**Understanding How Economics Affects Business*Chapter TwoCopyright 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

*What Is Economics?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 nations economy as a whole.

Microeconomics -- Concentrates on the behavior of people and organizations in markets for particular products or services.

The MAJOR BRANCHES of ECONOMICSLG1*2-*

*Resource Development -- The study of how to increase resources and create conditions that will make better use of them.What Is Economics?RESOURCE DEVELOPMENTLG1*2-*

*The Secret to Creating a Wealthy EconomyMalthus believed that if the rich had most of the wealth and the poor had most of the population, resources would run out.

Based on this belief, economics has been called The Dismal Science.

Neo-Malthusians believe there are too many people in the world and believe the answer is radical birth control.

THOMAS MALTHUS and the DISMAL SCIENCELG1*2-*

**Contrary to Malthus, some economists believe a large population can be a resource.

An educated population is highly valuable.

Business owners provide jobs and economic growth for their employees and communities as well as for themselves.

The Secret to Creating a Wealthy EconomyPOPULATION as a RESOURCELG12-*

*Adam Smith & the Creation of WealthSmith believed that:

Freedom was vital to any economys 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.

ADAM SMITH the FATHER of ECONOMICSLG1*2-*

*How Businesses Benefit the CommunityAs people improve their own situation in life, they help the economy prosper through the production of goods, services and ideas.

Invisible Hand -- When self-directed gain leads to social and economic benefits for the whole community.

The INVISIBLE HAND CONCEPTLG1*2-*

*A farmer earns money by selling his crops.To earn more, the farmer hires farmhands to produce more crops.When the farmer produces more, there is plenty of food for the community.The farmer helped his employees and his community while helping himself.How Businesses Benefit the CommunityUNDERSTANDING the INVISIBLE HAND CONCEPTLG1*2-*

**Understanding Free-Market CapitalismCapitalism -- 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 StatesEnglandAustraliaCanadaCAPITALISMLG22-*

**The Foundations of CapitalismThe right to own private property.The right to own a business and keep all that business profits.

The right to freedom of competition.

The right to freedom of choice.CAPITALISMS FOUR BASIC RIGHTSLG22-*

**How Free Markets WorkFree Market -- Decisions about what and how much to produce are made by the market.

Consumers send signals about what they like and how they like it.

Price tells companies how much of a product they should produce. If something is wanted but hard to get, the price will rise until more products are available.FREE MARKETSLG22-*

**How Prices are DeterminedA seller may want to sell shirts for $50, but only a few people can buy them at that price.

If the seller lowers the price to $30, more people buy the shirts.

The seller establishes a price of $30 based on what consumers are willing to pay.PRICINGLG22-*

**The Economic Concept of SupplySupply -- The quantities of products businesses are willing to sell at different prices.SUPPLY CURVESLG22-*

**The Economic Concept of DemandDemand -- The quantities of products consumers are willing to buy at different prices.DEMAND CURVESLG22-*

**The Equilibrium Point or Market PriceMarket Price (Equilibrium Point) -- Determined by supply and demand, this is the negotiated price.EQUILIBRIUMLG22-*

**Competition Within Free Markets Perfect CompetitionMonopolistic CompetitionOligopoly Monopoly FOUR DEGREES of COMPETITIONLG22-*

Market StructurePerfect Competition: Many sellers in a market and none is large enough to dictate the price.Local example: vegetables in wet markets

Monopolistic Competition: A large number of sellers produce similar products.Local example: Chinese restaurants

Market StructureOligopoly: A few sellers dominate a market.Local example: supermarkets

Monopoly: one seller controls the total supply and sets the price.Local example: public utilities

**Benefits and Limitations of Free MarketsBenefits:It allows for open competition among companies. Provides opportunities for poor people to work their way out of poverty.

Limitations:People may start to let greed drive them, and lead to financial crises.Social problems, such as uneven distribution of income and environmental degradation. FREE MARKET BENEFITS and LIMITATIONSLG22-*

**Understanding SocialismSocialism -- 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 Government is more involved in protecting the environment and the poorSOCIALISMLG32-*

**The Benefits of SocialismSocial equalityFree educationFree healthcareFree childcareLonger vacationsShorter work weeksGenerous sick leaveSOCIALISM BENEFITSLG32-*

**The Negative Consequences of SocialismFew incentives for businesspeople to take risks.Brain Drain: Some of a countries best and brightest workers (i.e. doctors, lawyers and business owners) move to capitalistic countries.Fewer inventions and innovations because the reward is not as great as in capitalist countries.The NEGATIVES of SOCIALISMLG32-*

**Understanding CommunismCommunism -- An economic and political system in which the government makes almost all economic decisions and owns almost all the major factors of production.

Prices dont 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.COMMUNISMLG32-*

**The Trend Toward Mixed EconomiesFree-Market Economies -- The market largely determines what goods and services are produced, who gets them, and how the economy grows.Command Economies -- The government largely determines what goods and services are produced, who gets them, and how the economy will grow.TWO MAJOR ECONOMIC SYSTEMSLG42-*

**The Trend Toward Mixed EconomiesMixed 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.MIXED ECONOMIESLG42-*

**The Trend Toward Mixed EconomiesCommunist governments are disappearing.

Mostly socialist governments are cutting back on social programs, lowering taxes and moving toward capitalism.

Mostly capitalist countries are increasing social programs and moving toward more socialism.

TRENDING TOWARD MIXED ECONOMIESLG42-*

**Gross Domestic ProductGross 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 countrys border, their numbers go into the countrys GDP (even if they are foreign-owned).

When the GDP changes, businesses feel the effect.

High GDP often enables the citizens to enjoy a high standard of living.GROSS DOMESTIC PRODUCTLG52-*

**The Unemployment RateUnemployment Rate -- The percentage of working population who are unemployed and tried to find a job within the prior four weeks.

Four Types of UnemploymentFrictionalStructuralCyclical Seasonal

UNEMPLOYMENTLG52-*

**Inflation and Price IndexesInflation -- The general rise in the prices of goods and services over time.

Disinflation -- When the price increases are slowing (inflation rate declining).

Deflation -- Prices are declining because too few dollars are chasing too many goods.

Stagflation -- Economy is slowing but prices are going up.INFLATIONLG52-*

**Consumer Price Index (CPI) -- Monthly statistics that measure the pace of inflation or deflation.

The government computes the costs of goods and services (housing, food, apparel, medical care, etc.) to see if they are going up or down.

Inflation and Price IndexesPRICE INDEXLG52-*

Main Economic Indicators in HKGDP in 2013 at market price: 2,125 billions GDP per capita in 2013: 295,700Unemployment rate in 2013: 3.4Composite consumer price index in 2013: 115.1, as compared to 110.3 in 2012 (the base year is 2009/10 which is 100) Attention should be paid to the trends (upward/downward) of economic indicators

**Productivity inthe United StatesProductivity in the service sector grows slowly because of less new technology.

Productivity in the U.S. has risen due to the technological advances that have made production faster and easier.

PRODUCTIVITYLG52-*

**Productivity inthe Service SectorThe higher the productivity, the lower the costs of producing goods and services. This helps lower prices.

New technology also adds to the quality of the services provided but not to the workers output.

A new form of measurement needs to be created to account for the quality as well as the quantity of output.PRODUCTIVITY in the SERVICE SECTORLG52-*

**The Business CycleBusiness Cycles -- Periodic rises and falls that occur in economies over time. Four Phases of Long-Term Business Cycles:Economic BoomRecession Two or more consecutive quarters of decline in the GDP.Depression A severe recession.Recovery When the economy stabilizes and starts to grow. This leads to an economic boom.BUSINESS CYCLESLG52-*

**Stabilizing the Economy Through Fiscal PolicyFiscal Policy -- The governments efforts to keep the economy stable by increasing or decreasing taxes or government spending. Tools of Fiscal Policy:TaxationGovernment Spending

FISCAL POLICYLG62-*

**National Deficit -- The amount of money the federal government spends beyond what it gathers in taxes.

National Debt -- The sum of government deficits over time.

National Surplus -- When government takes in more than it spends.Stabilizing the Economy Through Fiscal PolicyNATIONAL DEFICITS, DEBT and SURPLUSLG62-*

**Using Monetary Policy to Keep the Economy GrowingMonetary Policy -- The management of the money supply and interest rates by the Central Bank or the Federal Reserve Bank (the Fed) in the U.S.

The Feds most visible role is increasing and lowering interest ratesWhen 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 POLICYLG62-*

*.

Businesses can contribute to an economic system by inventing new products that increase the availability of resources.

*********Perfect Competition:High degree of competition You dont need to buy the item from a particular sellers Its difficult to find perfect competition in the real worldMonopolistic Competition:You have different choice Many Company give the customers have a picture that it is unique Sucees key: how to make the products different/ unqiue form other products

*Why oligopoly?The industry requires a very high investment in order to enter the market The price they set apart from the others seller at the simialr prices The action of one comeptitor will affect the action of others e.g. one of the frim in this market reduce the price, the other firm will follow Because they dont want to lose the market share, they will lose the customers due to the lower price provdied by the other firms

Monopoly?Who control the supply and set the price without other compeition Strong market power As the consumer you have no choice there is only one supply The firm may set a high price/ increase the price earn more profit This may harm the benefit of consumer So the govt may set the rules to restrict the firm in monopoly e.g. restirct the price increase or put some profit sharing (they can only get a certain amount of profit)In hong kong, the govt have scheme of control sign a long term contract with the firm and the profit is subjected to weight of return control allow profit protect the interest of citizens

*With more competition improve efficiency

Citizens will as the goveremnt to have more restirciotn and law to due with the environment and social problem

They can make profit, common people can earn income subject to high taxesThe governmet tend to involve more the enviornment helping the poor they think everyone should be equal they are a kind of welfare states

*H*High taxes is one of the solution for socialism When they earn more more money will be taken so why will they take risk

These all factors will affect the growth rate of business Because few innvation smart people move out the country less developing rate

Have the finical problem in the governemtFail to collect enough money from the tax to fininace these activitiesHave a heavy finical problem

The government play a dominant role in decifing all kind of business activites Capital, land, are all owned by the government The governmetn will assign you a job The government make all the decision The typical situation is that They have the central planning by the senior governemt officers They will develop some production inticator how many product they should produce a year They reset the quota for individual conssumption (e.g. how much food we consume) The government may produe some product that no one buy waste resources

Under communism It didnt encouagr the business man and workers to work hard The productivity remian low for a period of time No imporvment Thus, communism contries didnt; exit much now Another problem is cooruption Those senior officer may abuse the power to bring their own benefits serious corruption

*The major trend is socialist

Comand Economics ---------------mixed economics (blend of 2 systems) -------------- Free market

The solution is allow more economic freedom for the citizens

Capitalism: ask for more governemt regulation Free market: no pure capitalism more countrites becomes the mized economics system

*Cutting back the social services lower the tax rate move to socialism economic situation can be improved

Why know GDP?It indicate the growth rate of the economy When the GDP increase, the economic situation improve generate more proftis and revenue hire more employee A high GDP enable the citizens to enjoy a high standard of living high level of economic development

*# of unemployed / working population X 100% = unemployment rate

Unemplyment need to fulfil 3 conditions:

Fritctioal:People dont have a job, they quit the job because these people dont like the job and the boss

Structural :Refer to economic structuerDue to the restruturing of the econmic situation, however, the people loss the job and fail to find another job in other sector Because there is mismatch of workers and job nature

CyclicalRelate to business cycleThe business will go up and down sometimesPeople may be laid off, they lose their job during the econmoic downtuurn However, if the econmy recover, the problem can be resolved the compnay start to hire more worker

Seasonal There is hit season in business In some industry, such as retialer, the christmas holiday they will do more business In that case, some firm will hire more workers (seasonal worker), short term , part time worker When they hire more, the unemploymnet rate will go down But in some season, there is less bsuinsess to do , they will not hire the part time worker, and even laid off the long term worker incerase unemploymnet ratee.g. tourism

*Deflation We dont have enough money, but there are many products So it will attract people to buy If many suppliers lower the price deflation

Stagflatino We are not in a good economic situation When the economy has a recession, unemployment rate increaseThe economy is slowing but the price is going up

We use price index (consumer price index CPI) to show the degree of inflation the monthly statistice to measuere the inflation and defaltion

**It is quite high among the internation city

The most recent statistics of GDP increase 2.7% in the 3rd quatar of 2014vs 2013

Unemployment in 2014: 3.3 % decreased during the period of October to December !!!!!!!!!!!

*Productivity is lowering because lack technology in the service sector The nature of sWhen we have recession there will be unemployment

*Fiscal policy To influence the economy When the governent cut the tax, it will stimulate more consumption People would consume more The goverbmet launch more project create forces to have more investment from the business manStimulate the economic growth More jobs Lower the unemployment rate

The government over-heat Increase poperty/ income taxReduce government spending

Taxes increase consumption decreaseSpending decrease investment increaseThus economic situation is worse *When government spend more money national deficit They cannot collect enough money to cover all the expenditure They would borrow money from other countreis national deficit it thus becomes a national debt

National surplus Monetary policy

With higher interest rate, the business sector invest less as the interst rate increase Lower incentive in business sector to start a new project

Citizens will consume less as interst rate increase, you need to pay more when you use credit card

So interest rate increase consumption and investment decrease economy will be pulled down

When the interest rate lower down the cost of borrowing money decresaseThe business could easier borrow money, they are willing to invest As individual, they will also spend more money, Stimulate the whole economy economic broom to launch new project and hire more people

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