entrepreneurship ideas in action. different countries have different economic systems. these...

Entrepreneurship Ideas In Action

Chapter 3Entrepreneurs In A Market Economy


What Is An Economy?

Different countries have different economic systems.

These different systems affect how an item is produced, how it is distributed, and the demand for the item.

An economic system even determines whether an item is available at all.

You must always consider market structure, including supply, demand, and price, when starting a business in order to succeed.


Market & Command Economies

All economies produce goods and services.

Goods are products, such as television sets, compact discs, or greeting cards.

Service businesses include theme parks, restaurants, and repair shops.


Scarcity

In every economy, there are limited resources to produce goods and services.

However, individuals have unlimited needs and wants. This produces the basic economic problem of scarcity. Scarcity occurs when people’s needs and wants are unlimited and

the resources to produce the goods and services to meet those needs and wants are limited.

Consider people’s basic needs of food, clothing, and shelter. Scarcity occurs in every economy. Economies must choose a way to allocate, or distribute, the goods

and services that are available to the people who need or want them. Different economies have different ways of choosing which needs are

satisfied and how many resources are used to satisfy those needs. These different allocation processes are what create different

economies.


Command Economy

In a command economy, the government determines what, how, and for whom products and services are produced.

Because the government is making the decisions, there is very little choice for consumers in what is available.

The government sees no reason to have more than one type of the same item.

This means individuals may not always be able to obtain exactly what they want.

There will be shirts and pants, but there will not be many styles and colors from which to choose.


Market Economy

Market economies are about personal choice. In a market economy, individuals decide what,

how, and for whom goods and services are produced.

Decisions about production and consumption are made by millions of people, each acting alone.

Individual choice creates the market, so there are many items available that are very similar.

If a good sells, it will remain on the market. If not, the good will not continue to be produced. Individual choice also exists in how items are

produced.


Productivity

The level of output that an industry or company gets from each worker or each unit of input into its products and services is called productivity.

In order for the productivity of a company to increase, a new product must be produced or a current product must be produced better or more cheaply than the competition.

When production increases, a company makes more profit and can increase wages paid to employees.


Supply & Demand

If a market economy is based on personal choice, why does there always seem to be just enough of everything.

In a market economy, individual consumers make decisions about what to buy, and businesses make decisions about what to produce.

Consumers are motivated to buy goods and services that they need or want.

Business owners are driven by the desire to earn profits. These two groups, consumers and producers, together

determine the prices and quantities of goods and services produced.

To understand how this works, you need to understand two important forces: supply & demand.


Supply

Supply is how much of a good or service a producer is willing to produce at different prices.

Imagine that you supply lawn-mowing services. Let’s say that at a rate of $10 an hour, you are willing to spend

eight hours a week mowing lawns. If your neighbors are willing to pay just $1 an hour, you might

decide not to bother mowing lawns at all. If, however, that rate for lawn mowing rose to $50 an hour, you

would probably increase the number of lawns you would mow. You might even try to get some friends to help you mow even

more lawns. As the price of lawn-mowing services rises, suppliers are willing

to produce more. The quantity of lawn-mowing services supplied rises as the price

of lawn increases, as shown on the supply curve graph.


Demand

Demand is an individual’s need or desire for a product or service at a given price.

Let’s say that you are interested in having your lawn mowed.

At a rate of $10 an hour, you figure it is worth having your lawn mowed every two weeks.

If, however, the rate fell to just $5 an hour, you might be willing to have your lawn mowed every week.

As the price of the service or product decreases, consumers are willing to purchase more of the product or service.

Demand rises as the price falls, as shown on the demand curve graph.


When Supply & Demand Meet

How do the forces of supply and demand work together to determine price in a market economy?

The point at which the supply and demand curves meet is what is known as the equilibrium price and quantity.

This is the price at which supply equals demand. Above the equilibrium price, fewer people are interest in buying lawn-mowing

services than in selling them. In this part of the diagram, suppliers will not be able to sell as much of their services

as they would like because they have priced their services too high. Below the equilibrium price, the price is too low. Consumers would be very happy to purchase lots of the service at these prices, but

suppliers are not willing to produce enough to meet their demand. Only at the equilibrium price does the amount consumers want to buy exactly equal

the amount producers want to supply.


Market Structure & prices

In a competitive market, many suppliers compete for business, and buyers shop around for the best deal they can find.

In this kind of market, prices are said to be determined competitively. Not all markets are fully competitive. In some sectors of the economy, there is little or no competition. AMTRACK is the only train line serving certain routes in the United States. Although it competes with other means of transportation, in many areas of

the country AMTRAK does not face direct competition from other train lines.

When a company controls all of a market, it has a monopoly. A company that has a monopoly is able to charge more than a company

that has to compete with other companies. In a competitive market, a company cannot charge prices that are much higher than its competitors.

Consumers will simply switch to the lower-priced good or service. With a monopoly, consumers have nowhere else to go. They will continue to buy a product or service, even if the producer raises

prices.


Business Activities In a Market Economy

In a market economy, a business is free to produce and offer to consumers any legal product or service.

A knowledge of business activities will help entrepreneurs satisfy customers and make a profit.

These activities or functions of business include the following:› Production› Marketing› Management› Finance

Each of these functions is dependent on the others in order for the business to be effective.

Products can be produced, but if management is not functioning properly, if adequate financial records are not maintained, or if marketing is not getting the word out to consumers, the products probably will not be sold at profit.


Production

The primary reason a business exists in a market economy is to provide products or services to consumers and to earn a profit.

The production function creates or obtains products probably will not be sold at a profit.


Marketing

All businesses in a market economy need to complete marketing activities in order to make their products and services available to consumers.

These activities make up the marketing mix, which includes the following:› Product› Distribution› Price› Promotion

The goal is to attract as many customers as possible so that the product succeeds in the marketplace.


Management

It is necessary in all businesses in a market economy for a great deal of time to be spent developing, implementing, and evaluating plans and activities.

Setting goals, determining how goals can be met, and how to respond to the actions of competitors is the role of management.

Management also solves problems, manages the work of employees, and evaluates the activities of the business.


Finance

In a market economy, the finance function plans and manages financial records and information related to businesses’ finances.

One of the first responsibilities of finance is determining the amount of capital needed for the business and where the capital will be obtained.


The Concept Of Cost

To determine how much profit they are earning, entrepreneurs need to know how much it costs to produce their goods or services.

To do so, they must consider all the resources that go into producing the good or service to determine a price to charge.

A company that prices its product based only on the materials involved in producing it will lose money and go out of business very quickly.


Fixed And Variable Costs

Every business has fixed costs and variable costs. Fixed costs are costs that must be paid regardless of how

much of a good or service is produced. Fixed costs are also called sunk costs. Variable costs are costs that go up and down depending on

the quantity of the good or service produced. Understanding the difference between fixed and variable

costs is important. A business with many fixed costs is a higher risk than a

business with mostly variable costs because fixed costs will be incurred regardless of sales.

If sales turn out to be much lower than expected, the business will be stuck with many bills to pay and little revenue.


Marginal Benefit and Marginal Cost

Entrepreneurs make business decisions based on the concepts of marginal benefit and marginal cost.

Marginal benefit measures the advantages of producing one additional unit of a good or service.

Marginal cost measures the disadvantages of producing one additional unit of good or service.


Opportunity Cost

Another type of cost you should think about is opportunity cost.

Opportunity cost is the cost of choosing one opportunity or investment over another.

For example, you want to start your own business, but you have been offered a job that pays $28,000 a year. In addition to the salary, you will receive two weeks’ paid vacation, and your company will pay your medical insurance.

If you add in these benefits, which you estimate are worth $3,000 a year, the total of $31,000 represents the opportunity cost of starting your own business.

It is the amount you could have earned by choosing a different path.

Business people use the concept of opportunity cost to make business decisions.


Government’s Effect On What Is Produced?

Although the U.S. economy is made up of private companies, the government has an effect on what is produced in three important ways:› Purchases› Taxes› Subsidies


Purchases

First, the government purchases huge amounts goods and services.

For example, the aerospace industry is almost entirely dependent on government purchases.

The National Aeronautic and Space Agency (NASA) is the sole purchaser of various devices produced by aerospace companies.

Private companies also supply the government with everything from pens to office-cleaning supplies.


Taxes

Second, the government taxes certain goods and services.

Most states charge sales tax on retail sales, and most charge extra taxes on certain items, such as cigarettes, gasoline, and alcoholic beverages.

These taxes reduce consumption of these products, reducing producers’ revenues.


Subsidies

Finally, the government provides subsidies, or payments, to producers of certain kinds of goods.

Agricultural products are commonly subsidized. The government also pays subsidies to

companies to locate their businesses in certain inner-city neighborhoods, known as enterprise zones.

Entrepreneurs whose businesses can operate in such areas may be able to benefit from these subsidies.


Roles of the Government

In a market economy the government plays a different roles.

The government may serve as a regulator, as a provider of public good, as a provider of social programs, and as a redistributor of income.


The Government As A Regulator

A market economy is based on private companies producing goods and services in order to earn profits.

Sometimes, however, this desire to earn profits motivates business owners to engage in practices that put consumers in danger.


Inspection

To protect consumers, the government regulates certain businesses.

The U.S. Department of Agriculture (USDA), for example, inspects meat and poultry plants to ensure that appropriate hygienic measures are being observed.

The U.S. Occupational Safety and Health Administration (OSHA) inspects factories to ensure that the conditions are safe for workers.


Licenses

The government also regulates by requiring some businesses to obtain licenses.

Barbers and beauticians, for instance, must fulfill certain training requirements, and they must be licensed by the state in which they work.

Entrepreneurs entering fields requiring licenses must pass examinations and pay licensing fees before they can start their businesses.


The Government As A Provider Of Public Good

For most products, the benefits of ownership apply only to the owner of the product.

Your next-door neighbor, for example, gets no benefits from your microwave oven, just as you get no benefits from your neighbor’s central heating.

A public good is a good from which everyone receives benefits, not just the individual consuming the good.

Vaccinations against communicable diseases are a public good because everyone benefits from the national security they provide.

Because the country as a whole benefits from these kinds of goods and services, the government has a role to play in providing them.

Many entrepreneurs benefit from the fact that the government provides public goods.

Engineering firms consult on the building of highways, for example, and construction companies build schools.


The Government As A Provider Of Social Programs

The government provides a number of social programs for people. Social security, welfare, medical research, and aid for dependent

children and the aged are but a few of the many social programs the government offers.

The benefit of these programs lies in the fact that people who require help receive it.

Plus, the cost of providing these programs is spread among millions of taxpayers, which greatly reduces the cost to any one person.

Although there is much debate over how well social programs work, there is still a net benefit to society.

A large sum of money is spent on cancer and other medical research each year.

Many children and elderly persons are well taken care of and do not need to rely on private charity for survival.


The Government As A Redistributor Of Income

The government further affects the economy by redistributing income. People with higher incomes pay more in taxes than people with lower

incomes. Lower-income is more evenly distributed among members of a society. This redistribution of income affects entrepreneurs because the percentage of

income that must be paid in taxes increases as earnings increase. Thus, an entrepreneur who earns very little might pay only 15% in income tax

while one who earns a great deal might pay 40 percent in taxes. However, it is widely agreed that redistributing income is a positive action. Feelings of excessive inequality can arise in those who feel there is nothing

they can do about their economic situation. They may have a very low level of education, or they may actually be unable

to work. Hostile emotions and even riots can result from these feelings of inequality. By

redistributing income, the government reduces the chance of social problems due to low income.


Summary

In a command economy, the government determines what, how, and for whom products and services are produced.

In a market economy, individuals decide what, how, and for whom products and services are produced.

Supply is how much of a good or service a producer will make at different prices.

Demand is an individual’s need or desire for a product or service at a given price.

When supply and demand meet, supply equals demand. This point is referred to as the equilibrium price.

In competition markets, prices are similar for like products. Companies cannot charge prices that are much higher than their competitors.


Summary (continued)

The functions of business-production, marketing, management, and finance-are dependent on each other in order for a business to be run effectively.

Fixed costs exist regardless of how much of a good or service is produced. Variable costs go up and down depending on the quantity of the good or service

produced. A business with a high percentage of fixed costs may not always earn enough profit

to cover its expenses. Marginal benefits are the advantages of producing one additional unit of a good or

service. Marginal costs are the disadvantages of producing one more unit of a good or

service. Marginal benefits and marginal costs should be considered to determine whether an

idea is financially feasible. The government plays many roles in a market economy. To protect consumers, the

government regulates private companies. Providing public goods, such as vaccinations and national defense is, also a role of

the government. Public goods benefit everyone, not just the individual receiving the good.

The government also provides social programs. Income is commonly redistributed by the government so lower-income individuals receive benefits.


References

Allen, K. & Meyer, E. (2000). Entrepreneurship and Small Business Management. Retrieved August 25, 2012, from Glenco McGraw-Hill.

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