Chapter 2 (page 30 51) Understanding how Economics affects Business What is Economics?

? The study of how society chooses to employ resources (factors of production land, labor, capital, entrepreneurship, knowledge) to produce goods and services and distribute them for consumption among various competing groups and individuals. Two Branches: Macroeconomics: The part of economics that looks at the operation of the nations economy as a whole. Example: how many jobs exist in whole economy? It also includes the concepts of Gross Domestic Product (GDP), the unemployment rate and price indexes. Microeconomics: The part of economics that looks at the behavior of people and organizations in particular markets. Example: how many people will be hired in a particular market or industry? It also includes the concepts of pricing, supply and demand. Some economists define economics as the allocation of scarce resources. They believe that resources are scarce and need to be carefully divided among people usually by the government. But there is no way to maintain peace and prosperity in the world by dividing the resources we have today among the existing nations. There are not enough known resources available to do that. Outside of government, business may contribute to an economic system by investing into products that greatly increase the available resources. The challenge for macroeconomists is to determine what makes some countries relatively wealthy and other countries relatively poor and then to implement policies and programs that lead to increased prosperity for everyone in all countries. Resource Development The study of how to increase resources and create the conditions that will make better use of those resources. Recycling New ways of growing food Discover new energy sources New way of creating needed goods and services. Why economics was known as the Dismal Science? Thomas Malthus in late 1700s and early 1800s stated: Kings and rich people ---------- owned most of the wealth Majority of the people ---------- peasants---------too many children------result------too many people and not enough food and other resources. Solution is population control. And this population can be resources if they are educated. Thomas Carlyle called economics Dismal Science because economics is not capable of providing an absolute solution for problems of the society. It just comes up with ways which may help in reducing those problems but will never eliminate it. Give a man a fish and you feed him for a day, but teach a man to fish and you feed him for a life time Teach a person to start a fish farm, and he or she will be able to feed a village for a life time (Business)

Business owners provide jobs and economic growth for their employees and communities as well as for themselves. Growth Economics and Adam Smith Adam Smith: Father of the Modern Economics. He was one of the first people to imagine a system for creating wealth and improving the lives of everyone. He wrote a Book titled An inquiry into the nature and causes of the wealth of nations in 1776. The main theme of the book: creating more resources so that everyone could become wealthier. And when people see economic reward for their efforts, they would work for long hours and work hard. Result: economy would prosper with plenty of food and all kinds of products available to everyone. How business benefit the community In Adam Smiths view, businessmen necessarily do not try to help others, they think of their growth and prosperity. And people try to improve themselves and this effort serves as invisible hand that helps the economy grow and prosper through the production of needed goods, services and ideas. Thus the invisible hand turns self directed gain into social and economic benefits for all. Smith assumed that as people became wealthier, they would naturally reach out to help the less fortunate in the community. That has not always happened. Today, however, many business people are becoming more concerned about social issues and their obligations to return to society some of what they have earned. Example: British American Tobacco, Bangladesh (BATB) is engaged in tree plantation Understanding Free Market Capitalism Capitalism: The economic system that has led to wealth creation in the much of the world is known as capitalism. It as an economic system in which all or most of the factors of production and distribution are privately owned and operated for profit. In capitalist countries, business people decide what to produce, how to produce, how much to pay the workers, how much to charge for products and services, whether to produce certain goods in their own countries, import those goods or have them made in their own countries and so on. Foundations of Capitalism: four basic rights of people under free market capitalism 1. The right to private property 2. The right to own a business and to keep all the businesss profits. 3. The right to freedom of competition 4. The right to freedom of choice One of the benefits of four basic rights of capitalism is that people are willing to take more risks then they might otherwise. President Franklin D. Roosevelt believed that four additional freedoms were essential to economic success. They are: a) Freedom of speech and expression. b) Freedom of every person to worship God in his or her own way. c) Freedom from want. d) Freedom from fear.

How free market work A free market is one in which decisions about what to produce and in what quantities are made by the market by buyers and sellers negotiating prices for goods and services. We as the consumers send signals to tell producers what to make, how many, in what color and so on. We do that, by choosing to buy or not to buy certain products and services. The price tells the producer how much to produce. How prices are determined - In a free market, the prices are not determined by the seller, they are determined by the buyers and sellers negotiating in the market place. According to economics, price goes down when demand goes up. The economic concept of supply- Supply refers to the quantity of products that manufacturers or owners are willing to sell at different prices at a specific time. The general trend is when price goes up, supply also goes up. The supply curve indicates the relationship between the price and quantity supplied. All things being equal, the higher the price, the more the supplier will be willing to buy. The economic concept of demand- Demand refers to the quantity of products that people are willing to buy at different prices at a specific time. The general trend is when prices go down, the demand goes up. The demand curve indicates the relationship between the price and quantity demanded. All thing being equal, the lower the price, the more buyers are willing to buy. The equilibrium point or market price The equilibrium point is the place where quantity demanded and supplied meet. Price is the key factor in deciding the quantity supplied and quantity demanded. Market price is determined by supply and demand. Competition within free markets - four degrees of competition. 1. 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. The sellers produce products that appear to be identical. Example: agricultural products like rice, sugar, tea, potatoes, corn etc. 2. Monopolistic Competition: The market situation in which a large number of sellers produce products that are very similar but they are perceived by the buyers as different. Example: KFC, BFC, FFC, Chicken King. Product differentiation is the key to success here. Through advertising, branding and packaging sellers try to convince buyers that their products are different from competitors, though they may be very similar. 3. Oligopoly: This a form of competition in which just a few sellers dominate a market. Example: Automobile companies like Toyota, Mitsubishi, Nissan, Honda and soft drink companies like Coca-cola, Pepsi, Mojo, Pran, Rc- Cola. Product differentiation rather than price is the way to success because any price cut is immediately matched by other players. 4. Monopoly: occurs when there is only one seller for a product or services. One seller controls the total supply of a product and the price. Example: utility like water, gas, electricity producing organizations like DESCO, TITAS GAS etc.

Benefits and limitations of free market Benefits: 1. Allows open competition among companies. Business must provide customers with high quality products at fair prices with good service. If they dont, they lose customers to businesses that do. 2. Provides opportunities for poor people to work their way out of poverty. 3. Encourages business to be more efficient so that they can successfully compete on price and quantity. Limitations: 1. Inequality 2. Business people and other may let greed dictate how they act. Criminal charges brought against some big businesses in banking, telecommunications, insurance, pharmaceuticals indicate the scope of potential problem. Government laws and regulations are necessary.

Understanding Socialism Socialism: An economic system based on the premise that some, if not most, basic businesses such as steel mills, coal mines and utilizes should be owned by the government so that profits can be more evenly distributed among people. Entrepreneurs often own and run smaller business and individuals are often taxed relatively steeply to pay for social programs. Socialists acknowledge the major benefits of capitalism wealth creation but believe that wealth should be more evenly distributed then occurs in free market capitalism. They believe that government should carry out the distribution and be much more involved in protecting the environment and providing the poor. Benefits: 1. Equality through taxes from the wealthier people and redistributed to poorer members of the population through free education, free health care, free child care. 2. Workers get longer vacations, work fewer hours per week and have more employee benefits than those in countries where free market capitalism prevails. Negative Consequences: 1. Takes away some of the business peoples incentives to start work early and leave work late. Example: Some people migrate to countries with lower tax rate from high tax rate. 2. Fewer incentives and less innovation because those who come up with new ideas usually do not receive as much reward as they would in a capitalist system. Understanding Communism Communism: is an economic and political system in which the government makes almost all economic decisions and owns almost all the major factors of production. (North Korea, Cuba) Problems 1. The government has no way to know what to produce because prices do not reflect supply and demand. The government has to guess the economic needs of the people. As a result, there might be shortage of goods and services. 2. Dose not inspires business people to work hard because the government takes most of their earnings.

The trend towards Mixed Economics Free market Economics: Economic Systems in which the market largely determines what goods and services get produced, who gets them and how the economy grows. (Capitalism) Command Economics: Economic systems in which the government decides what goods and services will be produced, who will get them and how the economy will grow. (Socialism & Communism) Mixed Economics: An economic system in which some allocation of resources are made by the market and some by the government. Key Economic Indicators 1. Gross Domestic Product (GDP): is the total value of final goods and services produced in a country in a given year. Both domestic and foreign owned companies can produce the goods and services included in GDP as long as the companies are located within the countrys boundaries. A major influence on the growth of GDP is the productivity of the work force i.e. how much output workers create with a given amount of output. 2. The unemployment rate: The unemployment refers to the percentage of civilians at 16 years old who are unemployed and tried to find a job within the prior four weeks. There are four types of employment: Frictional, structural, cyclical and seasonal. Frictional unemployment refers to those people who have quit work because they did not like the job, the boss or the working conditions and who havent yet found a new job. It also refers to those people who are entering the labor force for the first time or are returning to the labor force after significant time away. There will always be some frictional unemployment because it takes some time to find job or a new job. Structural unemployment refers to unemployment caused by the restructuring of firms or by a mismatch between the skills of job seekers and the requirements of available jobs. Cyclical unemployment occurs because of a recession or a similar downturn in the business cycle (the ups and downs of business growth and decline over time). This type of unemployment is the most serious. Seasonal unemployment occurs where demand for labor varies over the year, as with the harvesting of crops. 3. Inflation and price indexes: Price indexes help gauge the health of the economy by measuring the levels of inflation, disinflation, deflation and stagflation. Inflation is a general rise in the prices of goods and services over time. Disinflation occurs when price increase are slowing (the inflation rate is declining). Deflation means that prices are declining. It occurs when countries produce so many goods that people cannot afford to buy them all. Stagflation occurs when the economy is slowing but prices are going up anyhow. Consumer price index (CPI) consists of monthly statistics that measure the pace of inflation or deflation. The government computes costs of goods and services including housing, foods, apparel and medical care to see whether they are going up or down. The CPI is an important figure because some wages and salaries, rents and leases, tax brackets, government benefits and interest rates are based in it. Producer price index (PPI) measures prices at the wholesale level. The Business Cycle Business Cycles are the periodic rises and falls that occur in economies over time. Economist Joseph Schumpeter identified the four phases of long term business cycles as boom-recession-depressionrecovery. 1. An economic boom is just what it sounds like the business is booming.

2. Recession is two or more consecutive quarters of decline in the GDP. In a recession prices fall, people purchase fewer products and business fail. A recession brings high unemployment, increased business failures and overall drop in living standards. 3. A depression is a severe recession, usually accompanied by deflation. Business cycles rarely go through a depression phase. 4. A recovery occurs when the economy stabilizes and starts to grow. This eventually leads to an economic boom, starting the cycle all over again. Stabilizing the economy through fiscal policy Fiscal policy: fiscal policy refers to governments efforts to keep the economy stable by increasing or decreasing taxes or government spending. The first fiscal policy tool is taxation. Theoretically, high tax rates tend to slow the economy because they draw money away from the private sector and put it into the government. High tax rates may discourage small business ownership because they decrease the profits businesses can earn and make the effort less rewarding. It follows, then, that low tax rates will theoretically give the economy a boost. The second fiscal policy tool is government spending on highways, social programs, education, infrastructure, defense and so on. The national deficit is the amount of money the government spends beyond what it gathers in taxes for a given fiscal year. If the government takes in more revenues than it spends, there is a national surplus. Using monetary policy to keep economy growing Monetary policy: Monetary policy is the management of the money supply and interest rates by the Central bank. The central banks most visible role is the raising and lowering of interest rates. When the economy is booming, the central bank tends to raise the interest rates. This makes money more expensive to borrow. Businesses thus borrow less, and the economy slows as business people spend less money on everything they need to grow, including labor and machinery. The opposite is true when the central bank lowers interest rates. Businesses tend to borrow more and the economy is expected to grow. Raising and lowering interest rates should therefore help control the rapid ups and downs of the economy. The central bank also controls the money supply. A simple explanation of this function is that the more money the central bank makes available to business people and others, the faster the economy is supposed to grow. To slow the economy, the central bank lowers the money supply. To sum up, there are two major tools for managing the economy: fiscal policy and monetary policy. The goal is to keep the economy growing so that people can rise up the economic ladder and enjoy a higher standard of living and quality of life. Also look: Chapter Summary Figure 2.1, 2.2, 2.3, 2.4, 2.6.