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Chapter 1: The Fundamentals of Business and Economics

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Chapter 1 Objectives:After studying this chapter, you will be able to:

1. Define what a business is and identify four vital social and economic

contributions that businesses make.

2. Differentiate between goods-producing and service businesses, and list five

factors contributing to the increase in the number of service businesses.

3. Differentiate between a free-market system and a planned system.

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Chapter 1 Objectives, cont.

4. Explain how supply and demand interact to affect price.

5. Discuss the four major economic roles of the U.S. government.

6. Explain how a free-market system monitors its economic performance.

7. Identify five challenges you will face as a business professional in the coming

years.

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In this course you’ll learn what it takes to run a business. As you progress though

this course, you’ll begin to look at things from the eyes of an employee or a

manager instead of a consumer. You’ll develop a fundamental business

vocabulary that will help you keep up with the latest news and make more

informed decisions. By participating in classroom discussions and completing the

chapter exercises, you’ll gain some valuable critical-thinking, problem-solving,

team-building, and communication skills that you can use on the job and

throughout your life.

Should you decide to pursue a career in business, this course will introduce you

to a variety of jobs in fields such as accounting, economics, human resources,

management, finance, marketing, and so on. You’ll see how people who work in

these business functions contribute to the success of a company as a whole.

You’ll gain insight into the types of skills and knowledge these jobs require. And

most important, you’ll discover that a career in business today is fascinating,

challenging, and often quite rewarding.

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This slide includes an image that relates profit and non-profit institutions. It

includes the subcategories shared by both for Social Service and Money Motive.

It ultimately links to Ethical Conduct with leads to efficiency and effectiveness,

and finally to Social Responsibility.

A business is a profit-seeking activity that provides goods and services that

satisfy consumers’ needs. The driving force behind most businesses is the

prospect of earning a profit—what remains after all expenses have been

deducted from business revenue. Still, not every organization exists to earn a

profit. Nonprofit organizations exist to provide society with a social or

educational service.

Although nonprofit organizations do not have a profit motive, they must operate

efficiently and effectively to achieve their goals. Thus, the business opportunities,

challenges, and activities discussed throughout this textbook apply to both profit-

seeking and nonprofit organizations. Moreover, to be successful, both profit-

seeking and nonprofit organizations must be socially responsible and ethical

when dealing with investors, employees, customers, the community, and society.

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Although difficult to define, Web 2.0 can be described as a shift in the philosophy

and technology of the Word Wide Web, from static, isolated, and tightly

controlled websites to connected, interactive, user-driven services.

Technologies often included under the Web 2.0 umbrella include blogging,

podcasting, wikis, newsfeeds, tagging, and virtual worlds

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This slide depicts a factory worker and describes the goods-producing business

as capital intensive. On the right, it includes a picture of a customer service

representative with a line of customers she is helping, with an explanation that

Service is Labor Intensive

Goods-producing businesses primarily produce tangible goods by engaging in

activities such as manufacturing, construction, mining, and agriculture. Because

they require large amounts of money, equipment, land, and other resources to

get started and to operate, goods-producing businesses are often capital-intensive businesses

Rather than creating tangible goods, service businesses perform activities for

customers. This category includes finance, insurance, transportation, utilities,

wholesale and retail trade, banking, entertainment, health care, repairs, and

information. Nordstrom, Jiffy Lube, and eBay are examples of service

businesses. Service businesses tend to be labor-intensive businesses, in that

they rely more on human resources than buildings, machinery, and equipment to

prosper

Slide 8

This slide includes an image of a bank teller providing customer service to a

customer.

Over the past few decades, the U.S. economy has undergone a profound

transformation from being dominated by manufacturing to being dominated by

services. The service sector now accounts for 70 to 80 percent of the nation’s

economic output, and service business will continue to create the vast majority of

new jobs.

Many consumers have more disposable income. The 76 million baby boomers in

the United States (people born between 1946 and 1964) are in their peak earning

years and look for services to help them invest, travel, relax, and stay fit.

Services target changing demographic patterns and lifestyle trends. As the

population changes, businesses find opportunities in providing services that

people can’t or don’t do for themselves, from in-home care for an increasingly

aging population to self-storage units for people who’ve used their increasing

incomes to buy more stuff than they can fit in their homes.

Services are needed to support complex goods and new technology. From home

theaters to automated production systems, many goods now require specialized

installation, repair, user training, or extensive support services.

Companies are increasingly seeking professional advice. Many firms turn to

professional advisers for help as they seek ways to cut costs, refine processes,

expand internationally, and harness the power of the Internet and other

technologies.

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This slide includes a three-circle interconnecting graphic that depicts the

relationship between microeconomics and macroeconomics.

Economics is the study of how a society uses its scarce resources to produce

and distribute goods and services. The study of economic behavior among

consumers, businesses, and industries who collectively determine the quantity of

goods and services demanded and supplied at different prices is termed

microeconomics. The study of a country’s larger economic issues, such as how

firms compete, the effect of government policies, and how an economy maintains

and allocates its scarce resources, is termed macroeconomics.

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This slide depicts an arrow facing right with text boxes visually explaining how

the fie factors of production are related.

Natural resources are things that are useful in their natural state, such as land,

forests, minerals, and water. Human resources are people—anyone from

company presidents to grocery clerks who work to produce goods and services.

Capital includes resources such as money, computers, machines, tools, and

buildings that a business needs in order to produce goods and services.

Entrepreneurship is the spirit of innovation, the initiative, and the willingness to

take the risks involved in creating and operating new businesses (see Exhibit

1.2). Knowledge is the collective intelligence of an organization. Knowledge

workers are employees whose primary contribution to their companies involves

the acquisition, analysis, and application of information.

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This slide shows how Scarce resources – human resources, capital,

entrepreneurs, knowledge and natural resources – are factors of production

which lead to goods or services being created. This is known as an Economic

System.

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This slide includes a graphic that shows the Free-Market System on the left and a

Planned System on the right of a linear spectrum. Beneath this is the spectrum of

economic freedom from most free to least free: left to right is Capitalism, Mixed

Capitalism, Socialism and Communism. Beneath this being linked from the Planned

System is Privatization.

The role that individuals and government play in allocating a society’s resources depend

on the society’s economic system, the basic set of rules for allocating a society’s

resources to satisfy its citizens’ needs. Two main economic systems exist today: free-

market systems and planned systems.

In a free-market system, individuals are free to decide what products to produce, how to

produce them, whom to sell them to, and at what price to sell them. Capitalism is the

term used to describe the free-market system. In modern practice, however, the

government sometimes intervenes in free-market systems to influence prices and wages

or to change the way resources are allocated. This practice of limited intervention is

called mixed capitalism.

In a planned system, governments control all or part of the allocation of resources and

limit the freedom of choice. The planned system that allows individuals the least degree

of economic freedom is communism. Private ownership is restricted. Resource allocation

is handled through centralized planning by government officials. Socialism involves a

relatively high degree of government planning and some government ownership of land

and resources. However, government involvement is limited to industries considered

vital to the common welfare. Several socialist and communist economies are moving

toward free-market systems. They are privatizing some of their government-owned

enterprises by selling them to privately held firms.

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This slides shows a Supply and Demand curve in which the Supply line runs from lower left to upper right.

The supply line begins with a $20 value (on the Y axis) and angles up to end at a $35 value. The Quantity is

depicted on the X axis and runs horizontally from a quantity of 10 jeans to a quantity of 35 jeans. The

Demand curve runs from the lower right to the upper left beginning at a price of $20 and ending at a price of

$35. The Equilibrium price is noted at $25 at a quantity of 20 jeans.

The theory of supply and demand is the immediate driving force of the free-market system. Demand refers

to the amount of a good or service that consumers will buy at a given time at various prices. Supply refers to

the quantities of a good or service that producers will provide on a particular date at various prices. Simply

put, demand refers to the behavior of buyers, whereas supply refers to the behavior of sellers. Both work

together to impose a kind of order on the free-market system.

Consider the airline industry. Airline travel is a cyclical business; its revenues rise and fall with the economy.

When the economy is robust, consumers and businesses spend more on discretionary travel. When the

economy falters, they cut back on such discretionary spending.

Is there a price that will make both the supplier and the customer happy? The answer is yes--the price at

which the quantity of jeans demanded equals the quantity supplied.

This relationship is shown in the graph above. A range of possible prices is listed vertically at the left of the

graph, with the lowest at the bottom and the highest at the top. Quantity of blue jeans is represented along

the horizontal axis. The points plotted on the curve labeled D indicate that on a given day the store would

sell 10 pairs of jeans if they were priced at $35, 15 pairs if they were priced at $27, and so on. The curve

that describes this relationship between price and quantity demanded is a demand curve.

Now think about the situation from the seller’s point of view. This relationship can also be depicted

graphically. The line labeled S shows that the store would be willing to offer 30 pairs of jeans at $35, 25

pairs at $30, and so on.

The point marked E shows that when jeans are priced at $25, consumers are willing to buy 20 pairs of them

and the store is willing to sell 20 pairs. In other words, at the price of $25, the quantity supplied and the

quantity demanded are in balance. The price at this point is known as the equilibrium price. Note that this intersection represents both a specific price ($25 in our example) and a specific quantity of

goods (20 pairs of jeans). It is also tied to a specific point in time. Note also that it is the mutual interaction

between quantity demanded and quantity supplied that determines the equilibrium price.

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This slide shows a 2 by 2 matrix with Pure Competition in the upper left, Monopoly on

the upper right, Oligopoly in the lower left and Monopolistic Competition in the lower

right.

Competition is the situation in which two or more suppliers of a product are rivals in the

pursuit of the same customers.

The nature of competition varies widely by industry. In theory, the ideal type of

competition is pure competition, which is characterized by three conditions: a

marketplace of multiple buyers and sellers, a product or service with nearly identical

features such as wheat or cotton, and low barriers of entry.

At the other extreme, in a monopoly there is only one supplier of a product in a given

market, and that supplier thus is able to determine the price (within regulatory limits).

A market that is dominated by only a few suppliers (primarily Boeing and Airbus

Industries), cause a situation known as an oligopoly

Most of the competition in advanced free-market economies is monopolistic competition, in which a large number of sellers (none of which dominates the market)

offer products that can be distinguished from competing products in at least some small

way. Toothpaste, cosmetics, soft drinks, Internet search engines, and restaurants are

examples of products that can vary in the features each offers.

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This slide shows an image of three businessmen in a first, second and third place

position on platforms of varying heights.

When markets become filled with competitors and products start to look alike,

companies use price, speed, quality, service, or innovation to gain a competitive advantage—something that sets one company apart from its rivals and makes

its products more appealing to consumers.

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Although the free-market system generally works well, it’s far from perfect. If left

unchecked, the economic forces that make capitalism succeed may also create

severe problems for some groups or individuals. To correct these types of

problems, the government serves four major economic roles: it enacts laws and

creates regulations to foster competition; it regulates and deregulates certain

industries; it protects stakeholders’ rights; and it intervenes to contribute to

economic stability.

Because competition generally benefits the U.S. economy, the U.S. federal

government and state and local governments create thousands of new laws and

regulations every year to preserve competition and ensure that no single

enterprise becomes too powerful.

Antitrust laws limit what businesses can and cannot do to ensure that all

competitors have an equal chance of producing a product, reaching the market,

and making a profit. Some of the earliest government moves in this arena

produced such landmark pieces of legislation as the Sherman Antitrust Act, the

Clayton Antitrust Act, and the Federal Trade Commission Act.

To preserve competition, the government may also stipulate requirements

companies must meet to gain approval of a proposed merger or acquisition. If the

government thinks a proposed merger or acquisition might restrain competition, it

may deny approval altogether.

Sometimes the government imposes regulations on specific industries to ensure

fair competition, ethical business practices, safe working conditions, or general

public safety.

In a regulated industry, close government control is substituted for free

competition, and competition is either limited or eliminated. In extreme cases,

regulators may even decide who can enter an industry, what customers they

must serve, and how much they can charge. For years, the telecommunications,

airline, banking, and electric utility industries fell under strict government control.

However, the trend over the past few decades has been to open up competition

in regulated industries by removing or relaxing existing regulations. Hopes are

that such deregulation will allow new industry competitors to enter the market,

create more choices for consumers, and keep prices in check. But the debate is

ongoing about whether deregulation achieves these goals.

In addition to fostering competition, another important role the government plays

is to protect the stakeholders of a business. Businesses have many

stakeholders—groups that are affected by (or that affect) a business’s

operations, including colleagues, employees, supervisors, investors, customers,

suppliers, and society at large. In the course of serving one or more of these

stakeholders, a business may sometimes neglect the interests of other

stakeholders in the process. To protect consumers, employees, shareholders,

and the environment from the potentially harmful actions of business, the

government has established several regulatory agencies.

Consumer Product Safety Commission: Regulates and protects the public from

unreasonable risks of injury from consumer products.

Environmental Protection Agency: Develops and enforces standards to protect

the environment.

Equal Employment Opportunity Commission: Protects and resolves

discriminatory employment practices.

Federal Aviation Administration: Sets rules for the commercial airline industry.

Federal Communications Commission: Overseas communication by telephone,

telegraph, radio and television.

Federal Energy Regulatory Commission: Regulates rates and sales of electric

power and gas.

A nation’s economy never stays exactly the same size. Economic expansion

occurs when the economy is growing and people are spending more money.

Consumer purchases stimulate businesses to produce more goods and services,

which in turn stimulates employment. Economic contraction occurs when such

spending declines. Business cuts back on production, employees are laid off,

and the economy as a whole slows down.

If the period of downward swing is severe, the nation may enter into a recession, traditionally defined as two consecutive quarters of decline in real gross domestic

product. When a downward swing or recession is over, the economy enters into

a period of recovery: Companies buy more, factories produce more, employment

is high, and workers spend their earnings.

These recurrent up-and-down swings are known as the business cycle. In an

attempt to avoid hardship and to foster economic stability, the government can

levy new taxes or adjust the current tax rates, raise or lower interest rates, and

regulate the total amount of money circulating in our economy. These

government actions have two facets: monetary policy and fiscal policy (see next

three slides).

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Economic indicators are statistics such as interest rates, unemployment rates,

housing data, and industrial productivity that are used to monitor and measure

economic performance. Statistics that point to what may happen to the economy

in the future are called leading indicators; statistics that signal a swing in the

economy after the movement has begun are called lagging indicators.

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This slide includes a picture with a spectrum on the top from left to right reading:

Inflation, Purchasing Power, Deflation. Under the Inflation is a picture of a man

in a suit carrying a large dollar sign. Under Purchasing Power is a person’s fist

wrapped around several dollar bills with the subtitle: Consumer Price Index (CPI).

Under deflation is a picture of a man in a suit on his knees throwing dollar bills in

the air.

Inflation is a steady rise in the prices of goods and services throughout the

economy. When the inflation rate begins to decline, economists use the term

disinflation. Deflation, on the other hand, is the sustained fall in the general price

level for goods and services. It is the opposite of inflation; that is, purchasing

power increases because a dollar held today will buy more tomorrow.

Slide 19

This slide includes a picture in the lower right hand corner of a computer server with a

small globe next to it.

In contrast to the CPI, the producer price index (PPI) measures price at the producer

or wholesaler level. (Although the PPI is usually referred to as a single index, it is

actually a family of more than 600 industry-specific indexes.) PPI calculations cover

virtually the entire goods-producing segment of the U.S. economy and many service

sectors as well.

The broadest measure of an economy’s health is the gross domestic product (GDP). The GDP measures a country’s output—its production, distribution, and use of goods

and services—by computing the sum of all goods and services produced for final use in

a market during a specified period (usually a year).

GDP has largely replaced an earlier measure called the gross national product (GNP), which excludes the value of production from foreign-owned businesses within a nation’s

boundaries and includes receipts from the overseas operations of domestic companies.

GNP considers who is responsible for the production; GDP considers where the

production occurs.

Globalization—the increasing tendency of the world to act as one market instead of a

series of national ones—opens new markets for a company’s goods and services and

new sources of natural resources, labor, and skills.

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Globalization—the increasing tendency of the world to act as one market

instead of a series of national ones—opens new markets for a company’s goods

and services. But at the same time it creates tougher competition and a raft of

new challenges for businesses:

Producing quality products and services that satisfy customer’s changing needs.

Today’s customer is well-informed and has many product choices.

Starting and managing a small business in today’s competitive environment.

Starting a new business or managing a small company in today’s global

economy requires creativity and a willingness to exploit new opportunities.

Thinking globally and committing to a culturally diverse workforce. Globalization

opens new markets for a company’s goods, increases competition, and changes

the composition of the workforce into one that is more diverse in race, gender,

age, physical and mental abilities, lifestyle, culture, education, ideas, and

background.

Behaving in an ethically and socially responsible manner. As businesses become

more complex through global expansion and technological change, they must

deal with an increasing number of ethical and social issues.

Keeping pace with technology and electronic commerce. Technology is

reshaping the world. The Internet and innovations in computerization and

telecommunication have made it possible for people anywhere in the world to

exchange information and goods.