the econ-omy by measuring the levels of inflation, disinflation, deflation, and stagfla-tion. Inflation is a general rise in the prices of goods and services over time.

inflA geof gtime

0

4.0

4.5

5.0

5.5

6.0

6.5

7.5

8.0

9.0

7.0

Percent

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2001 2002 2003 2004 2005 2006 22000

10.0

figuU.S. U

1989

Frictional unemploymentrefers to those people who have quit work because

they didnt like the job, the boss, or the working conditions and who haventyet found a new job. It also refers to those people who are entering the laborforce for the first time (e.g., new graduates) or are returning to the labor forceafter significant time away (e.g., parents who reared children). There will alwaysbe some frictional unemployment because it takes some time to find a first jobor a new job.

S l l f l d b h

figuFOUR

UNEM

uneTheleasunefindfour



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The official definition is a persistent increase in the level of consor a persistent decline in the purchasing power of money, caincrease in available currency and credit beyond the proportion oservices. Thus, it is also described as too many dollars chasgoods. Go back and review the laws of supply and demand to sworks. Rapid inflation is scary. If the prices of goods and services g7 percent a year, they will double in about 10 years. Think of how

was generated by the rapid increase in the price of gasoline in 20Disinflation occurs when price increases are slowing (the inf

declining). That was the situation in the United States throughouDeflation means that prices are declining.29It occurs when countso many goods that people cannot afford to buy them all (too fewchasing too many goods). Some experts believed that deflation co2011.30Stagflation occurs when the economy is slowing but pricup anyhow. Some economists fear the United States may face sthe near future.

The consumer price index (CPI) consists of monthly statistisure the pace of inflation or deflation. The government compugoods and servicesincluding housing, food, apparel, and medisee whether they are going up or down (see Figure 2.7). The CPI tant figure because some wages and salaries, rents and leases, tgovernment benefits, and interest rates are based on it. You may

core inflation.That means the CPI minus food and energy costsand energy have been going up rapidly, the core inflation figurmuch lower than the real CPI.

The producer price index (PPI) measures prices at the whoOther indicators of the economys condition include housing sales, and changes in personal income. You can learn more about tors by reading business periodicals, listening to business broadcaand television, and exploring business sites on the Internet.

disinflationA situation in which priceincreases are slowing (theinflation rate is declining).

deflationA situation in which pricesare declining.

stagflationA situation when theeconomy is slowing butprices are going up anyhow.

consumer priceindex (CPI)Monthly statistics that

measure the pace ofinflation or deflation.

producer priceindex (PPI)An index that measures

1. 400 data collectors visit stores and gather 80,000 retail price quot5,000 housing rent quotes, transmitting data daily to Washington.

2. 40 commodity analysts at the Bureau of Labor Statistics review abo

quarter of this avalanche of price data. 3. About nine days before the release of the CPI, the office is locked do

bright red RESTRICTEDAREAsigns posted on all the doors.

4. 90 peoplea mix of commodity analysts and other economists who in assembling the CPIcompute basic indexes for 211 item categoriesdivided into 38 index areas.

5. Final results are released at 8:30 a.m., Eastern time, about two weekend of the month in question.

figure 2.7HOW THE CONSUMER PRICE

INDEX IS PUT TOGETHER


C t i l th t i h t th U it d St t i


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It cmethetecthewitinc

of doaccscastimaHomeimpqu

Certainly, that is what the United States in nowexperiencing.

Now that the U.S. economy is a service econ-omy, productivity is an issue because service firms

are so labor-intensive. Spurred by foreign competi-tion, productivity in the manufacturing sector isrising rapidly. In the service sector, productivity isgrowing more slowly because service workersliketeachers, clerks, lawyers, and barbershave fewernew technologies available than there are for fac-tory workers.

Productivity in the Service SectorOne problem with the service industry is that aninflux of machinery may add to the qualityof the service provided but not totheoutput per worker.For example, youve probably noticed how many com-puters there are on college campuses. They add to the quality of education butdont necessarily boost professors productivity. The same is true of some equip-ment in hospitals, such as CAT scanners, PET scanners, and MRI scanners.They improve patient care but dont necessarily increase the number of patientsdoctors can see. In other words, todays productivity measures in the service

industry fail to capture the increase in quality caused by new technology.Clearly, the United States and other countries need to develop new mea-

sures of productivity for the service economy that include quality as well asquantity of output. Despite productivity improvement, the economy is likely togo through a series of ups and downs, much as it has over the past few years.Well explore that process next.

The Business CycleBusiness cycles are the periodic rises and falls that occur in economies overtime. Economists look at a number of business cycles, from seasonal cyclesthat occur within a year to cycles that occur every 4860 years.

Economist Joseph Schumpeter identified the four phases of long-termbusiness cycles as boomrecessiondepressionrecovery:

1. Aneconomic boomis just what it sounds likebusiness is booming.

2. Recession is two or more consecutive quarters of decline in the GDP.

In a recession prices fall, people purchase fewer products, andbusinesses fail. A recession brings high unemployment, increasedbusiness failures, and an overall drop in living standards. The 20082011 recession is an example.

3. A depression is a severe recession, usually accompanied by deflation.Business cycles rarely go through a depression phase In fact while

busThethaove

recTwoquaGDP

depA se


with certainty But one thing is certain: over time the economy


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with certainty. But one thing is certain: over time, the economyfall as it has done lately.

Since dramatic swings up and down in the economy cause all ruptions to businesses, the government tries to minimize such cha

fiscal policy and monetary policy to try to keep the economy frommuch or growing too rapidly.

LEARNING goal 6LEARNING oa

Contrast fiscal policy and monetary policy, and explain how each the economy.

Stabilizing the Economy through Fiscal PolicyFiscal policy refers to the federal governments efforts to keep tstable by increasing or decreasing taxes or government spending. Tpolicy tool is taxation. Theoretically, high tax rates tend to slow tbecause they draw money away from the private sector and put it ernment. High tax rates may discourage small-business ownership

decrease the profits businesses can earn and make the effort less refollows, then, that low tax rates will theoretically give the economyIn the United States, the percentage of GDP the government ta

taxes at all levels (federal, state, and local) is about 28 percent. Wheall fees, sales taxes, and more, taxes on the highest-earning citizens 50 percent. Is that figure too high or not high enough in your opini

The second fiscal policy tool is government spending on highprograms, education, infrastructure (e.g., roads and utilities), defon. The national deficitis the amount of money the federal govern

beyond what it gathers in taxes for a given fiscal year. The deficit isbe over $1 trillion for the next several years. Such deficits increasedebt. The national debt is the sum of government deficits over timthe national debt was over $14 trillion (see Figure 2.8). That is aleading number, however, since the unfunded obligation for Mediabout $34 trillion. The unfunded debt to Social Security is on top ogovernment takes in more revenue than it spends (i.e., tax reveexpenditures), there is a national surplus.That is not likely to hap

One way to lessen deficits is to cut government spending. Man

and those in Congress have promised to make the government sis, to reduce government spendingbut that doesnt happen very seems to be a need for more social programs or more defense speas for the wars in Iraq, Afghanistan, and Libya) each year, and thucontinue and add to the national debt. Some people believe that spending helps the economy grow. Others believe that the money

fiscal policyThe federal governmentsefforts to keep the economystable by increasing ordecreasing taxes orgovernment spending.

national debtThe sum of governmentdeficits over time.

Keynesian economicth


$14


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Thbecaam

wogewares

is about $3,272 per person in the United States.) President Barack Obamapromised to spend additional funds. Both presidents were following the basiceconomic theory of Keynes discussed in the Profile.33As you recall, Keynesianeconomic theory is the theory that a government policy of increasing spend-ing and cutting taxes could stimulate the economy in a recession.

Using Monetary Policy to Keep the Economy GrowingHave you ever wondered what organization adds money to or subtracts moneyfrom the economy? The answer is the Federal Reserve Bank (the Fed). The Fedis a semiprivate organization that is not under thedirect control of the government but does havemembers appointed by the president. We will dis-cuss the Fed in detail when we look at banking inChapter 20. Now we simply introduce monetary

policy and the role of the Fed in controlling theeconomy.

Monetary policy is the management of themoney supply and interest rates by the FederalReserve Bank. The Feds most visible role is the

i i d l i f i t t t Wh th

0

1

2

3

4

5

6

7

8

9

10

11

12

13

$14

Trillions

ofdollars

$1.8 trillion

$2.9 trillion$3.6 trillion

$4.6 trillion

$4.96 trillion$5.2 trillion $5.4 trillion

$5.6 trillion

$5.5 trillion$5.7 trillion

1980 81 82 83 84 85 86 87 88 89 90 91 92 93 94 96 97 98 99 00 01 02 03 04 05 095

$6.4 trillion

$8.4 trillion

$2.3 trillion

$1.4 trillion

0

2

4

6

7

9

10

$1.8 trillio

$2.9 trillio . tr o

$4.6 trillion

$4.96 trillion$5.2 trillion . tr on

$5.6 trillion

$ . on$5.7 trillion

6.4 trillion

. tr on

$2.3 trilli

. tr $994 billion

figuTHE N


but the economy remained sluggish. You can imagine the pressur


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but the economy remained sluggish. You can imagine the pressurthe head of the Federal Reserve.35

The Fed also controls the money supply. A simple explanationtion is that the more money the Fed makes available to busines

others, the faster the economy is supposed to grow. To slow the ecprevent inflation), the Fed lowers the money supply. The Fed pointo the economy in 20082011. What would you expect the resul

To sum up, there are two major tools for managing the ecoUnited States: fiscal policy (government taxes and spending) anpolicy (the Feds control over interest rates and the money supplyto keep the economy growing so that more people can rise up thladder and enjoy a higher standard of living and quality of life.

progress assess

Name the three economic indicators and describe how well theStates is doing based on each indicator.

Whats the difference between a recession and a depression?

How does the government manage the economy using fiscal po

What does the term monetary policymean? What organizationble for monetary policy?

summary

Learning Goal 1. Explain basic economics. What is economics?

Economics is the study of how society chooses to employ resoduce goods and services and distribute them for consumptionous competing groups and individuals. What are the two branches of economics?There are two major branches of economics: macroeconomicoperation of a nations economy as a whole, and microeconothe behavior of people and organizations in particular marke

people buy smaller cars when gas prices go up). How can we be assured of having enough resources?Resource development is the study of how to increase resourate the conditions that will make better use of them. How does capitalism create a climate for economic growth?Under capitalism businesspeople dont often deliberately set


Who decides what to produce under capitalism?


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p pIn capitalist countries, businesspeople decide what to produce, how muchto pay workers, and how much to charge for goods and services. They alsodecide whether to produce certain goods in their own countries, import

those goods, or have them made in other countries. What are the 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 businesss profitsafter taxes, (3) the right to freedom of competition, and (4) the right tofreedom of choice. President Franklin D. Roosevelt felt that other eco-nomic freedoms were also important: the right to freedom of speech andexpression, the right to worship in your own way, and freedom from wantand fear.

How does the free market work?The free market is one in which buyers and sellers negotiating prices forgoods and services influence the decisions about what gets produced andin what quantities. Buyers decisions in the marketplace tell sellers what toproduce and in what quantity. When buyers demand more goods, the pricegoes up, signaling suppliers to produce more. The higher the price, themore goods and services suppliers are willing to produce. Price is themechanism that allows free markets to work.

Learning Goal 3. Compare socialism and communism. What is socialism?

Socialism is an economic system based on the premise that some busi-nesses should be owned by the government. What are 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 andalso work fewer hours, with longer vacations. The major disadvantage ofsocialism 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 slowergrowth rate than capitalist economies. How does socialism differ from communism?Under communism, the government owns almost all major productionfacilities and dictates what gets produced and by whom. Communism isalso more restrictive when it comes to personal freedoms, such as reli-gious freedom.

Learning Goal 4. Analyze the trend toward mixed economies.

What is a mixed economy?A mixed economy is part capitalist and part socialist. Some businesses areprivately owned, but taxes tend to be high to distribute income moreevenly among the population. What countries have mixed economies?The United States has a mixed economy as do most other industrialized


Learning Goal 5. Describe the economic system of the United Stat


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the significance of key economic indicators (especially GDP), 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 produced in a country in a given year. The unemployment ratepercentage of civilians at least 16 years old who are unemployto find a job within the most recent four weeks. Theconsume(CPI)measures changes in the prices of about 400 goods and consumers buy. What are the four phases of business cycles?In aneconomic boom,businesses do well. Arecessionoccurs more quarters show declines in the GDP, prices fall, people pu

products, and businesses fail. Adepressionis a severe recessioccurs when the economy stabilizes and starts to grow.

Learning Goal 6. Contrast fiscal policy and monetary policy, and each affects the economy.

What is fiscal policy?Fiscal policy consists of government efforts to keep the econoincreasing or decreasing taxes or government spending. What is the importance of monetary policy to the economy?

Monetary policy is the management of the money supply rates. When unemployment gets too high, the Federal ReservFed) may put more money into the economy and lower interesis supposed to provide a boost to the economy as businessesspend more money and hire more people.

key terms

brain drain 42

business cycles 49

capitalism 35

commandeconomies 43

communism 42

consumer priceindex (CPI) 48

deflation 48

demand 37

depression 49

disinflation 48

economics 30

free-market economies 43

gross domestic product(GDP) 46

inflation 47

invisible hand 33

Keynesian economictheory 50

macroeconomics 30market price 37

microeconomics 30

mixed economies 44

monetary policy 50

monopolistic

monopoly 4

national deb

oligopoly 39

perfect comp

producer pr(PPI) 48

recession 4

resourcedevelopme

socialism 41

stagflation 4

supply 37

unemployme


critical thinking


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critical thinking

U.S. Supreme Court ruled that cities could have school voucher programs thatgive money directly to parents, who could then choose between competingschools, public or private. The idea was to create competition among schools.Like businesses, schools were expected to improve their services (how effec-tively they teach) to win students from competitors. The result would be im-provement in all schools, private and public, to benefit many students.

1. Do you believe economic principles like competition apply in both privateand public organizations? Be prepared to defend your answer.

2. Are there other public functions that might benefit from more competi-tion, including competition from private firms?

3. Many people say that businesspeople do not do enough for society. Somestudents choose to go into the public sector instead of business becausethey want to help others. However, businesspeople say that they do moreto help others than nonprofit groups do because they provide jobs for peo-ple rather than giving them charity. Furthermore, they believe businessescreate all the wealth that nonprofit groups distribute.

a. How can you find some middle ground in this debate to show that bothbusinesspeople and those who work for nonprofit organizations con-tribute to society and need to work together more closely to helppeople?

b. How could you use the concepts of Adam Smith to help illustrate yourposition?

developing workplace skills

1. In teams, develop a list of the advantages of living in a capitalist society.Then develop lists headed What are the disadvantages? and How couldsuch disadvantages be minimized? Describe why a poor person in asocialist country might reject capitalism and prefer a socialist state.

2. Show your understanding of the principles of supply and demand by look-

ing at the oil market today. Why does the price of gas fluctuate so greatly?What will happen as more and more people in China and India decide tobuy automobiles? What would happen if most U.S. consumers decided todrive electric cars?

3. This exercise will help you understand socialism from different perspec-h h h ld d d ff l


Explain why you marked the spot you chose. Students fromi d hi i f h i i d


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tries may want to do this exercise for their own countries anddifferences to the class.

5. Break into small groups. In your group discuss how the followhave affected peoples purchasing behavior and attitudes United States and its economy: the wars in Iraq and Afghincreased amount spent on homeland security, the governmment in banking and other industries, and the growth of tHave a group member prepare a short summary for the class.

taking it to the netPurposeTo familiarize you with the sources of economic information thatant to business decision makers.

Exercise

Imagine that your boss asked you to help her to prepare the comforecast for the coming two years. In the past, she felt that such tnations GDP, U.S. manufacturing, and manufacturing in Illinoicially helpful in forecasting sales. She would like you to do the fol

1. Go to the Bureau of Economic Analysiss website (www.blocate the gross domestic product data. Compare the annual flast four years. What do the figures indicate for the next coup

2. At the Bureau of Labor Statistics website (www.bls.gov) undeclick on Industries at a Glance to find the information about tturing industry. What is the employment trend in manufactur

last four years (percentage change from preceding period)?

3. Return to the Bureau of Labor Statistics home page and usefeature to find trends in employment for the state of Illinois. Lthe website to see what other information is available. Plot manufacturing employment in Illinois over the last four yeaown, discuss what economic changes may have influenced th

4. Based on the information you have gathered, write a brief what may happen to company sales over the next couple of ye

T th Th R l f 72 i it hh / b10

casing the web


video case


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video case

To access the video case featuring Oppurtunity International,

visit www.mhhe.com/ub10e


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bmgt110f understanding business 10th ed

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