Business Activity and Economic Structure Ch 2

Economy
 Economy is a system which attempts to solve the basic economic problem.
Function of an Economy
 The function of an economy is to allocate scarce resources amongst unlimited wants. The
basic economic problem is often broken down into three questions;
 What should be produced?
The economic system must decide which resources will be used to produce which
products. For example, hospitals or hotels? Cigarettes or computers?
 How should it be (goods) produced?
What type of material and labor will be used? Where it will be produced etc.
 For whom should it be produced?
An economy has to determine how the final goods and services will be allocated
amongst competing groups. For example, how much should go to students,
unemployed, sick, or just those who employed?
 Answers of above questions depend on the type of ‘Economic System’.
Different Economic Systems
 An economic system is a mechanism (social institution) which deals with the production,
distribution and consumption of goods and services in a particular society.
The most basic and general economic systems are:
 Market Economies/ Capitalist Economies/ Free Market Economies
In a free market economy decisions about what, how and for whom are made by
consumers and producers, the role of Govt. is very limited (only in defence, police and
justice systems). Price of things is set by market forces (demand & supply). Aim of
producers is to make profit.
 Advantages
 Consumers have variety of things to choose.
 Efficiently allocation of resources.
 Disadvantages
It will leads to inequality of income
 Due to competition, there will be a duplication of products and
this will lead to wastage of resources.
 Planned Economies/ Command Economies
In a command economy central Govt. decides (with planning committees) that what will
be produced, how it will be produced and how products will be distributed. This system
is more close to communist political system. Private business activity is very limited.
 Advantages
 According to the need of total system, Govt. can make effective long
term strategies which will avoid the duplication of resources.
 Resources can be distributed more equitably according to the values of
the society.
Disadvantages
No consumer choice
Due to no competition, there are low chances to improve things.
 Mixed Economies
In the real world no economy relies exclusively on the free market, nor can we find
examples of purely planned economies. A mixed economy combines elements of both the
 free market and planned systems; some decisions are made solely through the private
sector while others are made by the government.

 Advantages
 State will provide social facilities to all members in the society whether
they are rich or poor.
 Disadvantages
 Huge taxes
 Govt. organization (public sector) are less efficient
International Trade
It means trade between countries.
Reasons for International Trade
 All the countries of the world are dependent upon each
other to a certain extent. Very few can hope to produce every thing they need
because every country has a different climate, physical and geographical
conditions.
 Comparative advantage is also another reason for
international trade. It means that countries will produce those products in
which they are relatively more efficient (specialist).
 Benefits of International Trade
 Wider choice for the consumer
 Economies of scale
 Drawbacks of International Trade
 Domestic industry will damage. Due to overseas competition, ratio of
Infant Industries will increase (Infant Industries are that industries which need
protection from overseas competition).
Free Trade and Globalization
Free trade means that there are no trade barriers which can limit trade between countries.
Trade Barriers
Tariffs – taxes on imports
Quotas – limit of physical quantity or limit of value of certain goods
Voluntary export limits to avoid tariffs etc
 Globalization is the term used to
describe the growing integration of the world’s economy. It is suggested that as globalization
takes place, national economies are becoming integrated into a signal ‘global economy’ with
similar characteristics. This shrinking of the world is having a major impact on business
activity, especially from multi-nationals.
World Trade Organization – a movement towards free trade
Free trade blocks – group of countries, often geographically grouped, made for free
trade like NAFTA, ASEAN etc
Multinational Business/ Organization
 These are business organizations which have their headquarters in one country, but operating
branches, manufacturing or assembly plants in others.
 Why becomes a Multination
 Nearness to market
 Low cost of production due to low labor cost etc
Problems for a Multinational
Communication with headquarter
 Language and cultural differences
Impact on Host Countries
Employment opportunities
Increase in Gross Domestic Product (GDP)
State Intervention in Business Activity
Govt. Assistance for Business
Training programmes
Development area grants (Industrial zone)
Support for export
Govt. Control over Business activities
 Consumer protection
 Unfair competition
 Employee protection
 Environmental protection
 Monopolies
 Location of Industries
Policy of laissez-faire
This means allowing business to make its own decisions without Govt. intervention.
Objections on laissez-faire
Irresponsible behavior towards labor
Business can make monopolies
Consumer exploitation
Wrong location decisions to reduce cost
Irresponsible behavior towards disposal of wastage.
Arguments against Govt. Intervention
 Govt. control adds business cost and this will reduce the business
competitiveness in international market.