part ii: business environment introduction to business 3e 4 copyright © 2004 south-western. all...

Copyright © 2004 South-Western. All rights reserved.

Part II: Business EnvironmentPart II: Business Environment

Jeff MaduraIntroduction to

Business 3e

Introduction to Business 3e

44Assessing Economic Assessing Economic ConditionsConditions

Assessing Economic Assessing Economic ConditionsConditions

Copyright © 2004 South-Western. All rights reserved. 4–2

Business EnvironmentBusiness Environment


Learning GoalsLearning Goals• Identify macroeconomic factors that affect business performance.

•Explain how market prices are determined.

•Explain how the government influences economic conditions.


Assessing Economic Assessing Economic ConditionsConditions


Economic ConditionsEconomic Conditions•Reflect the level of production and consumption for a particular country, area, or industry– Macroeconomic conditions

Overall economic state of a country

– Microeconomic conditions Focus on conditions in a particular business

or industry


Impact of Economic Impact of Economic ConditionsConditions

•Economic conditions can affect:– Revenues of a business– Expenses of a business– Total value of a business


Impact of Economic Impact of Economic ConditionsConditions

•Some firms are more sensitive to changes in economic conditions than others:– Demand for fast food demand is not very

sensitive to declining economic conditions.– Demand for new automobiles is more

sensitive to weak economic conditions than food products.


Harley Davidson ExampleHarley Davidson Example•Demand for motorcycles is stronger when: – The economy is strong.– Customers have more income to buy

motorcycles.

•High demand for Harley Davidson’s motorcycles:– Generates greater revenue.– Improves company performance.


Harley Davidson ExampleHarley Davidson Example•Demand for motorcycles is weaker when: – The economy is weak.– Customers have less income to buy

motorcycles.

•Lower demand for Harley Davidson’s motorcycles:– Generates less revenue.– Weakens company performance.


Harley Davidson ExampleHarley Davidson Example•Harley Davidson tries to predict demand so it will have a sufficient supply of motorcycles to meet future demand.– Demand for motorcycles depends on

economic conditions.– Number of motorcycles produced also

depends on economic conditions.

•Government policies also affect economic conditions.


Harley Davidson ExampleHarley Davidson Example•Harley Davidson must determine:

– How prevailing economic conditions will affect the demand for the motorcycles it produces.

– How prevailing government policies will affect the demand for its motorcycles.


Macroeconomic Effects Macroeconomic Effects • The performance of most firms depends on three macroeconomic factors:– Economic growth

Changes in the general level of economic activity

– Inflation Increases in general level of prices over

specific period of time

– Interest rates Changes in the cost of borrowed money


Economic GrowthEconomic Growth•When the change in the general level of economic activity is higher than normal:– Total income level of all U.S. workers is

relatively high.– There is a higher volume of spending on

products and services.– Firms that sell products and services should

generate higher revenues.


RecessionRecession• Occurs when economic growth is negative for two consecutive quarters

• Lowers demand for products and services– Reduces the revenue of firms that sell products

and services.– Can cause firms to shut down factories in

response to low economic growth. General Motors Ford


Indicators of Economic Indicators of Economic GrowthGrowth

•Gross Domestic Product (GDP)– The level of total production of products and

services in the economy– Total market value of all final products and

services produced in the U.S.

•Aggregate Expenditures– Total amount of expenditures


Trend of Gross Domestic Product Trend of Gross Domestic Product (GDP)(GDP)

Exhibit 4.1


Indicators of Economic Indicators of Economic GrowthGrowth

• In the U.S., these indicators are closely related:– High level of consumer spending reflects a

large demand for products and services.– Total production level depends on total

demand for products and services.


Alternative Indicators Alternative Indicators of Economic Growthof Economic Growth

•Unemployment level• Industrial production level•New housing starts•Personal income level


Unemployment LevelsUnemployment Levels• Frictional unemployment– People who are

between jobs.

• Seasonal unemployment– People whose

services are not needed during some seasons.

• Cyclical unemployment– People unemployed

due to poor economic conditions.

– Best indicator of economic conditions.

• Structural unemployment– People who do not

have adequate skills.


Trend of U.S. UnemploymentTrend of U.S. Unemployment

Exhibit 4.2


InflationInflation•An increase in the general level of prices of products and services over a specified period of time.– Estimated by measuring percentage

changes in the consumer price index (CPI).– CPI is a market basket of prices on a wide

variety of consumer products: Grocery products, housing, gasoline,

medical services, electricity, etc.


U.S. Inflation Rates over U.S. Inflation Rates over TimeTime

Exhibit 4.3


Impact of InflationImpact of Inflation•Can affect a company’s operating expenses– Can increase cost of supplies and materials.– Can impact indexed wages (labor cost).– Higher inflation can cause large increases in

operating expenses.

•Can affect a company’s revenues– Companies may charge higher prices to

compensate for their higher expenses.


Cost-Push InflationCost-Push Inflation•Occurs when firms must charge higher prices because their production (input) costs are higher.– Change in price of oil impacts gasoline

prices and transportation costs.– Change in aluminum prices impacts

packaging cost of beer production.– Change in pulp prices impacts the cost of

paper towel production.


Demand-Pull InflationDemand-Pull Inflation•Occurs when product and services prices are pulled up by consumer demand.– Strong consumer demand can cause

shortages in the production of products. Firms that anticipate shortages may

increase prices for their products.

– Strong consumer demand may put pressure on wages and reduce unemployment. Firms may increase prices to recover higher

operating expenses.


Interest RatesInterest Rates• Represent the cost of borrowing money– Firm’s interest expense is based on market

interest rates and can have significant impact on a firm’s profitability. Firms may postpone expansion and other

projects when interest rates are too high.

– Interest rates also impact a firm’s revenue The increased cost of financing new homes

reduces demand for new homes. Revenues for construction firms and

equipment manufacturers also decline.


Effect of Interest Effect of Interest Rates Rates

on Interest on Interest Expenses Expenses and Profitsand Profits

Exhibit 4.4

Note: Assume that the firm’s revenue equals $400,000 and its operating expenses equal $300,000.


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How Macroeconomic Factors How Macroeconomic Factors Affect a Firm’s ProfitsAffect a Firm’s Profits

Exhibit 4.5


Market Price Market Price DeterminationDetermination

•Market price of a product is influenced by: – The total demand for that product by all

customers– Supply of that product produced by firms

•The interaction between demand and supply determines the market price.


Demand and SupplyDemand and Supply•Demand schedule

– Indicates the quantity of the product that would be demanded by customers at each possible price.

– Quantity demanded is higher when the price is lower.


How the Equilibrium Price is How the Equilibrium Price is Determined by Supply and DemandDetermined by Supply and Demand

Exhibit 4.6a


How the Equilibrium Price is How the Equilibrium Price is Determined by Supply and DemandDetermined by Supply and Demand

Exhibit 4.6b


Demand and Supply Demand and Supply (cont’d)(cont’d)

•Supply schedule– Indicates the quantity of the product that

would be supplied (produced) by manufacturers at each possible price.

– Quantity supplied (produced) is higher when the price is higher.


Interaction of Supply and Interaction of Supply and DemandDemand

• Interaction of demand and supply schedules determines the market price– Surplus: the quantity supplied by firms is

more than the quantity demanded by customers.

– Shortage: the quantity supplied by firms is less than the quantity demanded by customers.

– Equilibrium price: occurs when quantities supplied and demanded are equal.


Impact of Shifts in Impact of Shifts in DemandDemand

•Changing conditions can cause a demand schedule or supply schedule for a specific product to change.– Changes the equilibrium price of a product.

Increased product popularity (demand) results in a shortage of the product.

The shortage is corrected when the price is increased to the level at which the quantity supplied equals the quantity demanded.


How the Equilibrium Price is How the Equilibrium Price is Affected by a Change in DemandAffected by a Change in Demand

Exhibit 4.7


Impact of Shifts in SupplyImpact of Shifts in Supply•Change in supply can impact the equilibrium price of the product.– Technological improvements can lead to

reduced production costs causing firms to produce a larger supply at any given price. The supply schedule changes and yields a

surplus which can be sold only by lowering the price.

The surplus is eliminated when the price decreases to a level at which the quantity supplied equals the quantity demanded.


How the Equilibrium Price is How the Equilibrium Price is Affected by a Change in SupplyAffected by a Change in Supply

Exhibit 4.8


Factors Influencing Market Factors Influencing Market PricesPrices

•Consumer income– Determines the amount of products and

services individuals can purchase High levels of economic growth result in

more income for consumers. Increased demand causes demand

schedule shifts and price increases.

– When consumer income declines: Demand decreases and creates a surplus

as the demand schedule shifts and prices decrease.



•Changes in consumer tastes and preferences:– Impact the quantity of products and services

demanded by consumers Increased demand leads to price increase. Decreased demand leads to price decrease.



•Change in production expenses– A decrease in expenses can lead to increase

in quantity supplied and create a surplus. Firms must lower prices in order to

eliminate the surplus.

– An increase in expenses can lead to decrease in quantity supplied and create a shortage. Firms can increase prices until shortage is

corrected.


Monetary Policy Monetary Policy Impacts Economic Impacts Economic

ConditionsConditions•Monetary policy

– Made by the Federal Reserve System “Fed” is the central bank of the U.S.

– Decisions by Fed about the money supply: Impact interest rates. Impact firms’ interest expenses. Impact demand for products purchased

with borrowed funds.


Fed’s Impact on Interest Fed’s Impact on Interest RatesRates

•Maintains funds outside the banking system that are not loanable to firms or individuals

Used to buy Treasury securities held by individuals and companies

Provide individuals and firms with new funds for deposit in commercial banks– Deposits increase the money supply and the

supply of loanable funds.– Should result in decreased interest rates and

stimulate economic growth.


Fed’s Impact on Interest Fed’s Impact on Interest RatesRates

•Fed can pull funds out of commercial banks and other financial institutions to reduce the money supply.– Reduces the supply of funds available to

lend to borrowers (shortage) causing: Interest rates to increase. Individuals and companies to borrow less. Spending levels to decrease. The level of inflation to decline.


Fiscal PolicyFiscal Policy•How the federal government sets tax rates and spends money:– Personal income tax rates

Reduced tax rates produce higher after-tax incomes that stimulate spending and increase demand for products and services.

– Corporate taxes Impacts after-tax earnings

– Excise taxes Taxes on particular products that increase

prices consumers pay for these products.


Fiscal PolicyFiscal Policy•Sets the amounts of federal tax revenue government and federal spending– Federal budget deficit

Occurs when federal spending exceeds federal taxes and other revenue collected by the federal government.

Government borrowing to make up the difference creates higher demand for loanable funds and can drive up interest rates.


Example of How a Budget Deficit Example of How a Budget Deficit OccursOccurs

Exhibit 4.9


How Government Policies Affect How Government Policies Affect Business PerformanceBusiness Performance

Exhibit 4.10


Federal Government’s Federal Government’s Dilemma Dilemma

•A restrictive monetary or fiscal policy can be used to:– Maintain low rate of economic growth

Prevent inflationary pressure caused by excessive demand

Can also create unemployment

– Also requires a trade-off


Chapter SummaryChapter Summary•Firm performance depends on three macroeconomic factors: economic growth, inflation, and interest rates.

•Demand and supply conditions determine market prices.

•Federal government uses monetary and fiscal policies to influence macroeconomic conditions.

part ii: business environment introduction to business 3e 4 copyright © 2004 south-western. all...

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