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Course Number: BUS 508 508, Spring 2011

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Goals 1 Distinguish between microeconomics and macroeconomics. 2 Explain the factors that drive demand and supply. 3 Describe each of the four different types of market structures in a chapter 3 private enterprise system. 4 Compare the three major types of economic systems. 5 Identify and describe the four stages of the business cycle. 6 Explain how productivity, price level changes, and employment levels...

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Distinguish Goals 1 between microeconomics and macroeconomics. 2 Explain the factors that drive demand and supply. 3 Describe each of the four different types of market structures in a chapter 3 private enterprise system. 4 Compare the three major types of economic systems. 5 Identify and describe the four stages of the business cycle. 6 Explain how productivity, price level changes, and employment levels affect the stability of a nations economy. 7 Discuss how monetary policy and fiscal policy are used to manage an economys performance. 8 Describe the major global economic challenges of the 21st century. Ryan McVay/Photodisc/Getty Images Economic Challenges Facing Contemporary Business Copyright 2011 John Wiley & Sons c03.indd 66 11/3/09 6:33:59 PM A s Barack Obama took his historic oath of office, the U.S. economy was faltering. Daily news headlined the worst downturn since the Great Depression. All eyes turned to Washington, D.C., for help getting cash and credit flowing into the financial system again. Opinions remained deeply divided about the new presidents $787 billion economic stimulus plan, with some wanting less government spending and more tax cuts, but most people believed that the government had to do something. Reeling from a huge burden of bad debt left over from the bursting of the housing bubble, banks and other lending institutions had essentially withdrawn from the economic playing field, with too little cash or confidence to continue lending. Businesses that depended on short-term loans from these lenders were left without the funds they needed to conduct their everyday operations or expand for the future. As already debt-laden consumers grew wary of spending in an uncertain economy, sales slumped in industries across the board, inventories of unsold goods piled up, and companies like 3M, Home Depot, Starbucks, Microsoft, Nokia, and dozens more announced layoffs of thousands of workers in the wake of unprecedented financial losses. Unemployment was soaring, dampening consumer spending even further. Stock prices fell, sales of new homesa major indicator of the economys healthplunged, cars sat on dealers lots, and retailers reported the worst holiday selling season in decades. The United States cut imports of foreign-made products like televisions and computers. Foreign manufacturers cut back production, and with less money to spend, overseas businesses trimmed demand for U.S. products as well, forcing the countrys exports down. Bad news spread worldwide. In an ominous sign, the U.S. economy began to shrink. An economist at JPMorgan Chase noted, The fact that youre not seeing any evidence that things are turning for the better has added quite a bit to the urgency to get things done and do something substantial. After much debate, Congress adopted President Obamas plan to put government money into the economy, although it was certain to be only a partial solution. What was clear, however, was that only the government had both the funds to commit to such a huge economic rescue plan and the power to direct the money broadly to various projects that would create jobs across the nation. Jobs would generate income, increase confidence, and spur a recovery. In fact, President Obama hoped building projects in transportation and housing would quickly save or create at least 3.5 million jobs. The plan set aside almost $18 billion for investments in high-speed rail and mass transit projects and $48 billion for transportation improvements such as bridge and highway repair to kick-start that job creation. The rest of the $506 billion was divided among social programs that included roughly $87 billion for state Medicaid health insurance plans for lower- and middleclass families and over $82 billion for various education and job training programs. Cash payments to seniors and disabled veterans, financing to repair and modernize public housing, support for local law enforcement, and budgets to increase energy efficiency in government and military facilities, improve public parks, and modernize the nations electric grid were among many other spending lines. The stimulus also provided tax relief to businesses that are trying to make payroll and create jobs and to individuals and families. Among the $281 billion in tax breaks were some that rewarded consumers for new home and car purchases and others for businesses to help improve their short-term finances. For instance, business tax incentives for renewable energy facilities added up to more than $14 billion, with millions more for hiring disadvantaged workers and expanding industrial development. The governments goal was to inject money into the economy for both the short and long term so that businesses could continue to function, new jobs could put the unemployed back to work, and consumers could return money to the economy by picking up their spending on household goods, cars, and appliances, as well as on luxuries like restaurant meals and Chuck Kennedy/Bloomberg News/Landov Obamanomics: Stimulus to Help the Economy Copyright 2011 John Wiley & Sons c03.indd 67 11/3/09 6:34:30 PM vacations. It will take time for parts of the plan to be implemented and for the nation to know how well it has worked. Adjustments will be needed along the way. But businesses Chapter 3 OVERVIEW When we examine the exchanges that companies and societies make as a whole, we are focusing on the economic systems operating in different nations. These systems reflect the combination of policies and choices a nation makes to allocate resources among its citizens. Countries vary in the ways they allocate scarce resources. Economics, which analyzes the choices people and governments make in allocating scarce resources, affects each of us, because everyone is involved in producing, distributing, or simply consuming goods and services. In fact, your life is affected by economics every day. When you decide what goods to buy, what services to use, or what activities to fit into your schedule, you are making economic choices. Understanding how the activities of one industry affect those of other industries, and how they relate in the overall picture of a country, is an important part of understanding economics. The choices you make actually may be international in scope. If you are in the market for a new car, you might visit several dealers in a row on the same street Ford, Chrysler, Honda, Toyota, and General Motors. You might decide on Toyotaa Japanese firmbut your car might very well be manufactured in the United States, using parts from all over the world. Although firms sometimes emphasize the American origin of their goods and services in order to appeal to consumers desire to support the U.S. economy, many products are made of components from a variety of nations. Businesses and not-for-profit organizations also make economic decisions when they choose how to use human and natural resources; invest in equipment, machinery, and buildings; and form partnerships with other firms. Economists refer to the study of small economic units, such as individual consumers, families, and businesses, as microeconomics. economics social science that analyzes the choices people and governments make in allocating scarce resources. 68 and individuals were willing to work with the government to get the country back on its feet again. That will be a big step toward a global economic recovery.1 microeconomics study of small economic units, such as individual consumers, families, and businesses. On a broader level, government decisions about the operation of the countrys economy also affect you, your job, and your financial future. A few years ago, in an effort to improve the U.S. economy, the White House and Congress agreed on a package to stimulate markets through tax rebates for families and incentives for businesses. The plan also included elements designed to boost the housing market and provide relief to homeowners facing foreclosure.2 The study of a countrys overall economic issues is called macroeconomics (macro means large). Macroeconomics addresses such issues as how an economy uses its resources and how government policies affect peoples standards of living. The substitution of ethanol for gasoline has macroeconomic consequencesaffecting many parts of the U.S. economy and suppliers around the world. Macroeconomics examines not just the economic policies of individual nations but the ways in which those individual policies affect the overall world economy. Because so much business is conducted around the world, a law enacted in one country can easily affect a transaction that takes place in another country. Although macroeconomic issues have a broad scope, they help shape the decisions that individuals, families, and businesses make every day. This chapter introduces economic theory and the economic challenges facing individuals, businesses, and governments in the global marketplace. We begin with the microeconomic concepts of supply and demand and their effect on the prices people pay for goods and services. Next we explain the various types of economic systems, along with tools for comparing and evaluating their performance. Then we examine the ways in which governments seek to manage economies to create stable business environments in their countries. The final section in the chapter looks at some of the driving economic forces currently affecting peoples lives. macroeconomics study of a nations overall economic issues, such as how an economy maintains and allocates resources and how a governments policies affect the standards of living of its citizens. Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 68 11/3/09 6:34:59 PM Microeconomics: The Forces of Demand and Supply Think about your own economic activities. You shop for groceries, you Assessment Check subscribe to a cell phone service, you pay college tuition, you fill your cars tank with gas. Now think about your familys economic activities. When you 1. Define microeconomics. were growing up, your parents might have owned a home or rented an apart2. Define macroeconomics. ment. You might have taken a summer family vacation. Your parents may have shopped at discount clubs or at local stores. Each of these choices relates to the study of microeconomics. They also help determine both the prices of goods and services and the amounts sold. Information about these activities is vital to companies because their survival and ability to grow depends on selling enough products priced high enough to cover costs and earn profits. The same information is important to consumers who must make purchase decisions based on prices and the availability of the goods and services they need. demand willingness At the heart of every business endeavor is an exchange between a buyer and a seller. The and ability of buyers buyer recognizes that he or she needs or wants a particular good or servicewhether its a to purchase goods hamburger or a haircutand is willing to pay a seller for it. The seller requires the exchange in and services. order to earn a profit and stay in business. So the exchange process involves both demand and supply. Demand refers to the willingness and ability of buyers to purchase goods and services supply willingness at different prices. The other side of the exchange process is supply, the amount of goods and and ability of sellers services for sale at different prices. Understanding the factors that determine demand and supto provide goods and ply, as well as how the two interact, can help you understand many actions and decisions of services. individuals, businesses, and government. This section takes a closer look at these concepts. Factors Driving Demand For most of us, economics amounts to a balance between what we want and what we can afford. Because of this dilemma, each person must choose how much money to save and how much to spend. We must also decide among all the goods and services competing for our attention. Suppose you wanted to purchase a cell phone. Youd have to choose from a variety of brands and models. Youd also have to decide where you wanted to go to buy one. After shopping around, you might decide you didnt want a cell phone at all. Instead, you might purchase something else, or save your money. Demand is driven by a number of factors that influence how people decide to spend their money, including price. It may also be driven by outside circumstances or larger economic events. And it can be driven by consumer preferences. Despite a downturn in consumer spending during a recent year, videogames experienced a strong increase in sales of 43 percent above the previous year. Earlier increases were the result of shoppers buying new hardwareNintendo and Wii were the big hardware winners. But the recent growth represented consumers desire for new games to play on the systems, leading to strong sales of software.3 Demand can also increase the availability of certain types of Web sites and services. Recognizing the enormous popularity of Googles YouTube, and believing the demand would grow, networks NBC and Fox teamed up to launch an advertising-supported online video site, which provides programming from different entertainment companies. The site, called Hulu. com, offers free viewing of full-length movies and television shows. It also hosts programming from NBC and Fox and shows from Sony and Metro-Goldwyn-Mayer. Consumers identify with shows and films [instead of networks], explained the sites chief executive, Jason Kilar. When you aggregate great content together, it makes things easier for the user.4 id It They Sa Please send me a one-armed economist so we will not always hear On the other hand . . . Herbert Hoover (18741964) 31st president of the United States Chapter 3 Economic Challenges Facing Contemporary Business 69 Copyright 2011 John Wiley & Sons c03.indd 69 11/3/09 6:34:59 PM Eric Shelton/AP/Wide World Photos In general, as the price of a good or service goes up, people buy smaller amounts. In other words, as price rises, the quantity demanded declines. At lower prices, consumers are generally willing to buy more of a good. A demand curve is a graph of the amount of a product that buyers will purchase at different prices. Demand curves typically slope downward, meaning that lower and lower prices attract larger and larger purchases. Gasoline provides a classic example of how demand curves work. The left side of Figure 3.1 shows a possible demand curve for the total amount of gasoline that people will purchase at different prices. The prices shown may not reflect the actual price in your location at this particular time, but they still demonas strate the concept. When gasoline is priced at $2.99 a ences as well stes and prefer s gallon, drivers may fill up their tanks once or twice a by consumer ta their gas tank en to fill up Demand is driv nsumers tend week. At $3.39 a gallon, many of them start economizconditions. Co low. ice is by economic e per-gallon pr ing. They may combine errands or carpool to work. So uently when th more freq the quantity of gasoline demanded at $3.39 a gallon is lower than the amount demanded at $2.99 a gallon. The opposite happens at $2.59 a gallon. More gasoline is sold at $2.59 a gallon than at $2.99 a gallon, as people opt to run more errands or take a weekend trip. However, as mentioned earlier, other factors may cause consumers to accept higher prices anyway. They may have made vacation plans in advance and do not want to cancel them. Or they may be required to drive to work every day. Economists make a clear distinction between changes in the quantity demanded at various prices and changes in overall demand. A change in quantity demanded, such as the change that occurs at different gasoline prices, is simply movement along the demand curve. A change in overall demand, on the other hand, results in an entirely new demand curve. Businesses are Figure 3.1 Demand Curves for Gasoline A. Demand Curve for Gasoline and Change in Quantity Demanded B. Shift in the Demand Curve for GasolineChange in Demand $3.70 $ 3 .3 9 /gal. 3.30 $ 2 .9 9 /gal. 2.90 $ 2 .5 9 /gal. 2.50 2.10 Price per Gallon (P) Price per Gallon (P) $3.70 3.30 2.90 2.50 2.10 10 20 30 Quantity (Q) (millions of gallons) 70 New Demand Curve 10 20 30 Quantity (Q) (millions of gallons) Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 70 11/3/09 6:34:59 PM constantly trying to make predictions about both kinds of demand, and a miscalculation can cause problems. In the case of gasoline, which is derived from crude oil, many factors come into play. One factor that is beginning to make a major impact is the investment in and development of alternative fuels such as biodiesel, wind, and solar power. If alternatives are developed and readily available, then demand for oil may decrease. Another issue is the U.S. economy. When a downturn occurs, so does the demand for oil and other goods. If we are slowing down, we will not be buying as much goods from China and services from India, notes Addison Armstrong, director for marketing research at energy broker Tradition Energy. But disruptions in energy sources have the opposite effect; political unrest in oil-rich nations such as Nigeria or extreme weather that takes refineries offline increase the demand for the oil that is available. Also, industrial growth in developing countries such as China and India increase the overall worldwide demand for oil.5 We can illustrate how the increased demand for gasoline worldwide has created a new demand curve, as shown in Figure 3.1. The new demand curve shifts to the right of the old demand curve, indicating that overall demand has increased at every price. A demand curve can also shift to the left when the demand for a good or service drops. However, the demand curve still has the same shape. Although price is the underlying cause of movement along a demand curve, many factors can combine to determine the overall demand for a productthat is, the shape and position of the demand curve. These influences include customer preferences and incomes, the prices of substitute and complementary items, the number of buyers in a market, and the strength of their optimism regarding the future. Changes in any of these factors produce a new demand curve. Although U.S. consumers still love their cup of coffee every morning, makers of supermarket brands like Maxwell House and Folgers are experiencing a decrease in demand for their products. Instead, demand for coffee to go is on the rise. Starbucks, Dunkin Donuts, and McDonalds (which now serves Newmans Own) recently reported a combined growth of 15 percent.6 Perhaps the increase is because consumers prefer premium brands, or perhaps they like the convenience of these shops. Still, Starbucks is attempting to ward off competition from its less-expensive rivals by offering smaller cups of drip coffee for $1 with free refills.7 Changes in household income also change demand. As consumers have more money to spend, firms can sell more products at every price. This means the demand curve has shifted to the right. When income shrinks, nearly everyone suffers, and the demand curve shifts to the left. High-end retailers like Nordstrom, Saks, and Neiman Marcus experienced a decrease in demand for their luxury goods, as consumers thought twice about buying designer handbags, shoes, and clothing. Everyones shopping for the bare necessities, and people have stopped treating themselves, explained one retail consultant. Meanwhile, discount retailers such as JCPenney and Wal-Mart experienced an increase in sales, so their demand curve shifted a bit to the right.8 Table 3.1 describes how a demand curve is likely to respond to each of these changes. Table 3.1 Expected Shifts in Demand Curves Demand Curve Shifts Factor to the Right if: to the Left if: Customer preferences increase decrease Number of buyers increases decreases Buyers incomes increase decrease Prices of substitute goods increase decrease Prices of complementary goods decrease increase Future expectations become more optimistic pessimistic Chapter 3 Economic Challenges Facing Contemporary Business 71 Copyright 2011 John Wiley & Sons c03.indd 71 11/3/09 6:35:23 PM : on hot days, by the weather ks is affected ft drin ys. This smart Demand for so an on cold da d adjusts e soft drinks th or mperature an vendors sell m the outdoor te e weather is ne monitors cordingly. If th vending machi inks it holds ac e. e soft dr eases the pric the price of th matically incr machine auto hot, the Figure 3.2 Supply Curve for Gasoline Price per Gallon (P) $3.70 $ 3 .3 9 /ga l. 3.30 $ 2 .9 9 /ga l. 2.90 2.50 $2 .5 9 /ga l. 2.10 10 20 30 Quantity (Q) (millions of gallons) 72 John Bazemore/AP/Wide World Photos For a business to succeed, management must carefully monitor the factors that may affect demand for the goods and services it hopes to sell. In setting prices, firms often try to predict how the chosen levels will influence the amounts they sell. The CocaCola Company experimented with smart vending machines, adjusting prices to such variables as the weather. If the temperature was hot outside, the machines could automatically raise the price. If the vending machine contained too many cans of root beer and restocking was five days away, the machine could lower the price of root beer. Organizations also try to influence overall demand through advertising, free samples and presentations at retail stores, sales calls, product enhancements, and other marketing techniques. Factors Driving Supply Important economic factors also affect supply, the willingness and ability of firms to provide goods and services at different prices. Just as consumers must decide about how to spend their money, businesses must decide what products to sell, and how. Sellers would prefer to charge higher prices for their products. A supply curve shows the relationship between different prices and the quantities that sellers will offer for sale, regardless of demand. Movement along the supply curve is the opposite of movement along the demand curve. So as price rises, the quantity that sellers are willing to supply also rises. At progressively lower prices, the quantity supplied decreases. In Figure 3.2, a possible supply curve for gasoline shows that increasing prices for gasoline should bring increasing supplies to market. Businesses need certain inputs to operate effectively in producing their output. As discussed in Chapter 1, these factors of production include natural resources, capital, human resources, and entrepreneurship. Natural resources include land, building sites, forests, and mineral deposits. Capital refers to resources such as technology, tools, information, physical facilities, and financial capabilities. Human resources include the physical labor and intellectual inputs contributed by employees. Entrepreneurship is the willingness to take risks to create and operate a business. Factors of production play a central role in determining the overall supply of goods and services. Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd c03.indd 72 11/3/09 6:35:23 PM 2008 Organic Valley Family of Farms A change in the cost or availability of any of these inputs can shift the entire supply curve, either increasing or decreasing the amount available at every price. If the cost of land increases, a firm might not be able to purchase the site for a more efficient manufacturing plant, which would lower production levels, shifting the supply curve to the left. But if the company finds a way to speed up the production process anyway, allowing it to turn out more products with less labor, the change reduces the overall cost of the finished products, which shifts the supply curve to the right. Table 3.2 summarizes how changes in various factors can affect the supply curve. Sometimes forces of nature can affect the supply curve. During a recordbreaking freeze one recent January, nearly 75 percent of Californias citrus crop, including oranges and lemons, was severely damaged. Because they could not be harvested and shipped, supply dropped significantly. Agriculture officials estimated that growers lost more than $1.2 billion in crops. As a result, wholesale prices spiked for a short period and then settled in at about one and a half times the regular price. Florida fruit growers filled part of the gap in supply, because they did not experience the freeze.9 supply curve, The agriculture industry has often experienced uct shifts the a and for a prod t. Because of the dem such shifts in the supply curve. As consumers e of the produc y An increase in to provide mor , Organic Valle ers oducts causing produc d for organic pr increase their demand for organic products, more past. e in the deman w as it did in th recent increase much milk no and more dairy farmers are rushing to fill the nearly twice as is processing supply. Organic Valley, a Wisconsin-based cooperative, added 269 dairy farmers to its roster and is processing nearly twice as much milk as it did a year before. Horizon Organic, the largest U.S. organic dairy company, added 64 organic id It They Sa dairy farmers in one year. However, some industry experts caution that an oversupply of organic milk is about to hit the market. While this would normally drive prices down, dairy companies and retailers say they will not lower their prices, which are typically double that Framework for of regular milk.10 success: Rise early, work hard, and strike oil. Table 3.2 Expected Shifts in Supply Curves Supply Curve Shifts Factor to the Right if : to the Left if : Costs of inputs decrease increase Costs of technologies decrease increase Taxes decrease increase Number of suppliers increases J. Paul Getty (18921976) American businessperson and founder of Getty Oil Company decreases Chapter 3 Economic Challenges Facing Contemporary Business 73 Copyright 2011 John Wiley & Sons c03.indd c03.indd 73 11/3/09 6:35:36 PM Hit & Miss Miss Supply, Demand, and Swings in Oil Prices Low crude oil prices are a boon for U.S. consumers, who depend on oil as an ingredient in everything from nonstick cookware to gasoline and home heating fuel. OPEC, the group of oil-producing nations that supplies the bulk of the worlds crude oil, is usually able to control the price of crude, and ultimately of gasoline, by controlling the supply. If OPECs members agree to reduce their output, for example, oil supplies in industrialized nations grow tight, and prices at the pump and factories generally rise. When OPEC starts producing again, supplies rise, and prices are forced down. But everything doesnt always go according to plan. Following the global financial crisis, oil consumption fell as factories closed and consumer demand slowed, especially in the United States, the worlds largest oil consumer. Rising unemployment and a weak economy drastically cut the number of vehicles on the road. Demand for oil fell almost 8 percent and was expected to continue dropping. The price of crude crashed after hitting a high of $145 only a few months before. OPEC gradually slowed supply, hoping to prop the price up to its preferred level of at least $70 a barrel by reducing output by about 5 percent worldwide. But as much as oil producers want to keep prices up, in part to help meet rising production costs, many observers think any significant increase in the price of this critical factor of production will add more pain to the global economy. Can the price be too low? From oil consumers viewpoint, politically it is better to say we need the lowest possible oil prices, says the director of a Swiss energy research firm. But there are economic implications to low prices, and not just for OPEC producers. As long as oil is cheap, some fear that industrialized nations will continue to rely on it instead of investing in cheaper, cleaner, and ecologically renewable energy alternatives. Meanwhile, the drastic swings in oil prices left oil producers shaken. Our sector is no stranger to cycles, said the CEO of an Italian oil company. But the turbulence we are currently experiencingwith oil doubling in . . . nine months . . . and then losing two-thirds of its value in the following six monthsis unprecedented. Further complicating the price picture are oil traders, who buy at low prices, wait for prices to rise, then sell at a profit. The International Monetary Fund reported that such speculation has played a significant role in the run-up of oil prices and contributed to a rapid glut of what one observer calls historic proportions. While producers are cutting back production to keep prices from falling further, one thing is certain. As an economic recovery gets under way in earnest, global demand will rise again, and so will the price. Questions for Critical Thinking 1. What roles do supply and demand play in the economics of oil production? 2. What have you observed at your local gas station that suggests the fluctuation of oil supply and oil demand? Sources: Crude Oil Falls as Recession Batters U.S., MSNBC, February 6, 2009, http://www.msnbc.com; Jad Mouawad, OPEC Achieves Cut in Output, Halting Price Slide, The New York Times, January 26, 2009, http://www.nytimes.com; Donna Abu-Nasr, CEO of Eni Says Oil Price Bumps Unprecedented, Associated Press, January 26, 2009, http://www.google.com/hostednews/ ap/; Greg Flakus, Oil Storage at Record Levels as Speculators Await Higher Prices, VOA News, January 23, 2009, http://www. voanews.com. How Demand and Supply Interact Separate shifts in demand and supply have obvious effects on prices and the availability of products. In the real world, changes do not alternatively affect demand and supply. Several factors often change at the same timeand they keep changing. Sometimes such changes in multiple factors cause contradictory pressures on prices and quantities. In other cases, the final direction of prices and quantities reflects the factor that has changed the most. The Hit & Miss feature discusses issues of demand and supply in the international oil market. Figure 3.3 shows the interaction of both supply and demand curves for gasoline on a single graph. Notice that the two curves intersect at P. The law of supply and demand states 74 Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd c03.indd 74 11/3/09 6:35:45 PM Price per Gallon (P) that prices (P) are set by the intersection of the supply Figure 3.3 Law of Supply and Demand and demand curves. The point where the two curves meet identifies the equilibrium price, the prevailing market Demand price at which you can buy an item. Supply $3.70 If the actual market price differs from the equilibrium price, buyers and sellers tend to make economic choices 3.30 that restore the equilibrium level. When the price of gold P hit $900 an ounce, consumers could expect to pay more Equilibrium 2.90 for gold jewelry. Also, investors always seem to return Price to gold as a safe standard, according to economists, and 2.50 consumers who are intent on buying jewelry most likely will do so, but they may buy fewer pieces.11 2.10 In other situations, suppliers react to market forces by reducing prices. Chain restaurants such as Churchs Chicken and Sonic recently added and began promoting 20 30 10 everyday value menus to attract consumers. Sonic now Quantity (Q) (millions of gallons) offers guests more affordable options than ever before, said a Sonic spokesperson. Wendys and McDonalds have long offered value-priced items and have seen their popularity rise during tough economic times.12 A ssessment Check As pointed out earlier, the forces of demand and supply can be affected by a variety of factors. One important variable is the larger economic environ1. What is a demand curve? ment. The next section explains how macroeconomics and economic systems 2. What is a supply curve? influence market forces and, ultimately, demand, supply, and prices. 3. How do factors of production influence the overall supply of goods and services? Macroeconomics: Issues for the Entire Economy Every country faces decisions about how to best use the four basic factors of production. Each nations policies and choices help determine its economic system. But the political, social, and legal environments differ in every country. So no two countries have exactly the same economic system. In general, however, these systems can be classified into three categories: private enterprise systems; planned economies; or combinations of the two, referred to as mixed economies. As business becomes an increasingly global undertaking, it is important to understand the primary features of the various economic systems operating around the world. Capitalism: The Private Enterprise System and Competition Most industrialized nations operate economies based on the private enterprise system, also known as capitalism or a market economy. A private enterprise system rewards businesses for meeting the needs and demands of consumers. Government tends to favor a hands-off attitude toward controlling business ownership, profits, and resource allocations. Instead, competition regulates economic life, creating opportunities and challenges that businesspeople must handle Chapter 3 Economic Challenges Facing Contemporary Business 75 Copyright 2011 John Wiley & Sons c03.indd 75 11/3/09 6:35:45 PM Alternatives to Bonuses Long a way of life in certain industries, annual bonuses are meant to reward and retain key employees. But with companies struggling financially, cash bonuses may be difficult or impossible to pay. They are increasingly unpopular with shareholders in some firms and no longer affordable in others. More than one company in five expected to reduce the dollar value of long-term incentives in the coming year, while even more are looking for alternatives that reward good performance in ways other than financial. A Canadian Chrysler employee with a working spouse, grown children, and good benefits offered to be laid off so that her coworker with young kids and a laid-off spouse could keep his job instead. That generous offer spurred the idea that helping others is its own reward. If a firm cant give bonuses, here are some alternatives, which require only modest spending: Help employees give without spending their own money. Kansas-based Zillner Marketing Communications gave each of its 57 employees $50 to be used to help those less fortunate. Give employees extra time off with pay during the holidays when they want to get together with friends and families. Set up a time and place to conduct a gift barter, where employees can trade unwanted but new items like clothes, books, tools, or small appliances with one another. Everyone wins by saving time, money, and gas instead of going shopping. Barter as a firm, asking clients or suppliers to trade a valuable service your employees can use, like car tune-ups or dry cleaning services, in exchange for one your firm can provide, like computer troubleshooting or limousine service. Use your companys size as a bargaining chip to win year-long discounts for your employees to indulge in pampering services at local gyms and spas. Save employees money on their commute by organizing a carpool system. Better yet, let the boss be the designated driver who picks everyone up. Provide catered holiday meals to be delivered to everyone in the firm. Offer thoughtful menu choices for those with religious or dietary restrictions and a selection of delivery dates, and everyone will be pleased. Offer to pay one monthly bill for each employeeexcluding mortgages! Sources: Sarah Boesveld, Taking a Bullet for the Team, The Globe and Mail, January 26, 2009, http://www.theglobeandmail.com; Linda Cruse, Employees of Johnson County Firm Use Bonuses to Pay It Forward, The Kansas City Star, January 2, 2009, http://www.kansascity.com; Recession Forcing Companies to Cut Executive Bonuses, Watson Wyatt Survey Finds, Washington Business Journal, December 11, 2008, http://www.bizjournals.com; Scott Allen, Top 10 Recession-Proof Holiday Bonus Ideas, About.com, December 3, 2008, http:// entrepreneurs.about.com. 76 to succeed. One area of business that you will probably encounter in the private enterprise system is employee bonuses, so it is important to know some of the alternatives. Read the Business Etiquette feature for some tips. The relative competitiveness of a particular industry is an important consideration for every firm because it determines the ease and cost of doing business within that industry. Four basic types of competition take shape in a private enterprise system: pure competition, monopolistic competition, oligopoly, and monopoly. Table 3.3 highlights the main differences among these types of competition. Pure competition is a market structure, like that of small-scale agriculture or fishing, in which large numbers of buyers and sellers exchange homogeneous products and no single participant has a significant influence on price. Instead, prices are set by the market itself as the forces of supply and demand interact. Firms can easily enter or leave a purely competitive market because no single company dominates. Also, in pure competition, buyers see little difference between the goods and services offered by competitors. Fishing and agriculture are good examples of pure competition. The wheat grown and sold by one farmer in the Midwest is virtually identical to that sold by others. As rainfall and temperatures affect the crop growth, the price for this commodity rises or falls according to the law of supply and demand. The same concept applies to the fishing industry gathering clams and mussels off the coast of New England. The regions notorious red tide of algae sometimes contaminates part of the seasons supply of shellfish just when summer tourists want them the mostand prices skyrocket. The production of alternative fuels such as ethanol may shift toward pure competition. Monopolistic competition is a market structure, like that for retailing, in which large numbers of buyers and sellers exchange differentiated (heterogeneous) products, so each participant has some control over price. Sellers can differentiate their products from competing offerings on the basis of price, quality, or other features. In an industry that features monopolistic competition, it is relatively easy for a firm to begin or stop selling a good or service. The success of one seller often Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 76 11/3/09 6:35:45 PM Table 3.3 Types of Competition Types of Competition Pure Competition Monopolistic Competition Oligopoly Monopoly Number of competitors Many Few to many Few No direct competition Ease of entry into industry by new firms Easy Somewhat difficult Difficult Regulated by government Similarity of goods or services offered by competing firms Similar Different Similar or different No directly competing products Control over price by individual firms None Some Some Considerable in a pure monopoly; little in a regulated monopoly Examples Small-scale farmer in Indiana Local fitness center Boeing Aircraft Rawlings Sporting Goods, exclusive supplier of majorleague baseballs attracts new competitors to such a market. Individual firms also have some control over how their goods and services are priced. Pawnshops are one example of monopolistic competition, as discussed in the Hit & Miss feature. Another example of monopolistic competition is the market for pet food. Consumers can choose from private-label (store brands) and brand-name products in bags, boxes, and cans. Producers of pet food and the stores that sell it have wide latitude in setting prices. Consumers can choose the store or brand with the lowest prices, or sellers can convince them that a more expensive offering is worth more because it offers better nutrition, more convenience, more information, or other benefits. An oligopoly is a market situation in which relatively few sellers compete and high start-up costs form barriers to keep out new competitors. In some oligopolistic industries, such as paper and steel, competitors offer similar products. In others, such as aircraft and automobiles, they sell different models and features. The huge investment required to enter an oligopoly market tends to discourage new competitors. The limited number of sellers also enhances the control these firms exercise over price. Competing products in an oligopoly usually sell for very similar prices because substantial price competition would reduce profits for all firms in the industry. So a price cut by one firm in an oligopoly will typically be met by cause clams mpetition. Be ple of pure co al to those od exam rtually identic Fishing is a go herman are vi e fis ith changes in gathered by on es and falls w of algae rs, the price ris he ous red tide gathered by ot never a poison the supply of mand. Whe New England, supply and de off the coast of beds e skyrockets. infests the clam s and the pric ams plummet fresh cl Chapter 3 Economic Challenges Facing Contemporary Business Paul Poplis/Food Pix/Jupiter Images Corp Characteristics 77 Copyright 2011 John Wiley & Sons c03.indd 77 11/3/09 6:35:47 PM Hit & Miss Miss Pawnshops Prosper Pawnshops lend customers quick cash in exchange for merchandise they leave behind, from jewelry and designer handbags to tools and DVD players. The shops dont run credit checks but can sell the goodsusually for about half of retailif customers cant repay the loan plus a fee of 10 to 20 percent. Typically about 3 in 10 customers fail to retrieve their pawned items. Once seen as a sad refuge of the desperate, pawnshops now find their business booming. Financial woes and tightened credit markets have forced more people to try to capitalize on the value of the family silver, a guitar, a digital camera, even a vacuum cleaner, driving the number of first-time customers up 10 percent. Our door swings all day long, said one pawnshop owner who is president of the Kentucky Pawnbrokers Association. We are a safety net for so many citizens in our communities. Customers are changing, too. In the past most had household incomes under $30,000; now many are middleand upper-middle-class workers struggling with unexpected job losses and diminished savings. In wealthier neighborhoods, transactions involving furs and diamonds are up as much as 40 percent. Cash America, a pawnshop chain, has seen earnings rise dramatically, and a four-shop business in Maine reported lending one-third more cash than the year before. The banking industry is not giving out any money right now, the owner said, so people are relying on second-tier lending institutions. t ey Said I Th Using economics to influence public behavior is something this country is built onits called capitalism. Michael Bloomberg (b. 1942) Mayor, New York City 78 A pawnshop is a small bank, agrees Charlie Bell, a South Carolina pawnbroker. We just loan money to people. Pawnshops do feel the economic pinch in at least one way, however. The rate at which customers pay back their loans and retrieve their collateral has dropped by about 10 percent, which means shops are left with more goods to sell. One young engineer recently tried to pawn his $2,500 Movado watch to make a mortgage payment after being laid off. I want to help, said the Philadelphia pawnbroker he visited. But no market existed in his neighborhood for such an expensive timepiece, and unsold items become a liability for shop owners. The customer left with the watch in his pocket. Questions for Critical Thinking 1. In what ways do pawnshops meet the criteria for monopolistic competition? 2. What factors into a pawnbrokers decision about which loans to make? Sources: Marti Covington, Pawn Shops among Few Businesses That Get Busier During a Recession, Beaufort Gazette, February 7, 2009, http://www.beaufortgazette.com; Kevin Eigelbach, Some Local Pawn Shops See More People in Need of ShortTerm Loans, Business First of Louisville, February 6, 2009, http://www.bizjournals.com; Aili McConnon, For Pawnshops, the Recession Is a Golden Egg, BusinessWeek, February 4, 2009, http://www.businessweek.com; Gary Fields, People Pulling Up to Pawnshops Today Are Driving Cadillacs and BMWs, The Wall Street Journal, December 30, 2008, http://www.online.wsj. com; Judy Keen, Pawnshops Doing Brisk Business, USA Today, November 10, 2008, p. 3A. its competitors. However, prices can vary from one market to another, as from one country to another. Cement is another product for which an oligopoly exists. Mexican-based Cemex SA is the third-largest cement manufacturer in the world and the largest seller of cement in both the United States and Mexico. It holds 60 percent of the market share in Mexico. Cement is usually sold in bulk in the United States, like a commodity. However, it is sold as a branded product in Mexico. Cemex is also Mexicos largest seller of concrete, which is made with cement. Because Cemex has little or no competition in Mexico, individuals and builders often end up paying a higher price for its products. But such dominance can have pitfalls. After it acquired Australian cement company Rinker, Cemex came under scrutiny by the U.S. Department of Justice as a potential monopoly, discussed next.13 The final type of market structure is a monopoly, in which a single seller dominates trade in a good or service for which buyers can find no close substitutes. A pure monopoly occurs when a firm possesses unique characteristics so important to competition in its industry that Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 78 11/3/09 6:36:08 PM Chapter 3 Economic Challenges Facing Contemporary Business 2008 P&G Pet Care they serve as barriers to prevent entry by would-be competitors. After presiding over what many called a monopoly in several areas, Microsoft is facing hefty competition from Google. In addition to its strength in Internet search and online advertising, Google is offering online products aimed at Microsofts core business: computing tools such as word processing and spreadsheet applications. Google is focusing on Web access to these tools through wired and wireless devices. Ultimately, the competition should benefit consumers.14 Many firms create short-term monopolies when research breakthroughs permit them to receive exclusive patents on new products. In the pharmaceuticals industry, drug giants such as Merck and Pfizer invest billions in research and development programs. When the research leads to successful new drugs, the companies can enjoy the benefits of their patents: the ability to set prices without fear of competitors undercutting them. Once the patent expires, generic substitutes enter the market, driving down prices. Because a monopoly market lacks the benefits of competition, many governments regulate monopolies. Besides issuing patents and limiting their life, the government prohibits most pure monopolies through antitrust legislation such as the Sherman Act and the Clayton Act. The U.S. government has applied these istic ple of monopol laws against monopoly behavior by Microsoft and od is an exam gs, arket for pet fo om assorted ba The m oose fr ed by disallowing proposed mergers of large companies nsumers can ch and high-pric brand food competition. Co -priced storethese in ns of low in some industries. In other cases, the government differentiated boxes, and ca use pet food is ll it have me food. Beca stores that se permits certain monopolies in exchange for regulating brand-na and the ers of pet food uc ways, the prod ing prices. their activities. xibility in sett great deal of fle a With regulated monopolies, a local, state, or federal government grants exclusive rights in a certain market to a single firm. Pricing decisionsparticularly rate-increase requestsare subject to control by regulatory authorities such as state public service commissions. An example is the delivery of first-class mail, a monopoly held by the U.S. Postal Service. The USPS is a self-supporting corporation wholly owned by the federal government. Although it is no longer run by Congress, postal rates are set by a Postal Commission and approved by a Board of Governors. During the 1980s and 1990s, the U.S. government trended away from A ssessment Check regulated monopolies and toward deregulation. Regulated monopolies that have been deregulated include long-distance and local telephone service, cable 1. What is the difference between pure competition and monopotelevision, cell phones, and electric utilities. The idea is to improve customer listic competition? service and reduce prices for customers through increased competition. The Federal Communications Commission recently adopted a rule that bans cable 2. Distinguish between oligopoly and monopoly. operators from entering into exclusive agreements with owners of apartment buildings. This change will have an impact on the 30 percent of Americans 79 Copyright 2011 John Wiley & Sons c03.indd 79 11/3/09 6:36:08 PM who live in multiple-unit dwellings such as apartments, duplexes, and condominiums. Instead of being forced into a contract with one cable provider, residents of each apartment will have competitive choices. Phone companies such as AT&T and Verizon, which also offer cable service, are included in the rule.15 Planned Economies: Socialism and Communism id It They Sa A government big enough to give you everything you want is a government big enough to take from you everything you have. Gerald R. Ford (19132006) 38th president of the United States 80 In a planned economy, government controls determine business ownership, profits, and resource allocation to accomplish government goals rather than those set by individual firms. Two forms of planned economies are communism and socialism. One type of planned economy is socialism. Socialism is characterized by government ownership and operation of major industries such as health care and communications. Socialists assert that major industries are too important to a society to be left in private hands and that government-owned businesses can serve the publics interest better than can private firms. However, socialism allows private ownership in industries considered less crucial to social welfare, such as retail shops, restaurants, and certain types of manufacturing facilities. Scandinavian countries such as Denmark, Sweden, and Finland have socialist features in their societies, as do some African nations and India. The writings of Karl Marx in the mid-1800s formed the basis of communist theory. Marx believed that private enterprise economies created unfair conditions and led to worker exploitation because business owners controlled most of societys resources and reaped most of the economys rewards. Instead, he suggested an economic system called communism, in which all property would be shared equally by the people of a community under the direction of a strong central government. Marx believed that elimination of private ownership of property and businesses would ensure the emergence of a classless society that would benefit all. Each individual would contribute to the nations overall economic success, and resources would be distributed according to each persons needs. Under communism, the central government owns the means of production, and the people work for state-owned enterprises. The government determines what people can buy because it dictates what is produced in the nations factories and farms. A number of nations adopted communist-like economic systems during the early 20th century in an effort to correct abuses they believed existed in their previous systems. In practice, however, these new governments typically gave less freedom of choice in regard to jobs and purchases. These governments might be best described as totalitarian socialism. These nations often made mistakes in allocating resources to compete in the growing global marketplace. Government-owned monopolies often suffer from inefficiency. Consider the former Soviet Union, where large government bureaucracies controlled nearly every aspect of daily life. Shortages became chronic because producers had little or no incentive to satisfy customers. The quality of goods and services also suffered for the same reason. When Mikhail Gorbachev became the last president of the dying Soviet Union, he tried to improve the quality of Soviet-made products. Effectively shut out of trading in the global marketplace and caught up in a treasury-depleting arms race with the United States, the Soviet Union faced severe financial problems. Eventually, these events led to the collapse of Soviet communism and the breakup of the Soviet Union itself. Today, communist-like systems exist in just a few countries, such as North Korea. By contrast, the formerly communist Peoples Republic of China has shifted toward a more market-oriented economy. The national government has given local government and individual plant managers more say in business decisions and has permitted Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 80 11/3/09 6:36:21 PM Mixed Market Economies Private enterprise systems and planned economies adopt basically opposite rises, private enterp companies into approaches to operating economies. In ned enterprise, rnment-owned state-ow n of gove nada, once a or the conversio tenth-largest ficiency. Air Ca reality, though, many countries operate Privatization, w the worlds d increases ef . wers costs an ny, which is no often lo al marketplace The compa mixed market economies, economic or in the glob 20 years ago. essful competit went private a succ systems that draw from both types of air carrier, is international economies, to different degrees. In nations generally considered to have a private enterprise economy, government-owned firms frequently operate alongside private enterprises. In the United States, programs like Medicare are government run. France has blended socialist and free enterprise policies for hundreds of years. The nations energy production, public transportation, and defense industries are run as nationalized industries, controlled by the government. Meanwhile, a market economy flourishes in other industries. Over the past two decades, the French government has loosened its reins on state-owned companies, inviting both competition and private investment into industries previously operated as government monopolies. Some former colonies, such as Somalia in Africa, struggle to form working economies, as the Solving an Ethical Controversy feature describes. The proportions of private and public enterprise can vary widely in mixed economies, and the mix frequently changes. Dozens of countries have converted government-owned and -operated companies into privately held businesses in a trend known as privatization. Even the United States has seen proposals to privatize everything from the postal service to Social Security. Governments may privatize state-owned enterprises in an effort to raise funds and improve their economies. The objective is to cut costs and run the operation more efficiently. For most of its existence, Air Canada was a state-owned airline. But in 1989 the airline became fully privatized, and in 2000 the firm acquired Canadian Airlines International, becoming the worlds tenth-largest international air carrier. Assessment Check Air Canada now maintains an extensive global network, with destinations in the United States, Europe, the Middle East, Asia, Australia, the Caribbean, 1. On which economic system Mexico, and South America. It offers such amenities as la carte pricing, is the U.S. economy based? personal entertainment systems in seat backs, and fold-flat beds for transat16 2. What are the two types of lantic flights. planned economies? Table 3.4 compares the alternative economic systems on the basis of owner3. What is privatization? ship and management of enterprises, rights to profits, employee rights, and worker incentives. Chapter 3 Economic Challenges Facing Contemporary Business Jeff McIntosh/AP/Wide World Photos some private businesses. Households now have more control over agriculture, in contrast to the collectivized farms introduced during an earlier era. In addition, Western products such as McDonalds restaurants and Coca-Cola soft drinks are now part of Chinese consumers lives, and Chinese workers manufacture products for export to other countries. 81 Copyright 2011 John Wiley & Sons c03.indd 81 11/3/09 6:36:21 PM HIJACKING ON THE HIGH SEAS Regardless of their economic systems, some developing countries face the problem of piracy. Todays seafaring pirates are mainly Somalis, supporting various warlords in their leaderless country on the east coast of Africa. In a recent year they attacked over 100 ships in the heavily trafficked shipping lanes of the Gulf of Aden and Indian Ocean. Holding ships, crews, and cargos for ransom, sometimes for months, they have taken in many millions of dollars in ransom money. Foreign governments fear those payments finance more weapons to continue the war and regional conflicts. The hijackings that began as a desperate bid for economic survival have now become a sophisticated and profitable criminal enterprise. Pirates use high-tech GPS mapping systems, fleets of stolen ships, and heavy weaponry. Corrupt port officials provide safe havens for pirates and their captured ships and crews. Despite international efforts by the United States, Great Britain, Russia, Egypt, France, Germany, China, Yemen, Saudi Arabia, Sudan, Jordan, India, and others, no one can guarantee the safety of commercial ships in the 1.1 million square miles threatened by the pirates and their mother ships. Unless you have a warship in the immediate area, and crucially, with a helicopter, says an observer in South Africa, youve got no chance of stopping them. Should foreign governments pay ransom to pirates on the high seas? PRO 1. Their willingness to hold hundreds of captives hostage indefinitely gives pirates the upper hand. They will wait, months if necessary, for foreign governments to ransom their cargos and crew. 2. An unending series of attacks have established a businessas-usual pattern for the pirates, Solving an 82 particularly when dealing with countries like Britain, in which paying ransom is not illegal. One hijacker of a Ukrainian weapons freighter, accepting $3.2 million in return for leaving the cargo behind, said his group would continue hunting ships because thats our business. international group representing 24 different countries is looking at more ways to prevent piracy and investigate the pirates link to terrorists. But even as the problem grows, a new threat has appeared: rival pirate groups that try to intercept the ransom payments as they are ferried to captive ships. CON 1. The major problem is that piracy has given some groups the chance to lay their hands on money, says a Somalia expert at the University of South Africa. Since cash is the primary motive, cutting off its flow could help reduce the incentive for pirates to continue their attacks. 2. Some who have dealt with the Somali pirates cite a link with terrorists. If that is the case, governments that pay ransom money could be helping fund violent groups opposed to their own interests. Sources: Elizabeth A. Kennedy, FBI Joins Effort in Hostage Standoff with Pirates, Associated Press, April 9, 2009, http://news.yahoo.com; Maria Danilova, Ukrainian Crew Back Home after Pirates Free Ship, Associated Press, February 13, 2009, http://www. google.com/hostednews/; Andrew Njuguna, Somali Pirates Release Japanese Ship, Associated Press, February 13, 2009, http://www.google. com/hostednews; Jeffrey Gettleman and Mohammed Ibrahim, Somali Pirates Get Ransom and Leave Arms Freighter, The New York Times, February 5, 2009, http://www.nytimes.com; Who Do Pirates Call to Get Their Cash? BBC News, January 29, 2009, http://newsvote.bbc.co.uk/; Scott Baldauf, Who Are Somalias Pirates? The Christian Science Monitor, November 21, 2008, http://www.csmonitor.com. Summary India recently sank a pirate vessel, and patrolling U.S. and Russian warship crews have arrested dozens of pirates off the Somali coast. A new controversy Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 82 11/3/09 6:36:43 PM Table 3.4 Comparison of Alternative Economic Systems Planned Economies System Features Capitalism (Private Enterprise) Ownership of enterprises Communism Socialism Mixed Economy Businesses are owned privately, often by large numbers of people. Minimal government ownership leaves production in private hands. Government owns the means of production with few exceptions, such as small plots of land. Government owns basic industries, but private owners operate some small enterprises. A strong private sector blends with public enterprises. Management of enterprises Enterprises are managed by owners or their representatives, with minimal government interference. Centralized management controls all state enterprises in line with three- to five-year plans. Planning now being decentralized. Significant is government planning pervades socialist nations. State enterprises are managed directly by government bureaucrats. Management of the private sector resembles that under capitalism. Professionals may also manage state enterprises. Rights to profits Entrepreneurs and investors are entitled to all profits (minus taxes) that their firms earn. Profits are not allowed under communism. Only the private sector of a socialist economy generates profits. Entrepreneurs and investors are entitled to privatesector profits, although they often must pay high taxes. State enterprises are also expected to produce returns. Rights of employees The rights to choose ones occupation and to join a labor union have long been recognized. Employee rights are limited in exchange for promised protection against unemployment. Workers may choose their occupations and join labor unions, but the government influences career decisions for many people. Workers may choose jobs and labor union membership. Unions often become quite strong. Worker incentives Incentives are emerging Considerable incentives motivate people to perform in communist countries. at their highest levels. Incentives usually are limited in state enterprises but do motivate workers in the private sector. Capitalist-style incentives operate in the private sector. More limited incentives influence publicsector activities. Evaluating Economic Performance Ideally, an economic system should provide two important benefits for its citizens: a stable business environment and sustained growth. In a stable business environment, the overall supply of needed goods and services is aligned with the overall demand for those goods and services. No wild fluctuations in price or availability complicate economic decisions. Consumers and businesses not only have access to ample supplies of desired products at affordable prices but also have money to buy the items they demand. Growth is another important economic goal. An ideal economy incorporates steady change directed toward continually expanding the amount of goods and services produced from the nations resources. Growth leads to expanded job opportunities, improved wages, and a rising standard of living. Chapter 3 Economic Challenges Facing Contemporary Business 83 Copyright 2011 John Wiley & Sons c03.indd 83 11/3/09 6:36:44 PM Flattening the Business Cycle A nations economy tends to flow through various stages of a business cycle: prosperity, recession, depression, and recovery. No true economic depressions have occurred in the United States since the 1930s, and most economists believe that society is capable of preventing future depressions through effective economic policies. Consequently, they expect a recession to give way to a period of economic recovery. Both business decisions and consumer buying patterns differ at each stage of the business cycle. In periods of economic prosperity, unemployment remains low, consumer confidence about the future leads to more purchases, and businesses expandby hiring more employees, investing in new technology, and making similar purchasesto take advantage of new opportunities. recession cyclical As recent events show, during a recessiona cyclical economic contraction that lasts for economic contraction six months or longerconsumers frequently postpone major purchases and shift buying patthat lasts for six months terns toward basic, functional products carrying low prices. Businesses mirror these changes or longer. in the marketplace by slowing production, postponing expansion plans, reducing inventories, and often cutting the size of their workforces. During recessions, people facing layoffs and depletions of household savings become much more conservative in their spending, postpond It i They Sa ing luxury purchases and vacations. Sometimes they even postpone services like haircuts and dental cleanings. They often turn to lower-priced retailers like Target, Kohls, and JCPenney Its a recession for the goods they need. And they have sold cars, jewelry, and stocks to make ends meet. when your neighbor During one recession, they did this as well but with a twist: they turned to eBay. There, they loses his job; its a sold everything from old books to art work to kitchenware, contributing to their own success depression when as well as that of eBay. you lose your own. If an economic slowdown continues in a downward spiral over an extended period of time, the economy falls into depression. Many Americans have grown up hearing stories Harry S. Truman about their great-grandparents who lived through the Great Depression of the 1930s, when (18841972) 33rd president of the United States food and other basic necessities were scarce and jobs were rare and precious. In the recovery stage of the business cycle, the economy emerges from recession and consumer spending picks up steam. Even though businesses Assessment Check often continue to rely on part-time and other temporary workers during 1. Which stages of the business the early stages of a recovery, unemployment begins to decline as business cycle indicate a downturn in the activity accelerates and firms seek additional workers to meet growing economy? production demands. Gradually, the concerns of recession begin to disap2. Which stages point to an pear, and consumers start eating out at restaurants, booking vacations, and upswing? purchasing new cars. Productivity and the Nations Gross Domestic Product productivity relationship between the number of units produced and the number of human and other production inputs necessary to produce them. 84 An important concern for every economy is productivity, the relationship between the goods and services produced in a nation each year and the inputs needed to produce them. In general, as productivity rises, so does an economys growth and the wealth of its citizens. In a recession, productivity stalls or even declines. Productivity describes the relationship between the number of units produced and the number of human and other production inputs necessary to produce them. So productivity is a ratio of output to input. When a constant amount of inputs generates increased outputs, an increase in productivity occurs. Total productivity considers all inputs necessary to produce a specific amount of outputs. Stated in equation form, it can be written as follows: Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 84 11/3/09 6:36:44 PM Total productivity = Figure 3.4 Output (goods or services produced) _________________________________ Input (human/natural resources, capital) Nations with Highest Gross Domestic Products Many productivity ratios focus on only $14.3 trillion United States one of the inputs in the equation: labor productivity or output per labor-hour. An $4.8 Japan increase in labor productivity means that the $4.2 same amount of work produces more goods China and services than before. Many of the gains in $3.8 U.S. productivity are attributed to technology, Germany and in recent years the United States alone $3.0 appears to be enjoying the fruits of technology France and productivity. No other industrial nation $2.8 experienced the rapid growth of the United United Kingdom States, which leads the world in worker pro$2.4 Italy ductivity. Ireland is second. In addition, the productivity gap between the United States $1.8 Russia and the rest of the world continues to widen, $1.7 even in the manufacturing sector.17 Brazil Productivity is a widely recognized mea$1.6 sure of a companys eff iciency. In turn, the Canada total productivity of a nations businesses has become a measure of its economic strength and standard of living. Economists Source: Central Intelligence Agency, Field ListingGDP (Official Exchange refer to this measure as a countrys Rate), The World Factbook, accessed February 24, 2009, https://www.cia.gov. g ro ss domestic product (GDP) the sum of all goods and services produced within its boundaries. The GDP is based on the per-capita gross domestic product (GDP) sum of all goods output of a countryin other words, total national output divided by the number of and services produced citizens. As Figure 3.4 shows, the U.S. GDP remains the highest in the world. Japan within a countrys comes in a distant second. boundaries during a In the United States, GDP is tracked by the Bureau of Economic Analysis (BEA), a divispecific time period, sion of the U.S. Department of Commerce. Current updates and historical data on the GDP are such as a year. available at the BEAs Web site (http://www.bea.gov). ORDEM & PRO GR ESS O Price-Level Changes Another important indicator of an economys stability is the general level of prices. For the last 100 years, economic decision makers concerned themselves with inflation, rising prices caused by a combination of excess consumer demand and increases in the costs of raw materials, component parts, human resources, and other factors of production. The core inflation rate is the inflation rate of an economy after energy and food prices are removed. This measure is often an accurate prediction of the inflation rate that consumers, businesses, and other organizations can expect to experience during the near future. Excess consumer demand generates what is known as demand-pull inflation; increases in the costs of factors of production generates cost-push inflation. Americas most severe inflationary period during the last half of the 20th century peaked in 1980, when general price levels jumped almost 14 percent in a single year. In extreme cases, an economy may experience hyperinflationan economic situation characterized by soaring prices. This situation has occurred in South America, as well as in countries that once formed the Soviet Union. inflation rising prices caused by a combination of excess consumer demand and increases in the costs of raw materials, component parts, human resources, and other factors of production. Chapter 3 Economic Challenges Facing Contemporary Business 85 Copyright 2011 John Wiley & Sons c03.indd 85 11/3/09 6:36:44 PM id It They Sa Tough times dont last; tough people do, remember? Gregory Peck (19162003) American film actor (Thoughts on the Business Side of Life, Forbes, November 17, 2008, p. 144.) Inflation devalues money as persistent price increases reduce the amount of goods and services people can purchase with a given amount of money. This is bad news for people whose earnings do not keep up with inflation, who live on fixed incomes, or who have most of their wealth in investments paying a fixed rate of interest. Inflation can be good news to people whose income is rising or those with debts at a fixed rate of interest. A homeowner with a fixed-rate mortgage during inflationary times is paying off that debt with money that is worth less and less each year. Over the past decade, inflation helped a strong stock market drive up the number of millionaires to more than 9.3 million.18 But because of inflation, being a millionaire does not make a person as rich as it once did. To live like a 1960s millionaire, you would need almost $6 million today. When increased productivity keeps prices steady, it can have a major positive impact on an economy. In a low-inflation environment, businesses can make long-range plans without the constant worry of sudden inflationary shocks. Low interest rates encourage firms to invest in research and development and capital improvements, both of which are likely to produce productivity gains. Consumers can purchase growing stocks of goods and services with the same amount of money, and low interest rates encourage major acquisitions such as new homes and autos. But there are concerns. The fluctuating cost of oilwhich is used to produce many goodsis a continuing issue. Businesses need to raise prices to cover their costs. Also, smaller firms have gone out of business or have been merged with larger companies, reducing the amount of competition and increasing the purchasing power of the larger corporations. Business owners continue to keep a watchful eye on signs of inflation. The opposite situationdeflationoccurs when prices continue to fall. In Japan, where deflation has been a reality for several years, shoppers pay less for a variety of products ranging from groceries to homes. While this situation may sound ideal to consumers, it can weaken the economy. For instance, industries such as housing and auto manufacturing need to maintain strong prices in order to support all the related businesses that depend on them. ployment at a local unem r fill out claims rs ten an indicato Laid-off worke ment rate is of ns unemploy office. A natio . onomic health of its overall ec 86 Nati Harnik/AP/Wide World Photos Measuring Price Level Changes In the United States, the government tracks changes in price levels with the Consumer Price Index (CPI), which measures the monthly average change in prices of goods and services. The federal Bureau of Labor Statistics (BLS) calculates the CPI monthly based on prices of a market basket, a compilation of the goods and services most commonly purchased by urban consumers. Figure 3.5 shows the categories included in the CPI market basket. Each month, BLS representatives visit thousands of stores, service establishments, rental units, and doctors offices all over the United States to price the multitude of items in the CPI market basket. They compile the data to create the CPI. Thus, the CPI provides a running measurement of changes in consumer prices. Employment Levels People need money to buy the goods and services produced in an economy. Because most consumers earn that money by working, the number of people in a nation who currently have jobs is an important indicator of how well the economy is doing. In general, employment has been on the rise in the United States the past Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 86 11/3/09 6:36:44 PM Figure 3.5 Contents of the CPI Market Basket Transportation automobiles, airline fares, gasoline Recreation televisions, pets and pet products, sports equipment, movie tickets Medical Care prescription drugs, medical supplies, doctors office visits, eyeglasses Apparel mens shirts, womens dresses, jewellery Education and Communication tuition, postage, telephone services, computers Housing rent, fuel oil, furniture Other Goods and Services tobacco, haircuts, legal expenses Food and Beverages breakfast cereal, milk, coffee, wine, chicken, snacks Source: Information from Bureau of Labor Statistics, Consumer Price Indexes: Frequently Asked Questions, accessed February 24, 2009, http://www.bls.gov/cpi. few years, although there have been some dips. Areas that have seen gains include professional and technical services, as well as healthcare and food services.19 Economists refer to a nations unemployment rate as an indicator of its economic health. The unemployment rate is usually expressed as a percentage of the total workforce who are actively seeking work but are currently unemployed. The total labor force includes all people who are willing and available to work at the going market wage, whether they currently have jobs or are seeking work. The U.S. Department of Labor, which tracks unemployment rates, also measures so-called discouraged workers. These individuals want to work but have given up looking for jobs, for various reasons. Unemployment can Assessment Check be grouped into the four categories shown in Figure 3.6: frictional, seasonal, cyclical, and structural. 1. What is productivity? Frictional unemployment applies to members of the workforce who are 2. How does the U.S. government temporarily not working but are looking for jobs. This pool of potential track changes in price levels? workers includes new graduates, people who have left jobs for any reason and are looking for other employment, and former workers who have 3. Identify the four categories of unemployment. decided to return to the labor force. Seasonal unemployment is the joblessness of workers in a seasonal industry. Construction workers, farm laborers, Chapter 3 Economic Challenges Facing Contemporary Business 87 Copyright 2011 John Wiley & Sons c03.indd 87 11/3/09 6:37:02 PM Figure 3.6 Four Types of Unemployment Frictional Unemployment Temporarily not working Looking for a job Example: New graduates entering the workforce Structural Unemployment Not working due to no demand for skills May be retraining for a new job Example: Assembly line workers whose jobs are now done by robots Seasonal Unemployment Not working during some months Not looking for a job Example: Farm laborers needed only when a crop is in season Cyclical Unemployment Not working due to economic slowdown Looking for a job Example: Executives laid off during corporate downsizing or recessionary periods fishing boat operators, and landscape employees may contend with bouts of seasonal unemployment when wintry conditions make work unavailable. Cyclical unemployment includes people who are out of work because of a cyclical contraction in the economy. During periods of economic expansion, overall employment is likely to rise, but as growth slows and a recession begins, unemployment levels commonly rise. At such times, even workers with good job skills may face temporary unemployment. Workers in high-tech industries, air travel, and manufacturing have all faced unemployment during economic contraction. Structural unemployment applies to people who remain unemployed for long periods of time, often with little hope of finding new jobs like their old ones. This situation may arise because these workers lack the necessary skills for available jobs or because the skills they have are no longer in demand. For instance, technological developments have increased the demand for people with computer-related skills but have created structural unemployment among many types of manual laborers. Or workers may have been injured and unable to return to work in their original jobs. Managing the Economys Performance As recent years have vividly demonstrated, a national government can use both monetary policy and fiscal policy in its efforts to fight unemployment, increase business and consumer spending, and reduce the length and severity of economic recessions. The Federal Reserve System can increase or reduce interest rates, and the federal government can enact tax cuts and rebates, or propose other reforms. Monetary Policy monetary policy government actions to increase or decrease the money supply and change banking requirements and interest rates to influence bankers willingness to make loans. 88 A common method of influencing economic activity is monetary policy, government actions to increase or decrease the money supply and change banking requirements and interest rates to influence spending by altering bankers willingness to make loans. An expansionary monetary policy increases the money supply in an effort to cut the cost of borrowing, which encourages business decision makers to make new investments, in turn stimulating employment and economic growth. By contrast, a restrictive monetary policy reduces the money supply to curb rising prices, overexpansion, and concerns about overly rapid economic growth. In the United States, the Federal Reserve System (the Fed) is responsible for formulating and implementing the nations monetary policy. It is headed by a chairman and board of governors, all of whom are nominated by the president. The current chairman is Ben Bernanke, Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 88 11/3/09 6:37:03 PM who also serves as chairman of the Federal Open Market Committee, the Feds main agency for monetary policymaking. All national banks must be members of this system and keep some percentage of their checking and savings funds on deposit at the Fed. The Feds board of governors uses a number of tools to regulate the economy. By changing the required percentage of checking and savings accounts that banks must deposit with the Fed, the governors can expand or shrink funds available to lend. The Fed also lends money to member banks, which in turn make loans at higher interest rates to business and individual borrowers. By changing the interest rates charged to commercial banks, the Fed affects the interest rates charged to borrowers and, consequently, their willingness to borrow. These rate changes can sometimes help jump-start an economy that may be sliding into recession. id It They Sa The nine most terrifying words in the English language are Im from the government, and Im here to help. Ronald Reagan (19112004) 40th president of the United States Fiscal Policy Governments also influence economic activities by making decisions about taxes and spending. Through revenues and expenses, the government implements fiscal policy. This is the second technique that officials use to control inflation, reduce unemployment, improve the general standard of living, and encourage economic growth. Increased taxes may restrict economic activities, while lower taxes and increased government spending usually boost spending and profits, cut unemployment rates, and fuel economic expansion. On some occasions, the U.S. federal government has issued tax rebates to its citizens and businesses in an effort to stimulate investment and spending. fiscal policy government spending and taxation decisions designed to control inflation, reduce unemployment, improve the general welfare of citizens, and encourage economic growth. International Fiscal Policy Nations in the industrial world, including the United States, are currently struggling to find ways to help developing nations modernize their economies. One proposal is to forgive the debts of some of these countries, particularly those in Africa, to stimulate their economies to grow. But not all fiscal experts agree with this idea. They suggest that any debt forgiveness should come with certain conditions so that these countries can build their own fiscal policies. Countries should encourage and allow citizens to own property, lower their tax rates, avoid devaluing their currencies, lay a path for new businesses to start up, and reduce trade barriers. In addition, they must improve agriculture, education, and health care so their citizens can begin to set and reach financial goals. Hunger and malnutrition is not only an effect of poverty, it also causes poverty, says Robert Zoellick, president of the World Bank. The World Bank is an organization that offers such programs as low-interest loans and interestfree credit and grants to developing countries.20 The Federal Budget Each year, the president proposes a budget for the federal government, a plan for how it will raise and spend money during the coming year, and presents it to Congress for approval. A typical federal budget proposal undergoes months of deliberation and many modifications before receiving approval. The federal budget includes a number of different spending categories, ranging from defense and Social Security to interest payments on the national debt. The decisions about what to include in the budget have a direct effect on various sectors of the economy. During a recession, the federal government may approve increased spending on interstate highway repairs to improve transportation and increase employment in the construction industry. During prosperity, the government may allocate more money for scientific research toward medical breakthroughs or alternative fuels. Or it may approve funding for job training or arts programs. The primary sources of government funds to cover the costs of the annual budget are taxes, fees, and borrowing. Both the overall amount of these funds and their specific combination have major effects on the economic well-being of the nation. One way governments raise money is budget organizations plan for how it will raise and spend money during a given period of time. Chapter 3 Economic Challenges Facing Contemporary Business 89 Copyright 2011 John Wiley & Sons c03.indd 89 11/3/09 6:37:03 PM to impose taxes on sales and income. But increasing taxes leaves people and businesses with less money to spend. This might reduce inflation, but overly high taxes can also slow economic Th growth. Governments then try to balance taxes to give people necessary services without slowing economic growth. If all economists Taxes dont always generate enough funds to cover every spending project the government were laid end to hopes to undertake. When the government spends more than the amount of money it raises end, they would through taxes, it creates a budget deficit, which currently stands at more than $569 billion.21 not reach a To cover the deficit, the U.S. government borrows money by selling Treasury bills, Treasury conclusion. notes, and Treasury bonds to investors. All of this borrowing makes up the national debt. The U.S. Treasury Department estimates that the national debt is $10.9 trillion.22 One of the facGeorge Bernard Shaw tors contributing to the budget deficit has been the war in Iraq and related military operations. (18561950) Irish playwright If the government takes in more money than it spends, it is said to have a budget surplus. A balanced budget means total revenues raised by taxes equal the total proposed spending for the year. Achieving a balanced budgetor even a budget surplusdoes not erase the national debt. U.S. legislators continually debate how fast the nation should use revenues to reduce its debt. Most families want to wipe out debtfrom credit cards, automobile purchases, and college. To put the national debt into personal perspective, with a little over 306 million U.S. citizens, each one owes about $35,000 as his or her share. But for the federal government, the decision is more complex. When the government raises money by selling Treasury bills, it makes safe investments available to investors worldwide. If foreign investors cannot buy Treasury notes, they might turn to other countries, reducing the amount of money flowing into the United States. U.S. governAssessment Check ment debt has also been used as a basis for pricing riskier investments. If 1. What is the difference between the government issues less debt, the interest rates it commands are higher, an expansionary monetary policy raising the overall cost of debt to private borrowers. In addition, the governand a restrictive monetary policy? ment uses the funds from borrowing, at least in part, to invest in such public 2. What are the three primary services as education and scientific research. As a society, if we decide our sources of government funds? economy needs these services, debt reduction may not always be the best use of government funds. However, it can also be argued that paying down 3. Does a balanced budget erase the federal debt? the national debt will free up more money to be invested by individuals and businesses. t ey Said I Global Economic Challenges of the 21st Century Businesses face a number of important economic challenges in the 21st century. As the economies of countries around the globe become increasingly interconnected, governments and businesses must compete throughout the world. Although no one can predict the future, both governments and businesses will likely need to meet several challenges to maintain their global competitiveness. Table 3.5 identifies five key challenges: (1) the economic impact of the continuing threat of international terrorism, (2) the shift to a global information economy, (3) the aging of the worlds population, (4) the growth of China and India, and (5) efforts to enhance the competitiveness of every countrys workforce. No country is an economic island in todays global economy. Not only is an ever-increasing stream of goods and services crossing national borders, but a growing number of businesses 90 Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 90 11/3/09 6:37:04 PM Table 3.5 Global Economic Challenges Challenge Facts and Examples International terrorism Assistance in locating and detaining known terrorists by dozens of nations. Cooperation in modifying banking laws in most nations in an effort to cut off funds to terrorist organizations. Concerns over the safety of mass-transit systems following bombings in London and elsewhere. Shift to a global information economy Half of all American workers hold jobs in information technology or in industries that intensively use information technology, goods, and services. Software industry in India is growing more than 50 percent each year. Internet users in Asia and western Europe have more than doubled in five years. Aging of the worlds population Median age of the U.S. population is 36 plus, and by 2025, more than 64 million Americans will be age 65 or oldernearly double todays number. This will increase demands for health care, retirement benefits, and other support services, putting budgetary pressure on governments. As Baby Boomers, now reaching their early 60s, begin to retire, businesses around the globe will need to find ways to replace their workplace skills. Growth of India and China straining commodity prices China and India now make up more than one-third of the worlds population. Chinas economic growth has been in the industrial sector, and Indias focused more in services. Both countries are now consumers of oil and other commodities, affecting prices. Enhancing competitiveness of every countrys workforce Leaner organizations (with fewer supervisors) require employees with the skills to control, combine, and supervise work operations. have become true multinational firms, operating manufacturing plants and other facilities around the world. As global trade and investments grow, events in one nation can reverberate around the globe. Despite the risks of world trade, global expansion can offer huge opportunities to U.S. firms. With U.S. residents accounting for less than 1 in every 20 of the worlds nearly 7 billion people, growth-oriented American companies cannot afford to ignore the world market.23 U.S. businesses also benefit from the lower labor costs in other parts of the world, and some are finding successful niches importing goods and even services provided by foreign firms. Still, it is extremely important for U.S. firms to keep track of the foreign firms that supply their products. When it became apparent that some plastic toys supplied to U.S. toymakers by Chinese manufacturers contained lead paint that could be harmful to children, the U.S. firms issued massive recalls of these toys. Fisher-Price alone recalled 83 types, which amounted to nearly 1 million toys, including its popular Big Bird, Elmo, Dora, and Diego characters. The firm, which is owned by Mattel, urged parents to take toys away from their children if they suspected the toys fell into the recall category and to contact the company. In addition, Fisher-Price quarantined suspect toys before they even made it to Assessment Check store shelves.24 U.S. firms must also develop strategies for competing with each other 1. Why is virtually no country an economic island these days? overseas. In the huge but fragmented beverage industry, Coca-Cola still edges out Pepsi as the top-selling cola worldwide. Industry experts predict 2. Describe two ways in which global that China will be the next great battleground for the two soda giants. Cocaexpansion can benefit a U.S. firm. Cola still maintains better name recognition, but Pepsi is closing in.25 Chapter 3 Economic Challenges Facing Contemporary Business 91 Copyright 2011 John Wiley & Sons c03.indd 91 11/3/09 6:37:04 PM Whats Ahead Global competition is a key factor in todays economy. In Chapter 4, we focus on the global dimensions of business. We cover basic concepts of doing business internationally and examine how nations can position themselves to benefit from the global economy. Then we describe the specific methods used by individual businesses to expand beyond their national borders and compete successfully in the global marketplace. Summary of Learning Goals Distinguish between microeconomics and macroeconomics. Microeconomics is the study of economic behavior among individual consumers, families, and businesses whose collective behavior in the marketplace determines the quantity of goods and services demanded and supplied at different prices. Macroeconomics is the study of the broader economic picture and how an economic system maintains and allocates its resources; it focuses on how a governments monetary and fiscal policies affect the overall operation of an economic system. 1 Assessment Check Answers 1.1 Define microeconomics. Microeconomics is the study of economic behavior among individual consumers, families, and businesses whose collective behavior in the marketplace determines the quantity of goods and services demanded and supplied at different prices. 1.2 Define macroeconomics. Macroeconomics is the study of the broader economic picture and how an economic system maintains and allocates its resources. 2 Explain the factors that drive demand and supply. Demand is the willingness and ability of buyers to purchase goods and services at different prices. Factors that drive demand for a good or service include customer preferences, the number of buyers and their incomes, the prices of substitute goods, the prices of complementary goods, and consumer expectations about the future. Supply is the willingness and ability of businesses to offer products for sale at different prices. Supply is determined by the cost of inputs and technology resources, taxes, and the number of suppliers operating in the market. Assessment Check Answers 2.1 What is a demand curve? A demand curve is a graph of the amount of a product that buyers will purchase at different prices. 2.2 What is a supply curve? A supply curve shows the relationship between different prices and the quantities that sellers will offer for sale, regardless of demand. 92 2.3 How do factors of production influence the overall supply of goods and services? A change in the cost or availability of any of the inputs considered to be factors of production can shift the entire supply curve, either increasing or decreasing the amount available at every price. Describe each of the four different types of market structures in a private enterprise system. Four basic models characterize competition in a private enterprise system: pure competition, monopolistic competition, oligopoly, and monopoly. Pure competition is a market structure, like that in small-scale agriculture, in which large numbers of buyers and sellers exchange homogeneous products and no single participant has a significant influence on price. Monopolistic competition is a market structure, like that of retailing, in which large numbers of buyers and sellers exchange differentiated products, so each participant has some control over price. Oligopolies are market situations, like those in the steel and airline industries, in which relatively few sellers compete and high start-up costs form barriers to keep out new competitors. In a monopoly, one seller dominates trade in a good or service, for which buyers can find no close substitutes. Privately held local water utilities and firms that hold exclusive patent rights on significant product inventions are examples. 3 Assessment Check Answers 3.1 What is the difference between pure competition and monopolistic competition? Pure competition is a market structure in which large numbers of buyers and sellers exchange homogeneous products. Monopolistic competition is a market structure in which large numbers of buyers and sellers exchange differentiated products. 3.2 Distinguish between oligopoly and monopoly. An oligopoly is a market structure in which relatively few sellers compete, and high start-up costs form barriers to new competitors. In a monopoly, one seller dominates trade in a good or service. Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 92 11/3/09 6:37:05 PM Compare the three major types of economic systems. The major economic systems are private enterprise economy, planned economy (such as communism or socialism), and mixed market economy. In a private enterprise system, individuals and private businesses pursue their own interestsincluding investment decisions and profitswithout undue governmental restriction. In a planned economy, the government exerts stronger control over business ownership, profits, and resources to accomplish governmental and societalrather than individualgoals. Socialism, one type of planned economic system, is characterized by government ownership and operation of all major industries. Communism is an economic system without private property; goods are owned in common, and factors of production and production decisions are controlled by the state. A mixed market economy blends government ownership and private enterprise, combining characteristics of both planned and private enterprise economies. 4 Assessment Check Answers 4.1 On which economic system is the U.S. economy based? The U.S. economy is based on the private enterprise system. 4.2 What are the two types of planned economies? The two types of planned economies are socialism and communism. 4.3 What is privatization? Privatization is the conversion of government-owned and -operated agencies into privately held businesses. Identify and describe the four stages of the business cycle. The four stages are prosperity, recession, depression, and recovery. Prosperity is characterized by low unemployment and strong consumer confidence. In a recession, consumers often postpone major purchases, layoffs may occur, and household savings may be depleted. A depression occurs when an economic slowdown continues in a downward spiral over a long period of time. During recovery, consumer spending begins to increase and business activity accelerates, leading to an increased number of jobs. 5 Assessment Check Answers 5.1 Which stages of the business cycle indicate a downturn in the economy? Recession and depression indicate a downturn. 5.2 Which stages point to an upswing? Prosperity and recovery point to an upswing. Explain how productivity, price level changes, and 6 employment levels affect the stability of a nations economy. As productivity rises, so do an economys growth and the wealth of its citizens. In a recession, productivity stalls or possibly declines. Changes in general price levelsinflation or deflationare important indicators of an economys general stability. The U.S. government measures price-level changes by the Consumer Price Index. A nations unemployment rate is an indicator of both overall stability and growth. The unemployment rate shows the number of people actively seeking employment who are unable to find jobs as a percentage of the total labor force. Assessment Check Answers 6.1 What is productivity? Productivity is the relationship between the goods and services produced in a nation each year and the inputs that produce them. 6.2 How does the U.S. government track changes in price levels? The U.S. government tracks changes in price levels with the Consumer Price Index (CPI), which measures the monthly average change in prices of goods and services. 6.3 Identify the four categories of unemployment. The four categories of unemployment are frictional, seasonal, cyclical, and structural. Discuss how monetary policy and fiscal policy are used to manage an economys performance. Monetary policy encompasses a governments efforts to control the size of the nations money supply. Various methods of increasing or decreasing the overall money supply affect interest rates and therefore affect borrowing and investment decisions. By changing the size of the money supply, government can encourage growth or control inflation. Fiscal policy involves decisions regarding government revenues and expenditures. Changes in government spending affect economic growth and employment levels in the private sector. However, a government must also raise money, through taxes or borrowing, to finance its expenditures. Because tax payments represent funds that might otherwise have been spent by individuals and businesses, any taxation changes also affect the overall economy. 7 Assessment Check Answers 7.1 What is the difference between an expansionary monetary policy and a restrictive monetary policy? An expansionary monetary policy increases the money supply in an effort to cut the cost of borrowing. A restrictive monetary policy reduces the money supply to curb rising prices, overexpansion, and concerns about overly rapid economic growth. 7.2 What are the three primary sources of government funds? The U.S. government acquires funds through taxes, fees, and borrowing. 7.3 Does a balanced budget erase the federal debt? No, a balanced budget does not erase the national debt; it just doesnt increase it. Chapter 3 Economic Challenges Facing Contemporary Business 93 Copyright 2011 John Wiley & Sons c03.indd 93 11/3/09 6:37:05 PM Describe the major global economic challenges of the 21st century. Businesses face five key challenges in the 21st century: (1) the threat of international terrorism; (2) the shift to a global information economy; (3) the aging of the worlds population; (4) the growth of India and China, which compete for resources; and (5) efforts to enhance the competitiveness of every countrys workforce. 8 because many goods and services travel across national borders. Companies now are becoming multinational firms. 8.2 Describe two ways in which global expansion can benefit a U.S. firm. A f irm can benefit from global expansion by attracting more customers and using less expensive labor and production to produce goods and services. Assessment Check Answers 8.1 Why is virtually no country an economic island these days? No business or country is an economic island Business Terms You Need to Know economics 68 microeconomics 68 macroeconomics 68 demand 69 supply 69 recession 84 productivity 84 gross domestic product (GDP) 85 inflation 85 monetary policy 88 fiscal policy 89 budget 89 privatization 81 core inflation rate 85 deflation 86 Consumer Price Index (CPI) 86 unemployment rate 87 budget deficit 90 national debt 90 budget surplus 90 balanced budget 90 Other Important Business Terms demand curve 70 supply curve 72 equilibrium price 75 pure competition 76 monopolistic competition 76 oligopoly 77 monopoly 78 deregulation 79 planned economy 80 socialism 80 communism 80 mixed market economy 81 Review Questions 1. How does microeconomics affect business? How does macroeconomics affect business? Why is it important for businesspeople to understand the fundamentals of each? 2. Draw supply and demand graphs that estimate what will happen to demand, supply, and the equilibrium price of pizza if these events occur: a. A widely reported medical report suggests that eating cheese supplies a significant amount of the calcium needed in a persons daily diet. b. The price of flour increases. c. The state imposes a new tax on restaurant meals. d. The biggest competitor leaves the area. 3. Describe the four different types of competition in the private enterprise system. In which type of competition would each of the following businesses be likely to engage? a. small manufacturer of ice cream b. Stop & Shop supermarkets c. American Airlines 94 4. 5. 6. 7. 8. d. large farm whose major crop is corn e. Google Distinguish between the two types of planned economies. What factors do you think keep them from flourishing in todays environment? What are the four stages of the business cycle? In which stage do you believe the U.S. economy is now? Why? What is the gross domestic product? What is its relationship to productivity? What are the effects of inflation on an economy? What is deflation? How does the Consumer Price Index work? What does a nations unemployment rate indicate? Describe what type of unemployment you think each of the following illustrates: a. recent college graduate interviewing for a job b. flight attendants who have been laid off due to a reduction in flights c. manufacturing employees whose company has automated most production jobs Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 94 11/3/09 6:37:05 PM d. ski lift attendant e. retail worker who has quit one job and is looking for another 9. Explain the difference between monetary policy and fiscal policy. How does the government raise funds to cover the costs of its annual budget? 10. What is the difference between the budget deficit and the national debt? What are the benefits of paying down the national debt? What might be the negative effects? Projects and Teamwork Applications 1. Describe a situation in which you have had to make an economic choice in an attempt to balance your wants with limited means. What factors influenced your decision? 2. Choose one of the following products and describe the different factors that you think might affect its supply and demand. a. Crocs sandals b. iPhone c. Chase Freedom credit card d. Glaceau Smartwater e. Caribbean cruise 3. Go online to research one of the following agenciesits responsibilities, its budget, and the like. Then make the case for privatizing it: a. U.S. Army Corps of Engineers b. U.S. Postal Service c. Internal Revenue Service d. Transportation and Security Administration e. Social Security 4. Some businesses automatically experience seasonal unemployment. Increasingly however, owners of these businesses are making efforts to increase demandand employmentduring the off-season. Choose a classmate to be your business partner, and together select one of the following businesses. Create a plan for developing business and keeping employees for a season during which your business does not customarily operate: a. surf shop b. landscaping business c. inn located near a ski resort d. house painting service e. greenhouse 5. On your own or with a classmate, go online to research the economies of one of the following countries. Learn what you can about the type of economy the country has, its major industries, and its competitive issues. (Note which industries or services are privatized and which are government owned.) Take notes on unemployment rates, monetary policies, and fiscal policies. Present your findings to the class. a. China b. Japan c. India d. France e. Mexico f. United Kingdom g. Brazil W eb Assignments 1. Inflation. In the United States, the Bureau of Labor Statistics (BLS) compiles and publishes the most widely followed measure of inflation, the Consumer Price Index (CPI). Visit the BLS Web site (http://www.bls.gov) and click on Inflation & Consumer Spending. Answer the following questions: a. What is the current rate of inflation as measured by the CPI? b. Which components of the CPI have risen the most over the past year? Which components have risen the least? c. What is the difference between the rate of inflation and the so-called core rate of inflation? 2. World economic outlook. The International Monetary Fund (IMF) publishes several reports each year on the outlook for the world economy. Visit the IMF Web site (http://www.imf.org). Click on the Publications link and access the most recent report you can f ind. Review the report and identify one major policy issue facing the global economy and the economic outlook for one region or countryother than the United States. 3. Truth in lending regulations. The Federal Reserve is considering several changes to truth in lending regulations. Specifically, the proposed changes deal with unfair and deceptive home mortgage lending practices. Visit the Federal Reserve Web site (http://www.federalreserve.gov) Chapter 3 Economic Challenges Facing Contemporary Business 95 Copyright 2011 John Wiley & Sons c03.indd 95 11/3/09 6:37:05 PM and click on News & Events. Then look for news on the proposed rule change to amend the home mortgage regulation (Regulation Z). Prepare a brief report for your class answering the following questions: a. What did the Federal Reserve change? Case 3.1 Note: Internet Web addresses change frequently. If you do not find the exact sites listed, you may need to access the organizations or companys home page and search from there. An Economic Windfall: The Rise of Wind Energy Texas is well known for big thingsits size, its houses, its ranches, its dreams. So its no surprise that the state is going big for wind energy, as the search for clean, renewable energy sources becomes urgent. Currently, Texas is leading the nation in harnessing wind power, partly because its location and topography create the perfect conditions for wind. West Texas, in particular, experiences a near-constant wind speed of 17 miles per hour over wide-open terrain. It also has landowners who are ready and willing to invest in a new business. In addition, state lawmakers passed legislation requiring utilities to buy renewable power, and federal tax credits await those who invest in wind power. Finally, Texas is on its own power grid, separate from the rest of the country. All of this points toward economic opportunity for small towns that have seen a downturn. Roscoe is one of these towns. The train doesnt stop there anymore, and the Dairy Queen closed. Stores dont have a lot to sell, and the 1,300 people who live there arent shopping anywayat least they werent until recently. Together with Airtricity, an energy firm based in the United Kingdom, the town of Roscoe has built one of the biggest wind farms in the world. The Roscoe Wind Farm generates 209 megawatts of electricityenough to power about 60,000 homes and save about 375,000 tons per year in greenhouse gas emissions. The wind power is sold through TXU Wholesale under a five-year contract. In addition, the landowners, on whose property the farm is built, will eventually receive royalties on the electricity sales. We used to cuss the wind, recalls Cliff Etheredge, a local cotton farmer who helped originate the project with Airtricity. Now, we love the wind. Etheredge also 96 b. Whom did these regulatory changes affect? c. Why did the Federal Reserve make these changes? proudly cites the economic rejuvenation of Roscoe: two new restaurants and other businesses that are opening or expanding. Hopefully, well see Roscoe reborn here. The wind energy industry in Texas has much broader implications than for a single small town, as companies bid for the rights to develop wind farms off the states coast in the Gulf of Mexico. The future of the nations offshore wind industry is off the coast of Texas, asserts the states Land Office commissioner. The Land Office has jurisdiction over the waters up to 10 miles offshore. Theres international interest in these tracts, and this will be the first time the market will be able to place a value on what I think is a very valuable asset. Across the nation in upstate New York, an environmental engineering firm named Tetra Tech is working on the Maple Ridge Wind Energy Program as part of the states initiative to reduce its traditional energy use by the year 2015. The firm is working toward the goal of helping to ensure that one-fourth of New Yorks energy is produced by renewable sources by 2013. New York officials believe that wind is the most economical resource compared with traditional sources, but wind turbines must be built to certain specifications in order to maximize their output and minimize their impact. Still, wind power is showing great promise.26 Questions for Critical Thinking 1. What factors do you think will affect the supply and demand curve for wind energy? 2. Describe what type of competition you predict will arise in the wind energy industry. Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 96 11/3/09 6:37:06 PM Music and Money: Breaking Record-Labels Stranglehold on Artists You probably have access to digital downloads of your favorite tuneswhether its for an iPod, MP3 player, laptop or desktop computer, or other device. You might have discovered the next big hit by watching YouTube or MySpace. The music industry has finally recognized the influence of new technologies on their business. The big record labels have acknowledged that they no longer have as much control over music creation or its distribution as they once did. Whereas a decade ago musicians earned 60 percent of their income through record labels from prerecorded music and the rest from concerts, endorsements, and merchandise, today those percentages are reversed. Concert ticket sales have nearly tripled, and the record labels dont profit from them. As these companies are trying to stop the flood of music and dollars out their own doors, they are also rethinking their business models in an attempt to find new ways of attracting talent and distributing their music. Some labels such as EMI are revising their contracts with artists. Called multiple-rights or all-rights contracts, these new agreements encompass live music, merchandise, and endorsements, instead of a simple cut of CD sales. Although artists are not enthusiastic about the new agreements, record executives insist that they are necessary. Its a discussion you have with every new artist now, says Jeanne Meyer of EMI. Some musicians have said no to the new arrangement, preferring to launch on their own or teaming up with smaller, start-up firms like Musicane, Indie911, Fuzz, Snocap, and TuneCore. Nine Inch Nails, Radiohead, Oasis, and Madonna are just a few of the increasing number of such groups. Trent Reznor of Nine Inch Nails left EMI and went to Musicane, where he dictated his own requirements for Web design, pricing, and other aspects of his music. He also helped the companys programmers, administrators, and designers produce albums for other artists. Reznor is an example of the new musician who is Case 3.2 savvy about both technology and business. Trent is wellinformed, articulate and is very knowledgeable about technology, notes Musicane CEO Dushin Shahani. But the big labels arent through yet. One of the new business models being adopted by larger firms involves bundling music subscriptions with the price of Internet access so that the music downloads appear to be free. Nokia Corp. is launching a service called Comes With Music, which allows users of certain cell phones a year of unlimited access to music without extra charges. In addition, the music labels are planning to license songs for ad-supported Web sites, where users watch videos or listen to full-length tracks posted by other users for free. Finally, four of the worlds largest recording companies Sony BMG, Vivendi SAs Universal Music Group, Warner Music Group, and EMIagreed to license music for sale online as unprotected MP3 files, which mean they can be played on multiple devices. It seems clear theres an accelerated pace of change that comes hand in glove with accelerated decline in traditional business, observes Eric Garland, CEO of a firm that tracks online entertainment. The big companies are a bit grudging about the changes, acknowledging their necessity if somewhat unenthusiastically. Theres no denying that Warner Music Group and the industry as a whole have been struggling for almost a decade now with the challenges and opportunities that the digital space presents, admits Edgar Bronfman, chairman and CEO. The recent trend of dramatic changes in the recorded music market will continue . . . And, though its a clich, its a clich because its true: technology will also provide us with new opportunities.27 Questions for Critical Thinking 1. How has the rapid development of technology affected competition in the music industry? 2. How does this technology affect supply and demand in the music industry? Chapter 3 Economic Challenges Facing Contemporary Business 97 Copyright 2011 John Wiley & Sons c03.indd 97 11/3/09 6:37:06 PM VIDEO Case 3.3 Companies build demand for their goods and services in a variety of ways. Automaker Kia attracts buyers with current styling and low prices. Sony increases the demand for its PlayStation games by limiting the supply, making the computer games harder to getand more popular. A ski resort like New Yorks Lake Placid builds demand by hosting a variety of competitions and activities for tourists and athletes year roundfrom horse shows to figure skating tournaments. Jake Burton built demand by creating a sport. Burton, founder and owner of Burton Snowboards, wont take credit for inventing snowboarding, which he says has actually been around since the 1920s. But when he was a teenager, Burton started sliding down hills on a wooden board with a rope attached to it called a Snurfer. The Snurfer was primitive and didnt offer much control to the rider, but Burton was hooked. From that time on, I felt like it could be a sport, but it wasnt a sport for the company that was manufacturing it. They were selling (the Snurfer) like it was a hula hoop or something, he recalls. Burton thought he could improve on the designand the sport. In 1977, Burton moved from New York to Vermont to start Burton Snowboards. I was blindly optimistic, he says. In addition to all of the struggles associated with developing a new product, Burton had to build awareness of and interest in the new sport itself. I became more concerned with hyping the sport to make sure it happened so that I was right, Burton recalls. One major hurdle was the fact that at the time, ski resorts didnt allow snowboarding on their slopes, so snowboarders had to climb hills, carrying their snowboards, in order to ride down. Burton knew he had to change that situation, or his sportand companywould never get off the ground. He had to build demand not only among consumers but among the ski resorts that attracted those consumers, convincing them that snowboarders would eventually become an important market. He got his first break when Vermonts Stratton Mountain Resort agreed to allow snowboards on its slopes. 98 Burton Snowboards Takes Demand for a Ride Gradually, interest in the sport and in Burton Snowboards spread. Then Burton began to get inquiries from European dealers and distributors, which opened up a whole new market for him. Fifteen years later, demand had increased so much that snowboarding debuted as an Olympic sport at the Nagano Winter Olympics in 1998 proof positive that the sport had arrived. Today, Burton Snowboards conducts business in more than 30 countries, with 3,000 dealers worldwide. Still, the company hasnt stopped looking for new ways to build demand by attracting new recruits to the sport. Recognizing that snowboarding has been taught and learned haphazardlywhich worries adult riders and parents of young ridersBurton Snowboards has established a systematic method of teaching called the LearnTo-Ride (LTR) program. The program includes lessons taught by certified American Association of Snowboard Instructors, as well as specially manufactured Burton boards, boots, and bindings designed for beginners. Stowe Mountain Resort, in Stowe, Vermont, was one of the first resorts to host the LTR program. For over a decade, Stowe has been the frontier for learning to snowboard, notes Jeff Wise, director of the Stowe Snowboard School. Learning from the industrys leading professionals has been made even better with the addition of LTR equipment. In addition, in 1995 Burton Snowboards started a nonprofit, after-school learning program for underprivileged and at-risk children in the Burlington, Vermont, area where the company is based. The program, called Chill, has since expanded to Boston, Los Angeles, New York, and Seattle. Chill takes schoolchildren snowboarding once a week for seven weeks, providing everything they need, from equipment to lift passes to instruction. Why do this? There are so many companies out there doing things for the environment, but we decided to address the people side of things, says Burton. Chill not only takes kids off the streets but puts them on the slopescreating a whole new generation and economic class of snowboarders. Part 1 Business in a Global Environment Copyright 2011 John Wiley & Sons c03.indd 98 11/3/09 6:37:06 PM During the rush to grow business quickly, when it seemed that companies couldnt go public fast enough, Jake Burton says hed rather not. He likes the control that ownership of the company gives him, and the flexibility. Im first and foremost a snowboarder, he says, and I use the fact that I dont have to be [in my office] every day like I used to as an opportunity to get more immersed in the sport. Such enthusiastic words from a man who took a sport from its infancy to its debut at the Olympicsand brought a whole new category of athletes along for the ride.28 Questions for Critical Thinking 1. In addition to the materials discussed in the case, what other factors might affect demand for Burton Snowboards? 2. What factors might affect supply of the snowboards? 3. What type of competition would you consider the snowboard industry to be at this time? 4. What challenges might Burton Snowboards face when doing business abroad? Chapter 3 Economic Challenges Facing Contemporary Business 99 Copyright 2011 John Wiley & Sons c03.indd 99 11/3/09 6:37:07 PM

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