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*Chapter Two

*
Understanding
How Economics
Affects Business

Economics: Use of scarce resources to produce


goods/services, distribute them among competing groups/individuals

Land

Entrepreneurship

Labor

Knowledge

Capital

The MAJOR BRANCHES of 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.
For example: Why Interest rate changes? Why unemployment goes
up?

Microeconomics -- Concentrates on the behavior of people and


organizations in markets for particular products or services.

For Example: Why people choose to use Gas (CNG conversion)


rather than oil.
Why people more buy more of a product at reduced price?

What is ECONOMICS?

Economics is the study of the allocation of scarce


resources which emphasizes on Resource Development.
Businesses can contribute to an economic system by
inventing products that greatly increase the available
resources.
For example: By discovering new energy sources
(hydrogen fuel for autos), new ways of growing foods
(hydroponics, organics), new ways producing goods and
services (nanotechnology).

DIFFERENCE BETWEEN MICRO AND MACRO ECONOMICS :

MICROECONOMICS:1.Evolution of micro economics took place earlier than macro economics.


2.It is branch of economics, which studies individual economic variables like demand,
supply, price etc.
3.It has a very narrow scope i.e. an individual, a market etc.
4.Demand,supply,market forms etc. related to micro economics.
5.It is helpful in analysis of an individual economics unit like firm.
6.Theory of demand, theory of production, price determination theory etc develop from
micro economics.
MACROECONOMICS:1.It evolved only after the publication of Keynes book, General theory of employment
interest and money.
2.It is a branch of economics which studies aggregate economic variables, like
aggregate demand, aggregate supply, price level etc.
3.It has a very wide scope i.e. a country.
4.Aggregate demand aggregate supply, national income etc. related to macro
economics.
5.It is helpful for analyzing the level of employment, income, economic growth etc.
6.Theory of national income, theory of employment theory of money, theory of general
price level etc. develop from macro economics.

Economic Theory

Thomas Malthus (Early 1800s)


Dismal Science
Too many people

Adam Smith (1776)


Freedom is vital
Invisible Hand

THOMAS MALTHUS and


the DISMAL SCIENCE

Malthus believed that if the rich had most of the wealth and the
poor had most of the population, resources would run out.

This belief led the writer Thomas Carlyle to call economics The
Dismal Science.

Neo-Malthusians believe there are too many people in the world


and believe the answer is radical birth control.

Nations like Japan, Germany, Italy, Russia, Canada, and USA


suffer from low population growth (Story of Canada..having
children is a gift!) with more old people less of young generation
(Story of USA.Olds are being a major burden for the nation but
it makes joke by offering senior citizens status).
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ADAM SMITH the


FATHER of ECONOMICS
Smith believed that:

Adam Smith &


the Creation of
Wealth
LG1

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.
He is considered as the father of
modern economics!
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Four Whats of
an Economic System
$ What (how it) is produced
$ What amount is produced
$ What method of output distribution
$ What rate of economic growth
Adapted from: Edwin Mansfield Economics (New York: W.W. Norton, 1976), p.8

Three Economic Systems


Mixed
Socialism

(Highly Controlled)

(Little Control)

Communism

Capitalism

CAPITALISM/ Market economy

*Understanding
Free-Market
Capitalism
LG2

Capitalism -- 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 States
England
Australia
Canada

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Capitalism

Private Property
Individuals can buy, sell and properties.

Profit/Ownership
Profit acts as incentive for taking risk and initiative.

Freedom of Competition
Possesses right to compete each other.

Freedom of Choice
Free to choose what to do and what not.

Supply Curve
High

Price(P)
S
Low

Quantity(S)

High

Demand Curve
High

Price(P)
D
Low

Quantity(D)

High

EQUILIBRIUM
POINT
Surplus

High

Market Equilibrium

Price
S
Low

Shortage

Quantity

D
High

Degrees of Competition
Monopolistic
Oligopoly

Competition

One
Monopoly

Many
Sellers

Pure Competition

Monopoly = One Seller

Diamonds

South-Africa

Utilities

WASA
DESA

Oligopoly = Few Sellers

Tobacco

Gold-Leaf -Banson
Pall Mall -Sheikh
More -Garam -Pine

Automobiles

Toyota -Ford
Porshe -Nissan

Monopolistic Competition =
Many Sellers With Perceived Differences

Fast Food

McDonalds
Pizza Hut

-KFC
-Subway

University/College

Harvard
Stanford
Orford

Pure Competition

Sellers

Buyer

Limitations of Free-Market

Inequality of Wealth- Causes


National & World Tension

Potential Environmental
Damage

Limitations Push Country


towards Socialism =
Government Regulation

SOCIALISM
Socialism -- 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 almost 60% usually.
Government is more involved in protecting the
environment and the poor
Brain-drain: The loss of best and brightest people to other countries

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Socialism

Private & Public Ownership


Some Choices are Limited
Creates Social Equality
Reduces Individual Incentive

COMMUNISM

Communism -- 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.

Some countries even dont allow its citizens to practice different


religions, change jobs, or move to a different town they prefer.

Example: North Korea, Cuba, Venezuela practice Socialism. China


also practices Communism but it is rapidly being open.

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Communism

Public Ownership
Productive Capacity
Capital

Central Planning/Controlled
Economy
Managers = Mandatory Party
Membership

Comparis
on of the
main
economic
systems

MIXED ECONOMIES
Mixed 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.
Bangladesh is a vibrant example of Mixed
Economy!
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Mixed Economies

Free-Market Economy = Capitalism


Command Economy
Socialism
Communism

Trend Results in Blend


Capitalism > Socialism
Socialism > Capitalism

Understanding Economic System


Key Economic Indicators
Gross Domestic Product (GDP)

Unemployment Rate

Price Indexes
Consumer Price Index(CPI)
Producer Price Index(PPI)

GDP, GNP and NNP

Gross 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).

Gross national product (GNP) is the total income earned by a


countrys factors of production in a year or a given time period,
regardless of where assets are located (nations' output).

Net national product (NNP) is the total market value of all final
goods and services produced by residents in a country during a
given time period.

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What Makes Up the


Consumer Price Index

SOURCE: U.S. Bureau of Labor Statistics

Economic Scenarios
Inflation: A general rise in the prices of goods and services over time.
Disinflation: A situation in which price increases are slowing (the inflation rate is
decreasing).
Deflation: A situation in which prices are declining.
Stagflation: A situation when the economy is slowing but prices are going up
anyhow.
Consumer price Index (CPI): Monthly statistics that measure the pace of
inflation or deflation.

BUSINESS CYCLES

The Business
Cycle
LG5

Business Cycles -- Periodic rises and falls that

occur in economies over time.

Four Phases of Long-Term Business Cycles:

1. Economic Boom
2. Recession Two or more consecutive quarters
of decline in the GDP.
3. Depression A severe recession.
4. Recovery When the economy stabilizes and
starts to grow. This leads to an Economic Boom.
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Government Economic Tools

Monetary Policy- (management of money supply)

Expansionary Monetary Policy


Contractionery Monetary Policy

Fiscal Policy- management of taxes and government


expenditures

National Debt- Refers total debt/loan owed by a nation

Internal Debt

-External Debt

Governments Role in Economics

Enforces Rules/Regulations
Provides Public Goods
Transfers Payments
Fosters Competition
Contributes to Economic Stability

FISCAL POLICY

Stabilizing the
Economy Through
Fiscal Policy

LG6

Fiscal Policy -- The federal governments efforts to

keep the economy stable by increasing or decreasing


taxes or government spending.

Tools of Fiscal Policy:


-

Taxation
Government Spending

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Industrialized
Nations Tax Rate

Source: Parade Magazine, Apr. 12, 1998.

MONETARY POLICY

*Using Monetary

Policy to Keep the


Economy Growing

LG6

Monetary Policy -- The management of the

money supply and interest rates by the Federal


Reserve Bank (the Fed).

The Feds most visible role is increasing and


lowering interest rates.

- When 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.
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