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Bus& 101 Chapter 02

How Economics affects Business
Goals:

1. Basic Economics
2. What is capitalism and how to free markets work?
3. What are the major differences between socialism and
communism?
4. Explain the trend toward mixed economies
5. Discuss the economic system in the USA, including the
economic indicators
1. GDP (Gross Domestic Product)
2. Unemployment
3. Price Indexes
4. Productivity
6. Define Fiscal Policy and Monetary Policy, and explain
how each affects the economy
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Define Economics

• The study of how society chooses to employ

resources (factors of production: land, labor, capital,
entrepreneurship, knowledge) to produce goods &
services and distribute them for consumption among
various competing groups and individuals
• The study of the allocation of scarce resources
▫ There are not enough resources for all 6 billion people
to have and do exactly what they want

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Resource Development
• The study of how to increase resources and to create
conditions that will make better use of those
resources
▫ Examples:
 Recycling
 Oil conservation
 New energy sources
 New ways of growing food

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Macroeconomics
• Looking at operation of nation’s economy as a whole
• Topics such as:
▫ GDP (Gross Domestic Product)
▫ Unemployment rate
▫ Price indexes
▫ Population growth
• Some Macroeconomists try to figure out what makes
a country relatively wealthy or relatively poor
▫ Example: Hernando de Soto, an economist from Peru,
studied why entrepreneurs did not thrive and
discovered that it was in large part due to the fact that
there were no laws to provide property titles
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Microeconomics
• The part of economics that looks at the behavior of
people and organizations in particular markets
• Topics such as:
▫ Pricing
▫ Supply and Demand

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 Credit = Loan = Debt = Borrow Money

• Credit = Loan = Debt = Liability = Borrowed Money

• Really?
• There are always two sides to the coin:
• 1 side = Borrower
• 2 side = Lender
• Borrower Lends money
• Borrower borrows money
• Interest is rent on money
• Borrowers pay interest (expense)
• Lenders receive interest (revenue) 7
 Paid Back Borrowed amount and Interest at end
Years 1
Amount of Loan $150.00
Interest Rate per year (compounded only once) 6.95%
Interest $10.43
Total Paid in 1 year $160.43
Paid Back Borrowed amount and Interest at end
Years 5
Number of compounding Periods Per Year 12
Amount of Loan $5,000.00
Interest Rate per year (compounded 12 times a year) 6.95%
Monthly Interest Rate 0.58%
Interest $2,070.53
Total Paid in 5 year $7,070.53
Paid Back Borrowed amount and Interest at end
Years 5
Amount of Loan $5,000.00
Interest Rate for each year on original Amount 6.95%
Interest paid each year $347.50
Loan paid back $5,000.00
Total Interest Paid = $5,000*6.95%*5 = $1,737.50 $1,737.50
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Total Paid $6,737.50
Credit and Entrepreneurs help create wealth
• Entrepreneurs:
▫ See problems
▫ Think of idea to solve problem
▫ To start a business they need money
▫ Often credit (loan money for interest) is used
▫ Start business
▫ Business employs people
▫ Business provided solution to problem
▫ Business pays taxes (remember: private property and
enforcing contacts are done by governments)
▫ Everyone is better off.
▫ But can all entrepreneurs get credit at a reasonable
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rate?
Analogy For Why Businesses Helps To
Alleviate Poverty
• Teach a person to start a fish farm, and she or he will
be able to feed a village for a lifetime
▫ This is true because entrepreneurs and businesses
provide goods and service, employment and taxes
(amongst other benefits)

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Thomas Malthus

• (1766-1835) Author of an Essay on the Principles of

Population in 1798 postulating that any temporary or
local improvement in living conditions will increase
population faster than the food supply, and that
disasters such as war and pestilence, which check
population growth, are inescapable features of
human society. (answers.com)

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Adam Smith
• (1723 – 1790) Adam Smith believed that the freedom to
own property and keep profits was the best incentive for
people to work hard and long hours. With this freedom
people would be self-directed to gain profit, produce
goods/services, add jobs to the economy and supply new
ideas which in turn would benefit society as a whole and
lead to economic prosperity.
• Adam Smith assumed that wealthy people would help
less fortunate people in society
• Adam Smith coined the term:
▫ Invisible Hand
 The process that turns self-directed gain into social and
economic benefit for all
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In the 2007-2010 Financial Crisis,
did the Invisible Hand work?

▫ Invisible Hand
 The process that turns self-directed gain into social and
economic benefit for all
▫ Without some regulation by governments the invisible
hand can turn into a greedy hand
▫ There is good empirical evidence that shows that after
deregulation of financial markets (Reagan, Clinton,
Bush), banking and other financial crisis increased
dramatically
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How Do Different Economic Systems
Promote Or Hinder
• Business growth
• The creation of wealth
• A higher quality of life for all

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Economic Systems

• Capitalism
• Communism
• Socialism

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Capitalism
• An economic system in which all or most of the
factors of production and distribution are privately
owned and operated for profit
▫ Business people decide:
 What to produce
 How much to pay workers
 (Government does set minimum wage)
 Prices for goods/services
 Whether to import or export goods/services
• Capitalism goes not guarantee success, but it does
provide the opportunity to create new businesses
(success or failure)
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Capitalism Is Also Known As “Free-market”
Or “Free Market Capitalism”

▫ Market not controlled by government

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There Are Four Basic Rights Under “Free
Market Capitalism”:
• The right to private property
• The right to own a business and to keep all of the
business’s profits
• The right to freedom of competition
• The right to freedom of choice

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The Right To Private Property

• If you own the property you have the incentive to

take good care of your property

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The Right To Own A Business And To Keep
All Of The Business’s Profits
• Profit = Revenue – (Expenses including Tax Expense)

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The Right To Freedom Of Competition

• Within some government guidelines, individuals are

free to compete with others by offering new
goods/services promotions, and signing contracts as
they see fit
▫ Guidelines like:
 Uniform Commercial Code
 Minimum Wage Laws

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The Right To Freedom Of Choice

• Freedom to choose where to work, where to live,

what to buy, what to say, who to worship, and
freedom from want and fear (FDR).

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How Free Markets Work

• When consumers choose to buy or not buy certain

products they send signals to producers
• When consumers raise or lower the price that they
are willing to pay for a good/service they send signals
to producers

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Prices (“Price Signal”)
• If everyone wants a particular item and there are not
many of that item, the price goes up.
▫ At that point, the item can be sold at that higher price,
or more items can be made, or a substitute for the
original item can be made.
• When the price goes up enough, this is a signal to
producers to make more of that item. As more
producers make that item and the supply of items
gets large, the price will go back down again.

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How Prices Are Determined
• Buyers (Demand) and sellers (Supply) negotiate in
the marketplace

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Supply (Supply Curve)

• The quantity of products that manufacturers or

owners are willing to sell at different prices at a
specific time.
• Supply tends to increase as the price increases (direct
relationship)
• Price determines quantity

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Demand (Demand Curve)

• The quantity of products that people are willing to

buy at different prices at a specific time.
• Demand tends to decrease as the price increases
(indirect or inverse relationship)
• Price determines quantity

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Equilibrium Point (Market Price)
• The point at which the Supply and Demand Curves
intersect
▫ In the long-run, the Equilibrium Point is the Market
Price
• This is the “Price Signal”
▫ In free markets the price of an item that is determined
in the market place is called the “price signal”. This price
signal is what tells producers what to make and how
much to make of a particular product
• In countries without free markets, the price signal is
not available and so the government does not always
know what to make, or how much to make. 28
 Supply & Demand Curves do not
always work the same for:
• Financial Assets (Stocks, Bonds, etc.)
▫ When stock price go up, does a business issue more
stock?
▫ Would you like it if you owned stock and every time the
price went up, the company issued more stock?
▫ We want a stock where supply cannot be increased to
meet demand because then the price will stay high
(because it is scarce).
• Fine Art & Luxury Goods:
▫ High Price = High Demand (because it is scarce)
▫ If there is a high price and high demand for a Matisse
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painting, do suppliers make more?
If You Know Algebra and the Price
is the independent variable…

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Competition Within Free Markets

• Perfect Competition
• Monopolistic Competition
• Oligopoly
• Monopoly

• Competition is good
▫ Competition make you better!
▫ Competition between business means that the
consumer gets a better product at a cheaper price

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Perfect Competition

• The market situation in which there are many sellers

in a market and no seller is large enough to dictate
the price of a product
• Products appear to be identical
• There are no examples of businesses that compete in
a Perfect Market. Farms may be the closest, but with
fewer farms and government price supports Farms
do not compete in a Perfect Competition Market

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Monopolistic Competition
• The market situation in which a large number of
sellers produce products that are very similar but that
are perceived by buyers as different
• As companies consolidate (companies buy other
companies), there are fewer and fewer examples in
the United States.
• Examples:
▫ Computers (could also be oligopoly)
▫ Candy (could also be oligopoly)
▫ Fast-food (could also be oligopoly)
• Product Differentiation (packaging, advertising,
branding) is the key to success (more than price) 33
Oligopoly
• A form of competition in which just a few sellers
dominate the market. Usually cause by the high cost of
setting up the business
• Examples:
▫ Airlines, Soft Drinks, Autos
• Product Differentiation (packaging, advertising,
branding) is the key to success (more than price)
• Prices tend to be the same (Think of airlines) because
if one company lowers the price, everyone would
come to them. As a result, if one drops the price, they
all tend to drop the price.
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Monopoly

• A Market in which there is only one seller for a

product/service
• Examples: Utility companies
• Monopoly:
▫ Microsoft Windows?
▫ Apple iTunes?

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Benefits And Limitations Of Free Markets

• Benefits
▫ Quality Products at Fair Prices
 If companies do not do this, they will lose business
▫ Entrepreneurial activity helps to reduce poverty
▫ Wealth

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Benefits And Limitations Of Free Markets
• Limitations
▫ Income inequality
 Owners are wealthier than workers. Over time, the gap
between wealth and poor can increase
▫ The old and sick may not be able to start businesses
▫ Greed leads to company failures such as Enron,
Anderson International, Fannie Mae and AIG, Lehman
Brothers
 The managers of these companies pursued personal
wealth in a reckless and irresponsible manner. The result
was that many workers and ordinary people lost jobs,
houses and more. In some cases tax payers had to pay
Fannie Mae and AIG).
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Benefits And Limitations Of Free Markets
▫ Unchecked greed and cruelty can lead to activities such
as slavery and child labor
▫ Free-market mechanisms haven’t been responsive
enough to the needs of the poor, the old, the disables
and the environment. Voters can elect politicians who
will adopt social and environmental programs

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Communism (Also Known As Command
Economies)
• An economic and political system in which the state
makes almost all the economic decisions and owns
almost all the major factors of production, and limits
personal choices
• There are no price signals for the government to help
make production decisions
▫ Shortages and surpluses are common
• Because people do not own personal property, the
incentive to work hard in low

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Socialism
• Most businesses should be owned by the government
so that profits can be distributed evenly. Some small
businesses may be owned individually, but taxes are
very high
• The benefits can be such things as
▫ Less income inequality
▫ Longer vacations
▫ Fewer hours worked
▫ Medical benefits

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Socialism
• The draw backs can be things such as
▫ Less incentive to work hard
▫ Brain drain (brightest and smartest may move to
capitalist countries because of high taxes)
▫ Fewer innovations
▫ Less wealth

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Mixed Economies

• Economic system in which some of the allocation of

resources is made by the market place and some by
the government
• USA is a Mixed Economy
▫ Social Security
▫ Regulation of stock markets
▫ Take over Insurance Companies!?
• USA  more government involvement
• China & France  less government involvement

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Major Key Economic Indicators:

• GDP
• Unemployment Rate
• Price Indexes
• Productivity Measures

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GDP (Gross Domestic Product)

• Total value of final goods and services produced in a

country in a given year
• This measure is important because the more that is
made, the more people are working and can support
their families

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Productivity

• The higher the productivity (make more with fewer

inputs), the lower the cost of production, the lower
the price to the consumer
• Service industry
▫ Although technology has increased the quality in fields
like teaching and health care, productivity measures
have not increased much (because productivity
measures do not measure quality as much)

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Unemployment Rate

• The number of civilians at least 16 years old who are

unemployed and tried to find a job within the prior
four weeks
• Four types of unemployment:
 Frictional Unemployment
 Structural Unemployment
 Cyclical Unemployment
 Seasonal Unemployment

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Frictional Unemployment

• People who have quit because they wanted to quit,

because they are searching for their first job, or have
been away from the job market for a while
▫ There is always Frictional Unemployment

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Structural Unemployment

• Caused by businesses that restructure or is due to a

mismatch between skills (or location) of job seeker
and requirements of available jobs

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Cyclical Unemployment

• Recession or downturn in the business cycle (normal

ups and downs of business throughout the years)
▫ This is the most serious

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Seasonal Unemployment

• The demand for labor varies throughout the year due

to things like harvesting crops or Christmas sales

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Purchasing Power of $1 in future
• Inflation
▫ The general rise in prices of goods and services over
time
▫ Purchasing power of $1 goes down
• Disinflation
▫ The situation in which price increases are slowing (the
inflation rate in declining)
• Deflation
▫ A situation in which prices are declining
▫ Purchasing power of $1 goes up
• Stagflation
▫ Economy goes down and prices go up 51
Inflation / Deflation
• Inflation
▫ Purchasing power of $1 goes down
▫ Debt repayment is benefited
• Deflation
▫ Purchasing power of $1 goes up
▫ Debt repayment becomes more burdensome

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Price Indexes

▫ Consumer Price Index (CPI) and Chained

Consumer Price Index (C-CPI)
▫ Monthly statistics that measure the pace of inflation or
deflation
• Producer Price Index (PPI)
▫ Prices measurement at wholesale level

* Chained Consumer Price Index (C-CPI) tried to

take into account that people can switch when price
go up.
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Business Cycle

• The periodic rises and falls that occur in all

economies over time

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Four Phases Of Long-term Business Cycles
• Boom
▫ Businesses are doing well
• Recession
▫ Two or more consecutive quarters of decline in the GDP
▫ In general, prices fall, fewer consumer purchases,
businesses fail, high unemployment, Drop in living
standards
• Depression
▫ A severe recession which usually has deflation
• Recovery
▫ Economy stabilizes and starts to grow
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Fiscal And Monetary Policy
• Governments try to use Fiscal and Monetary Policy
to prevent Business Cycles from getting too extreme
• Fiscal:
▫ Taxes (down spurs growth)*
▫ Government spending (up spurs growth)*
• Monetary (Federal Reserve):
▫ Interest rates (down spurs growth)*
▫ Money supply (up spurs growth)*
▫ Lender of last resort (to prevent bank runs)*
• Keynesian Fiscal And Monetary Economic Theory:
▫ During recession increase spending & reduce taxes
*in theory 56
 National Debt

The Outstanding Public Debt as of 25 Mar 2010 at 08:51:13 PM GMT is:

Total debt $12,666,299,517,353.90
The estimated population of the United States 308,074,045.00
so each citizen's share of this debt = $41,114.46
Debt added per day (since Sep 2008) $4,030,000,000.00
Debt added per hour $167,916,666.67
Debt added per minute $2,798,611.11
Debt added per second $46,643.52

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Fiscal Policy
• The federal government’s efforts to keep the
economy stable by increasing or decreasing taxes or
government spending
• Taxes
▫ High taxes theoretically slow economy
▫ Low taxes theoretically boost economy
• Government spending during a recession can help
people get back to work:
▫ Roads
▫ Unemployment payments

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 Monetary Policy
• The management of the money supply and interest rates
by the Federal Reserve
▫ Money Supply
 If you increase the money supply too much, inflation may
grow because there will be lots of money chasing fewer
products
▫ Interest Rates
 Low Interest rates can encourage borrowing and may lead to
more investment in capital goods and in turn help the
economy grow
 Low interest rates for long periods of time can increase the
money supply too much and may cause speculative bubbles
(housing prices)
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Compare And Contrast The Economics Of
Despair With The Economics Of Growth
• The Economics Of Despair
▫ Governments do little to promote:
 Private property and contact laws
 Entrepreneurship
• The Economics Of Growth
▫ Governments promote:
 Private property and contact laws
 Entrepreneurship

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What Is Capitalism And How
To Free Markets Work?
• Capitalism
▫ An economic system in which all or most of the factors of
production and distribution are privately owned and
operated for profit
▫ Free Markets:
 The right to private property
 The right to own a business and to keep all of the business’s
profits
 The right to freedom of competition
 The right to freedom of choice

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What Is Capitalism And How
To Free Markets Work?
▫ Free Markets work
 Supply and Demand Price Signals help to efficiently allocate
scare resources

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What Are The Major Differences Between
Socialism And Communism?
• The amount of government control
▫ Communism
 Controls almost everything
 More shortages because price signals are not available
▫ Socialism
 Controls fewer elements of society
 Smaller business are allowed to be owned privately
 Fewer shortages

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Explain The Trend Toward Mixed Economies
• Free Market inefficiencies such as:
▫ Owners have more wealth than workers and income
inequality can become great as the years pass
 Elected officials therefore enacts social programs such
as Social Security and Unemployment programs
▫ The profit motive can encourage greed
 The Credit Crisis in 2007 and 2008 exposed exploitive
lending practices that damaged the economy
 No regulation by government contributed to these
exploitive practices, therefore government will regulate
to prevent exploitive activities
▫ The credit Crisis 0f 2007 & 2008 caused the
government to take over banks 64
Discuss The Economic System In The USA,
Including The Economic Indicators
1. The economic system in the USA is a mixed
economy where free markets and government
programs work to allocate the factors of production
2. GDP (Gross Domestic Product)
1. Total produced by USA in a time period
3. Productivity
1. Output/Input; 6/2 = 3  8/2 = 4
4. Business Cycle
1. Boom, Recession, Depression, Recovery

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 Define Fiscal Policy And Monetary Policy,
And Explain How Each Affects The
Economy
• Fiscal Policy
▫ Government spending
▫ Taxation
• Monetary Policy
▫ Federal Reserve
 Changes interest rates
 Changes the money supply
 In the 2007 and 2008 Credit Crisis, the Federal Reserve
has extended their activities to include loaning money to
or taking over private companies (mixed economy)
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Chapter 2
• Unemployment Numbers reported for March 2010:
▫ 9.7% (unchanged)
▫ 162,000 new jobs
▫ How is this possible?
• Fiscal & Monetary Policy?
▫ Fiscal = Fed. Gov. adjust taxes or spending
▫ Monetary = Fed. Reserve adjusts interest rates or $ supply
• Real and Nominal Interest Rates
▫ Real = inflation takes out
▫ Nominal = actual rate
• Demography
▫ Census?
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