capitalism A broad economic system where

competition in a free market determines the price, production and consumption of goods and services through the “invisible hand” of supply and demand

socialism Broad economic system in which the major

enterprises are either owned or controlled by the state

What companies are going to flourish in the future?

Starting the LAF mutual fund

The role of profits… and losses

Chile mine disaster In August 2010, 33 miners were trapped 2,300

feet underground in a mine in Chile They were three miles from the entrance It was presumed they were killed in collapse 17 days after the accident, a bore hole drilled

came back with a note: "Estamos bien en el refugio, los 33" (English: "We are well in the shelter, the 33“)

‘Capitalism Saved the Miners’

Wall Street Journal

“If those miners had been trapped a half-mile down like this 25 years ago anywhere on earth, they would be dead. What happened over the past 25 years that meant the difference between life and death for those men? Short answer: the Center Rock drill bit.”

“The Center Rock drill… is in fact a piece of tough technology developed by a small company in it for the money, for profit. That's why they innovated down-the-hole hammer drilling. If they make money, they can do more innovation.”

“The profit=innovation dynamic was everywhere at that Chilean mine... In an open economy you will never know what is out there on the leading developmental edge of this or that industry. The miners’ rescue is a thrilling moment for Chile... But I’m thinking of that 74-person outfit in Berlin, Pa., whose high-tech drill bit opened the earth to free them...”

What are the world’s freest economies? Hong Kong, 20th consecutive year Singapore, Australia, Switzerland, New

Zealand Canada, Chile, Mauritius, Ireland, Denmark

So, what did we learn from Chapter 6?

Profits and Losses Remember: P&L play equally important roles

in maintaining and advancing the standards of living of the country

Profits and Losses Remember: P&L play equally important roles

in maintaining and advancing the standards of living of the country

Both P&L force efficiencies on companies

Profits and LossesRemember: P&L play equally important roles

in maintaining and advancing the standards of living of the country

Both P&L force efficiencies on companiesNo accident that people in free markets have

higher standards of living than those in controlled economies

Profits and losses When one business in a market economy –

aka capitalism – finds a way to lower costs, competitors usually have to do the same

Profits and losses When one business in a market economy –

aka capitalism – finds a way to lower costs, competitors usually have to do the same

Wal*Mart lowers food prices by 6-12% when it rolls into town

Profits and losses When one business in a market economy –

aka capitalism – finds a way to lower costs, competitors usually have to do the same

Wal*Mart lowers food prices by 6-12% when it rolls into town

How city of Sarasota responds: $5 million subsidy for Whole Foods, refuses to allow Wal*Mart to build on Ringling Avenue

Mystery: why aren’t prices lower in socialist nations with no profits??

Profits, take 2 Hope for profits and threat of losses force

capitalists to produce at the lowest cost and sell what customers are willing to buy… i.e., an incentive to be as efficient as possible with scarce resources that have alterative uses

Profits, take 2 Hope for profits and threat of losses force

capitalists to produce at the lowest cost and sell what customers are willing to buy… i.e., an incentive to be as efficient as possible with scarce resources that have alterative uses

Consumers gain when companies fight to earn profits and avoid losses through lower prices and innovation

More about ProfitsProfits are the price paid for efficiency

More about ProfitsProfits are the price paid for efficiency If the cost of the profits exceeded the value of

the efficiency they promoted, then non-profits like governments and schools could get the same things done cheaper or better than for-profit companies

More about ProfitsProfits are the price paid for efficiency If the cost of the profits exceeded the value of

the efficiency they promoted, then non-profits like governments and schools could get the same things done cheaper or better than for-profit companies

Fat chance… governments outsourcing of garbage, janitorial services, payrolls, security, prisons to private businesses

Even more about profits While capitalism has a visible cost – profits –

that does not exist under socialism, socialism has an invisible cost: inefficiency

Even more about profits While capitalism has a visible cost – profits –

that does not exist under socialism, socialism has an invisible cost: inefficiency

Profit is the price paid for efficiency

Even more about profits While capitalism has a visible cost – profits –

that does not exist under socialism, socialism has an invisible cost: inefficiency

Profit is the price paid for efficiency History shows that capitalism has had far

more people living well than socialism

Greedy capitalists

Myths about profits “Greed” drives profits, resulting in higher

prices for consumers

Myths about profits “Greed” drives profits, resulting in higher

prices for consumers Fact: most fortunes have been made by

companies making things cheaper for consumers… Wal*Mart, Facebook, Henry Ford, Dell, Google

Myths about profits Profit margins for American business are

obscene

Myths about profits Profit margins for American business are

obscene Average rate of return on investments ranged

from 2.2-7.8% from 1960-2005

Profits redux In private business, the owner is an

“unmonitored monitor” rather than having layers of authorities

Profits redux In private business, the owner is an

“unmonitored monitor” rather than having layers of authorities

Self-interest takes the place of external monitors and forces attention to detail… driving efficiency

Profit Rates Gross profit on sales: buy something for $10

and sell it for $15

Profit Rates Gross profit on sales: buy something for $10

and sell it for $15 Net profits: profits after overhead such as

employees, electricity, inventories, taxes, etc. are accounted for

Profit Rates Gross profit on sales: buy something for $10

and sell it for $15 Net profits: profits after overhead such as

employees, electricity, inventories, taxes, etc. are accounted for

Profit on investment (aka, Return on Investment or ROI): most important measure, because it’s what causes $ to flow to various sectors

Costs of Production Crucial factor in determining prices and profits

Costs of Production Crucial factor in determining prices and profits No set cost for producing anything: it costs a

lot more to make 1,000 of something than 100 million

Costs of Production Crucial factor in determining prices and profits No set cost for producing anything: it costs a

lot more to make 1,000 of something than 100 million

Costs of Production Crucial factor in determining prices and profits No set cost for producing anything: it costs a

lot more to make 1,000 of something than 100 million

Economies of scale: up to a certain point, it’s cheaper to make more of the same thing because you spread fixed costs over larger units of output, whether cars or pizzas

“Lower costs/unit of output as numbers increase is economy of scale”

Costs of production Advertising can actually improve sales and

profits if it causes more units to be sold

Costs of production Diseconomy of scale: there is a point where

the enterprise gets so large, it’s difficult to coordinate and monitor

Costs of production Diseconomy of scale: there is a point where

the enterprise gets so large, it’s difficult to coordinate and monitor

J&J is a $65 billion company broken up into 250 subsidiaries

Costs of production Diseconomy of scale: there is a point where

the enterprise gets so large, it’s difficult to coordinate and monitor

J&J is a $65 billion company broken up into 250 subsidiaries

Many big companies become stagnant and inefficient: GM, Microsoft

Costs of production Diseconomy of scale: there is a point where

the enterprise gets so large, it’s difficult to coordinate and monitor

J&J is a $65 billion company broken up into 250 subsidiaries

Many big companies become stagnant and inefficient: GM, Microsoft

McDonald’s grows through franchises to ensure local knowledge

Costs and Capacity Costs not only vary with the volume of output,

they also vary according to the extent to which capacity is being used

Costs and Capacity Costs not only vary with the volume of output,

they also vary according to the extent to which capacity is being used

In many industries, capacity must be built to handle peak volume, i.e., electricity companies, computer networks, phone companies

Costs and Capacity Costs not only vary with the volume of output,

they also vary according to the extent to which capacity is being used

In many industries, capacity must be built to handle peak volume, i.e., electricity companies, computer networks, phone companies

Priceline and Travelocity responded to excess capacity in travel industry

‘Passing on’ costs/savingsPassing on of costs depends on competition

‘Passing on’ costs/savingsPassing on of costs depends on competitionMyth that companies can charge whatever

they want

‘Passing on’ costs/savingsPassing on of costs depends on competitionMyth that companies can charge whatever

they want If you develop a new technology that lowers

your production costs, you can either keep the extra profit or lower your price and sell more

‘Passing on’ costs/savingsPassing on of costs depends on competitionMyth that companies can charge whatever

they want If you develop a new technology that lowers

your production costs, you can either keep the extra profit or lower your price and sell more

Over time, competitors will match your advantage… thus constant innovation is essential

Specialization and Distribution A businesses is limited in the range of

functions it can perform efficiently

Specialization and Distribution A businesses is limited in the range of

functions it can perform efficiently Car companies buy tires, stereos, many other

parts

Specialization and Distribution A businesses is limited in the range of

functions it can perform efficiently Car companies buy tires, stereos, many other

parts Computer makers buy chips, screens,

sometimes most of their machines

Specialization and Distribution A businesses is limited in the range of

functions it can perform efficiently Car companies buy tires, stereos, many other

parts Computer makers buy chips, screens,

sometimes most of their machines Many companies buy janitorial, security,

payroll, accounting, ‘back office’ services

No, ‘middlemen’ are not baddiesGoods tend to flow to their most valued uses

in a free market and are more valuable to those who can handle them more efficiently at a given stage

No, ‘middlemen’ are not baddiesGoods tend to flow to their most valued uses

in a free market and are more valuable to those who can handle them more efficiently at a given stage

Furniture makers don’t own stores, many farmers don’t have transportation services

No, ‘middlemen’ are not baddiesGoods tend to flow to their most valued uses

in a free market and are more valuable to those who can handle them more efficiently at a given stage

Furniture makers don’t own stores, many farmers don’t have transportation services

What connects the self-interest of a company with the efficiency of the economy as a whole are prices

Distribution Middlemen can typically distribute products

more efficiently, whether in a developed or developing nation

Distribution Middlemen can typically distribute products

more efficiently, whether in a developed or developing nation

Socialist countries often eliminate middlemen and specialists at great sacrifices of efficiency

“These are the people who steal your salary.” Argentina

Assignment February 18 Chapter 7: “Big Business and Government”