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ECONOMICS: THE FRAMEWORK FOR BUSINESS

BUSN11 Chapter 2

Economics: Navigating a Crisis

■  Understanding how the government, businesses, and individuals respond to issues requires understanding some basic definitions:

■  The Economy: A financial and social system of how resources flow through society

■  Economics: The study of the choices people, companies, and governments make in allocating resources

■  Macroeconomics: The study of a country’s overall dynamics

■  Microeconomics: Focuses on smaller economic units

2-1

Global Economic Crisis: How Did This Happen?

2-1a

Moving in a Better Direction 2-1b

Managing the Economy Through Fiscal Policy ■  Fiscal Policy: Government efforts to influence the economy through

taxation and spending –  Designed to encourage growth, boost employment, and curb

inflation –  Most economists agree that lower taxes can boost the economy –  Most economists also agree that government spending can boost

the economy –  The challenge is finding the right balance

2-2a

Debt Ceiling/Fiscal Cliff

■  Budget Surplus: When revenue is greater than expenses over a given period of time

■  Budget Deficit: When expenses are greater than revenue over a given period of time

■  Federal Debt: The sum of all the money the government has borrowed over the years and not repaid –  When operating on a deficit, the government often has to borrow

money –  At the end of 2018, the U.S. Federal Debt is estimated to be

$21.48 Trillion

2-2b

Managing the Economy Through Monetary Policy ■  Monetary Policy: Federal Reserve decisions that shape the economy

by influencing interest rates and the supply of money –  The Federal Reserve is essentially the central bank of the United States –  Federal Reserve functions include: ■  Bailing out and propping up shaky financial firms ■  Banking services for member banks and the federal government

■  Commercial Banks: Privately owned financial institutions that accept demand deposits and make loans and provide other services for the public

2-2c

Definitions of Money

■  Money Supply: The total amount of money within the overall economy

■  Money: Anything generally accepted as a medium of exchange, a measure of value, or a means of payment

■  M1 Money Supply: Includes all currency plus checking accounts and traveler’s checks

–  Includes paper bills and metal coins

■  M2 Money Supply: Includes all of M1 Money Supply and savings accounts, money market accounts, and certificates of deposit

Open Market Operations ■  Open Market Operations: The Federal Reserve function of buying and

selling government securities –  Include treasury bonds, notes, and bills

■  When the economy is weak, the Fed buys government securities on the open market

–  The money the Fed pays the sellers of the securities, that money goes directly into circulation, stimulating spending

■  When inflation is a concern, the Fed sells government securities –  Buyers write checks to the Fed, the Fed withdraws these funds from banks,

making them unable to make as many loans, credit becomes tighter, and the money supply shrinks

Discount Rate Changes ■  Discount Rate: The rate of interest that the Federal Reserve charges

when it loans funds to banks

■  When the Fed reduces the discount rate, banks can get funds at a lower cost and use them to make more loans to their customers

–  More businesses and individuals are likely to take out loans from banks, thus stimulating the economy

–  Usually happens during recessions

■  The Fed usually increases the discount rate in response to inflation –  Higher interest rates mean fewer businesses and individuals willing to take out

loans, thus slowing down the economy

Reserve Requirement Changes

■  Reserve Requirement: Specifies the minimum amount of reserves (funds) a bank must hold –  Expressed as a percentage of bank’s deposits –  Helps protect depositors who may want to withdraw their money

without notice

Capitalism: The Free Market System

■  Economic System: A structure for allocating limited resources

■  Capitalism: An economic system based on private ownership, economic freedom, and fair competition –  Also known as the private enterprise or free market system

2-3

The Fundamental Rights of Capitalism ■  The right to own a business and keep after-tax profits

–  If you do earn profits, you get to keep your after-tax income and spend how you see fit

■  The right to private property –  Individuals and private businesses can buy, sell, and use property in any way

that makes sense to them

■  The right to free choice –  People and businesses must be free to buy (and not to buy) according to their

wishes

■  The right to fair competition –  Capitalism depends on fair competition to drive higher quality, lower prices, and

more choices

2-3a

Four Degrees of Competition 2-3b

Supply and Demand: Fundamental Principles of a Free Market System ■  Supply: Quantity of products that producers are willing to offer for sale

at difference –  Supply Curve: Graphed relationship between price and quantity from a supplier

standpoint

■  Demand: Quantity of products that consumers are willing to buy at different market prices

–  Demand Curve: Graphed relationship between price and quantity from a customer demand standpoint

■  Equilibrium Price: Price associated with the point at which quantity demanded equals quantity supplied of a product

2-3c

Socialism

■  Socialism: Based on the principle that the government should own and operate key enterprises that directly affect public welfare

–  Enterprises such as utilities, telecommunications, and healthcare

■  Goal is to run these enterprises in the best interest of the overall public

–  Inefficiencies and corruption often interfere with this goal

■  Have higher taxes, designed to distribute more wealth through society –  Tax revenues fund things like free childcare, free university, and free public

healthcare

2-4a

Communism

■  Communism: Economic and political system that calls for public ownership of virtually all enterprises, under the direction of a strong central government

■  Karl Marx envisioned communism to drastically improve the lot of the worker at the expense of the super rich

■  Most communist countries have not thrived

–  They imposed authoritarian governments that suspended individual rights and choices

2-4b

Mixed Economies: The Story of the Future ■  Mixed Economies: Economies that embody elements of both planned

and market-based economic systems –  Even the U.S. – one of the most market-oriented economies – does not have a pure market economy

■  Privatization: Process of converting government owned businesses to private ownership

2-5

Ways to Evaluate Economic Performance ■  Gross Domestic Product

■  Employment Level

■  The Business Cycle

■  Price Levels

■  Productivity

2-6

Gross Domestic Product

■  Gross Domestic Product (GDP): Measures the total value of all final goods and services produced within a nation’s physical boundaries over a given period of time

■  All domestic production is included – even if the firm is foreign owned –  Ex. GDP includes Hyundai Sonatas built in Alabama, even though Hyundai is a

Korean firm

■  GDP is a vital measure of economic health –  Business people, economists, and political leaders all use GDP to measure

economic performance

2-6a

Employment Level

■  Unemployment Rate: The percentage of people in the labor force 16 years old and up who do not have jobs and are actively seeking employment

■  Some unemployment is good –  Means you have the freedom to change jobs –  Ex. If you have an awful boss, you may want to just quit

2-6b

The Business Cycle ■  The Business Cycle: Periodic contraction and expansion that occur

over time in virtually every economy

2-6c

The Business Cycle ■  Contraction: A period of economic downturn, marked by rising

unemployment and failing business production –  Recession: An economic downturn marked by a decrease in GDP for 2

consecutive quarter –  Depression: An especially long and deep recession

■  Recovery: A period of rising economic growth and employment

■  Expansion: Period of robust economic growth and high employment

Price Levels ■  The rate of price change across the economy is a basic measure of

economic well-being

■  Inflation: A period of rising average prices across the economy

■  Hyperinflation: An average monthly inflation rate of more than 50%

■  Disinflation: A period of slowing average price increases across the economy

■  Deflation: A period of falling average prices across the economy

2-6d

How the Government Evaluates Inflation ■  Consumer Price Index (CPI): A measure of inflation that evaluates the

change in the weighted-average price of goods and services that the average consumer buys each month

■  Producer Price Index (PPI): A measure of inflation that evaluates the change over time in the weighted-average wholesale prices

Productivity

■  Productivity: Refers to the relationship between the production of goods and services and the resources needed to produce them

■  Calculated using the following equation: Output/Input = Productivity

2-6e

THE BIG PICTURE

■  One key goal of Economics is to guide your decision making by offering a deeper understanding of the broad forces that affect both your business and your personal life

■  Knowing basic principles of Economics can help you make better business decisions in virtually every area

■  You won’t find an Economics department in a business – instead you’ll find people throughout the organization applying theories and trends to their work