CHAPTER 2 (Economics)

How Economics Affects Business: The Creation and Distribution of Wealth Refresh Memory: Managing Within The

Dynamic Business Environment: Taking Risks and Making Profits.

Math Practice
If you spend Tk 5.7 M for your company taxes, and Tk 4.3 M for employee salary and receive revenue from garments business Tk 3.7.M and Tk 4.4 M from manufacturing sector for the Last quarter (Oct, Nov, Dec) of 2007 For your company, is that profit or Loss? Calculate the amount?

Topics

Economics?

Macroeconomics and Microeconomics

Growth Economics and Adam Smith -Invisible Hand Major form of economic system Key Economic Indicators

What is Economics?

Economics is the social science that studies the allocation of scarce resources to satisfy unlimited wants. It is the study of how society chooses to employ resources to produce goods and services and distribute them for consumption among various competing groups and individuals. Resources of a society also known as factors of production includes land, labor, capital, entrepreneurship and knowledge.

What is Economics (Cont.)?

Economics can be subdivided into two branches, namely: Macroeconomics and Microeconomics.
economics study that looks at the operation of a nation's economy as a whole. It deals with such factors as a societys GDP, unemployment, inflation, production and price levels.

Macroeconomics is the part of

What is Economics?

Microeconomics is the study of the individual parts of the economy, the household and the firm, and how decisions made by individuals, households and firms interact to form the prices of goods and services and the factors of production. It thus deals with issues such as pricing, supply and demand. For example, macroeconomic might look at such factors as how many jobs exist in the whole economy whereas microeconomics might deal with factors as how many jobs exist in a particular industry.

Resource Development

Economics is the social science which deals with allocating the scarce resources of the world to satisfy the unlimited wants. Resources are scarce and need to be carefully divided among the people, usually by the government. But there are not enough resources in this world to satisfy everyone. Thus we need to find ways in which to increase resources or to make the optimum use of current resources. For instance, businesses may find innovative ways of producing products that increase available resources. Such resources might include new energy resources , new ways of growing food, and new ways of creating goods and services. Resource development is the study of how to increase resources and to create the conditions that will make better use of these resources.

Resource Development (contd)

The world population is increasing at a faster rate but our resources are not. However technological advances in many countries have provided the means to increase production of food and other resources in a way that people in those countries are leading a better life than they did before. According to many economists, a large population can be a valuable resource, provided they are equipped with knowledge. One of the keys to economic growth is to better educate the people. Once people are educated, they can form their own businesses which provide employment for other people in the community. For those who do not want to start their own businesses, they can work for organizations and offer managerial and technical knowledge to them.

Growth Economics and Adam Smith

Adam Smith was a Scottish economist who was one of the first people to imagine a system for creating wealth and improving the lives for everyone. He believed in increasing current available resources so that everyone could become wealthier rather than believing that fixed resources had to be divided between competing groups and individuals. According to Smith, freedom is vital for the survival of any economy. This freedom includes the freedom to own land and property and to be able to keep the profit of ones hard work. The people of a country needs to know that if they work hard, their condition of living will improve. As long as farmers, laborers and business people could see economic reward for their efforts , they would work long hours. As a result of their efforts, the countrys economy would prosper.

Growth Economics and Adam Smith

Under Adam Smiths theory, entrepreneurs dont necessarily start business to help others. They work to improve their own condition of living. But in the process, they help society as well. The efforts of the entrepreneurs serve as an invisible hand that helps the economy grow and prosper through the production of needed goods, services and ideas.

Economic System

The major form of economic system of the world are:

Free-Market

Capitalism

Socialism
Communism Mixed

Economies

Free-Market Capitalism

Capitalism is the economic system that has led to wealth creation in much of the world Capitalism is an economic system in which all or most of the factors of production and distribution are privately-owned rather than owned by the government and are operated at a profit. In capitalist countries, businesspeople or entrepreneurs decide what to produce, how much to produce, how much to charge for the produced goods and services, how much to pay workers, whether to export the produced goods and so on. No country is purely capitalist. The government in most countries get involved in issues such as determining minimum wage, setting certain laws and regulations, setting farm prices and so on.

The Foundations of Free Market Capitalism

The four basic rights people have under freemarket capitalism are:
right to private property This is the most fundamental of all rights under capitalism. It means that individuals can buy, sell and use land, buildings, machinery and other forms of property. The right to own a business and to keep all businesss profits Entrepreneurs under capitalism can keep the profits earned from their business. This works as a major incentive for business owners.
The

The Foundations of Free Market Capitalism

right to freedom of competition Individuals under a capitalist system are free to compete with other individuals or businesses by offering new products and promotions. The right to freedom of choice Individuals are free to choose where they want to work and what career they want to follow. Other freedom of choice includes where to live, what to buy and sell.
The

Competition Within Free Markets

Under the Free-Market Capitalist System, four different degrees of competition exist:
Perfect

Competition Monopolistic Competition Oligopoly Monopoly

Competition Within Free Markets

Perfect Competition The market situation of perfect competition exists when there are many sellers in the market and no seller holds a market share large enough to dictate or settle the price of a product. Under perfect competition, sellers produce products that are identical. Examples of such products include agricultural products such as rice, potatoes, wheat and so on.

Competition Within Free Markets

Monopolistic Competition The market situation of monopolistic competition exists when a large number of sellers produce products that are very similar but are perceived by buyers as slightly different. Examples of such products include fastfood restaurants, candies, biscuits and so on. Under monopolistic competition, product differentiation is a key to business success.

Competition Within Free Markets

Oligopoly Oligopoly is a form of competition in which

there are a few sellers who dominate the market. One good reason why there are a few sellers in this form of competition is due to the heavy investment that is required to enter the business. Examples of products under this form of competition are automobiles, aircraft, real-estate business and so on. As with monopolistic competition, product differentiation is a key to business success under oligopoly. Prices of products tend to be the same or almost close since a price cut on the part of one competitor will soon be matched by other competitors in the business.

Competition Within Free Markets

Monopoly A monopoly occurs when there is one seller for a product or a service. Thus one seller controls the total supply of a product and the price. Examples of products under this form of competition includes public utility goods and services such as water, electricity. In the U.S, laws prohibit the creation of monopolies. The intention of this prohibition is to increase competition so as to offer prices at a lower rate.

Benefits and Limitations of Free Market

Benefits of Free-Market Economy

Free-market

economy is a major factor in creating wealth that the developed nations of the world now enjoy. It provides opportunities for poor people to work their way out of poverty. It encourages businesses to be efficient so that they can successfully compete on price and quality.

Benefits and Limitations of Free Market

Limitations of the Free-Market System Free-market

capitalism brings about inequality. Business owners and managers make more money than workers. The greed of some entrepreneurs dictate how they act. Some businesspeople deceive the public about their products while others deceive the stockholders about the value of their stock.

Socialism

Socialism is an economic system based on the premise that

some, if not most, basic businesses should be owned by the government so that profits can be evenly distributed among the people. Such basic businesses include steel mills, coal mines and utilities.

For instance, France owns more than 75 percent of the communications company France Telecom. Under socialism, entrepreneurs often own smaller businesses, but they are taxed heavily to pay for social programs. For instance, in the United States which is a country heavy on capitalism, the income tax that is paid by a top federal official is 35 percent, whereas more socialist countries such as Denmark and Netherlands pays tax as high as 60 percent. The United States pays a sales tax of around 5 percent whereas socialist countries pay as much as 15 to 20 percent.

Cont. on Socialism

Socialism is an economic system based on the premise that some, if not most, basic businesses should be owned by the government so that profits can be evenly distributed among the people. Such basic businesses include steel mills, coal mines and utilities. For instance, France owns more than 75 percent of the communications company France Telecom. Under socialism, entrepreneurs often own smaller businesses, but they are taxed heavily to pay for social programs. For instance, in the United States which is a country heavy on capitalism, the income tax that is paid by a top federal official is 35 percent, whereas more socialist countries such as Denmark and Netherlands pays tax as high as 60 percent. The United States pays a sales tax of around 5 percent whereas socialist countries pay as much as 15 to 20 percent.

Socialism

The major benefits of capitalism is wealth creation, but socialists believe that wealth should be more evenly distributed than that occurs in free-market capitalism. They believe that government should be the agency that carries out the distribution. Socialist nations rely heavily on the government to provide education, health care, retirement benefits. Unemployment benefits and other social services. Countries heavy on socialism includes Sweden, Finland, Belgium and some African countries. Many countries are now trying to reach a middle ground by achieving a mix between socialism and capitalism.

Benefits of Socialism

The main benefit of socialism is social equality. There is more equality in terms of wealth in socialism since income is taken from the wealthier people on the form of heavy taxes and redistributed to the poorer people through various government programs such as free education, free health care, child care and so on. Workers in socialist countries enjoy longer vacations, tend to work fewer hours per week and have more employee benefits.

Drawbacks of Socialism

The most negative consequence of socialism is brain drain. Since socialism relies on heavy taxation, it takes away incentives of business people, doctors, lawyers , who are charged a tax as high as 50 percent or even more, to work long hours or to even stay in the socialist countries. These people thus leave socialist countries for more capitalist countries like the United States. This loss of the best and brightest people of one country to other countries is known as brain drain.

Socialism also results in fewer inventions and less innovations because those who come up with the new ideas do not get rewarded and hence are not motivated to work on it.

Communism

Communism is an economic and political system in which the state or the government makes al economic decisions and owns almost all the major factors of production. Communism interferes with the life of its citizens even more than socialism does. For instance, some communist countries do not allow its citizens to practice certain religions, change jobs or move to the town of their choice. Examples of communist countries include North Korea, Cuba and some parts of former Russia.

Communism

Most communist countries are suffering severe economic depression and people in those countries are starving. There are two basic problems under communism.
Government

must guess what the economic needs of people are, instead of letting the market do it. As a result, shortages of many items may develop, including shortages of food and basic clothing. The other problem in communism is that businesspeople are not inspired to work hard because government takes most of their earnings.

Mixed Economies

The nations of the world have largely been divided between those that followed the concepts of capitalism and those that adopted the concepts of communism and socialism. Free market economies are economic systems in which the market largely determines what goods and services get produced, who gets them and how the economy grows. Command economies are economic systems in which the government largely decides what goods and services will be produced, who will get them and how the economy will grow.

Mixed Economies

But absolute free market economy or absolute command economy have not resulted in optimum economic conditions. Free market economy have not been responsive to the needs of the poor, the old or the disabled. It also does not contribute much to protect the environment. On the other hand, socialism and communism have not been able to create enough wealth and provide adequate jobs for the economy, as a result of which their economy slowed down. Therefore purely capitalist countries are taking some attributes of socialism and purely socialist countries are taking attributes of capitalism, resulting in a blend economic system, which is neither purely capitalist nor purely socialist.

Mixed Economies

For instance, capitalist countries like the United States have elected officials to undertake social and environmental programs such as Social Security, unemployment compensation, and other environmental protection acts. Socialist countries have been lowering taxes on business and workers to generate more incentive for people to work which eventually leads to business growth, creation of more jobs and hence prosperity.

Mixed Economies

The result of capitalist systems moving toward socialism and socialist system moving towards capitalism has given rise to the world of mixed economies. Mixed economies are economic systems in which some allocation of resources are made by the government and some by the market. The goal of government in mixed economies such as the United States is grow the economy while at the same time maintaining some social equality.

Key Economic Indicators

Three major indicators of economic conditions are:

Gross

Domestic Product The Unemployment Rate The Price Indexes

Key Economic Indicators

Gross Domestic Product (GDP) Gross domestic product is the total value of final goods and services produced in a country in a given year. Either a domestic company or a foreign owned company may produce the goods and services included in the GDP as long as the companies are located within the countrys boundaries. Higher GDP growth mean the quantity of produced goods and services is more, and hence more people are employed in the production of goods and services leading to more employment and economic prosperity.

Key Economic Indicators

The Unemployment Rate The unemployment rate is a key indicator of the countrys economy. High unemployment rate means a huge number of people without a job, which in turn indicates a slow economy. There are 4 kinds of unemployment:
Frictional

Unemployment Structural Unemployment Cyclical Unemployment Seasonal Unemployment

Key Economic Indicators

Frictional Unemployment refers to those people who have quit work because they did not like the job and who have not yet found a new job. It also refers to those people who are entering the labor force for the first time or returning to the labor force after significant time away. Structural Unemployment refers to unemployment cause by restructuring of firms or by a mismatch between skills of job seekers and the requirements of available jobs.

Key Economic Indicators

Cyclical Unemployment refers to unemployment due to recession or a similar downturn in the business cycle. This type of unemployment is the most serious. Seasonal Unemployment occurs when demand for labor varies over the year, for instance in the harvesting of crop.

Key Economic Indicators

The Price Indexes The price indexes help to measure the health of an economy by measuring the levels of inflation, disinflation, deflation and stagflation. The consumer price index measure the pace of inflation or deflation. Inflation refers to a general rise in the prices of goods and services over time. Disinflation occurs where price increases are slowing or in other words the inflation rate is declining. Deflation occurs when prices are declining because the countrys production of goods and services is more than what the people can buy. Stagflation occurs when the economy is slowing but prices are going up anyhow.

The Business Cycle

Business Cycles are the periodic rises and falls that occurs in all economies over time. Four phases of long term business cycles include

Economic Recession Depression Recovery

boom

The Business Cycle

Economic Boom occurs when businesses are booming and the economy is growing at a good pace. Recession occurs when there is two or more consecutive quarters of decline in GDP. In a recession, prices fall, people purchase fewer products and businesses fail. Negative consequences for recession are high unemployment, increased business failures and drop in living standard. A depression is a severe recession accompanied by deflation. A recovery occurs when the economy stabilizes and starts to grow. This eventually leads to economic boom starting the cycle all over again.

Stabilizing the Economy through Fiscal Policy

Fiscal Policy refers to the governments efforts to keep the economy stable by increasing or decreasing taxes or government spending. Theoretically high tax rates tend to slow the economy, since high tax rates draws money from businesspeople and workers, which gives them less incentive to work and hence their effort decreases. It also leaves less money to spend in the hands of consumers. Government spending refers to the spending by the government on highways, social programs, education, defense and so on. Optimum level of government spending helps an economy prosper.

Using Monetary Policy To Keep The Economy Growing

Monetary Policy refers to the management of money supply and interest rates. When economy of a country is booming, interest rates are raised. When economy of a country is slow interest rates are lowered so that there is more money available for people to borrow and the economy takes off.

Any Q?