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Chapter 02 - Understanding Economics and How It Affects Business
2-16
bonus case 2-1
FOUNDATIONS OF THE CAPITALIST
SYSTEM
What are the moral, ethical, and spiritual foundations of capi-
talism? (See the complete case, discussion questions, and sug-
gested answers beginning on page 2.75 of this manual.)
PPT 2-16
Capitalism
CAPITALISM
2-16
• Countries with capitalist
foundations:
- United States
- England
- Australia
- Canada
LO 2-2
• Capitalism -- All or most of the land, factories and
stores are owned by individuals, not the government,
and operated for profit.
lecture enhancer 2-3
TRACKING THE UNDERGROUND
ECONOMY
Not all incomes are reported to the IRS. Is the U.S. govern-
ment losing out? (See the complete lecture enhancer on page
2.64 of this manual.)
lecture enhancer 2-4
EU NATIONS ADD UNDERGROUND
ECONOMIES TO GDP
EU countries like U.K., Italy, and Ireland are adding illicit
activities like drug sales, prostitution, and even smuggling to
their lists of official goods and services to boost their GDP.
(See the complete lecture enhancer on page 2.65 of this manu-
al.)
PPT 2-17
State Capitalism
STATE CAPITALISM
2-17
LO 2-2
• State Capitalism -- When the state, rather than
private owners, run some businesses.
• Well-known countries practicing state capitalism:
- China
- Russia
• These countries have experienced some success
using capitalistic principles, but the future is still
uncertain.
Chapter 02 - Understanding Economics and How It Affects Business
2-17
c. The right to FREEDOM OF COMPETITION
d. The right to FREEDOM OF CHOICE
2. One benefit of such rights is that people are willing
to take more RISKS than they would otherwise.
3. President Franklin Roosevelt believed FOUR AD-
DITIONAL FREEDOMS were essential:
a. Freedom of SPEECH AND EXPRESSION
b. Freedom to WORSHIP IN YOUR OWN WAY
c. Freedom from WANT
d. Freedom from FEAR
C. HOW FREE MARKETS WORK
1. In a free-market system, decisions about what to
produce and in what quantities are made by THE
MARKET.
2. CONSUMERS send signals to PRODUCERS
about what to make, how many, and so on
through the mechanism of PRICE. (Text example:
T-shirts supporting favorite baseball teams.)
3. In a free market the PRICE tells producers how
much to produce, reducing the chances of a long-
term shortage of goods.
D. HOW PRICES ARE DETERMINED
1. Prices in a free market are not determined by
sellers; rather, buyers and sellers negotiating in
the marketplace determine them.
2. Price is determined through the economic con-
cepts of supply and demand.
E. THE ECONOMIC CONCEPT OF SUPPLY
Chapter 02 - Understanding Economics and How It Affects Business
2-18
PPT 2-18
Capitalism’s Four Basic Rights
CAPITALISM’S
FOUR BASIC RIGHTS
2-18
LO 2-2
1. The right to own private
property.
2. The right to own a business
and keep all that business
’
s
profits.
3. The right to freedom of
competition.
4. The right to freedom of choice.
PPT 2-19
Roosevelt’s Four Additional Rights
ROOSEVELT’S FOUR
ADDITIONAL RIGHTS
2-19
LO 2-2
1. Freedom of speech and
expression.
2. Freedom to worship in your
own way.
3. Freedom from want.
4. Freedom from fear.
PPT 2-20
Free Markets
FREE MARKETS
2-20
LO 2-2
• Free Market -- Decisions about what and how much
to produce are made by the market.
• Consumers send signals about what they like and
how they like it.
• Price tells companies how much of a product they
should produce.
• If something is wanted but hard to get, the price
will rise until more products are available.
lecture enhancer 2-5
THE CIRCULAR FLOW MODEL
The Circular Flow Model is used to explain how businesses
and individuals interact in a free-market economy. (See the
complete lecture enhancer on page 2.65 of this manual.)
PPT 2-21
Circular Flow Model
CIRCULAR FLOW MODEL
2-21
LO 2-2
PPT 2-22
Pricing
PRICING
2-22
LO 2-2
• A seller may want to sell
shirts for $50, but only a
few people may buy them
at that price.
• If the seller lowers the price
to $30, more people buy
the shirts.
• The seller establishes a
price of $30 based on what
consumers are willing to
pay.
Chapter 02 - Understanding Economics and How It Affects Business
2-19
1. SUPPLY refers to the quantity of products that
manufacturers or owners are willing to sell at dif-
ferent prices at a specific time.
2. The amount supplied will INCREASE as the price
INCREASES (DIRECT relationship).
3. The quantity producers are willing to SUPPLY at
certain prices is illustrated on a SUPPLY CURVE.
F. THE ECONOMIC CONCEPT OF DEMAND
1. DEMAND refers to the quantity of products that
people are willing to buy at different prices at a
specific time.
2. The quantity demanded will DECREASE as the
price INCREASES (INVERSE relationship).
3. The quantities consumers are willing to buy at
certain prices are illustrated on a DEMAND
CURVE.
G. THE EQUILIBRIUM PRICE, OR MARKET PRICE
1. The key factor in determining the quantity sup-
plied and the quantity demanded is PRICE.
a. At the EQUILIBRIUM POINT, the supply and
demand curves cross, and the quantity de-
manded equals the quantity supplied.
b. MARKET PRICE is the price determined by
supply and demand.
2. In free-market economies it is the INTERACTION
between SUPPLY and DEMAND that determines
the market price in the long run.
a. If SURPLUSES (too many products) develop,
a signal is sent to sellers to LOWER the price.
Chapter 02 - Understanding Economics and How It Affects Business
2-20
PPT 2-23
Supply Curves
TEXT FIGURE 2.1
The Supply Curve at Various Prices
SUPPLY CURVES
0
5
10
15
20
25
30
35
40
45
50
Price ($)
510 15 20 25 30
Quantity of T-Shirts
35 40 45 50
Supply curve
2-23
LO 2-2
• Supply -- The quantities of products businesses are
willing to sell at different prices.
PPT 2-24
Demand Curves
TEXT FIGURE 2.2
Demand Curves
DEMAND CURVES
2-24
LO 2-2
• Demand -- The quantities of products consumers are
willing to buy at different prices.
PPT 2-25
Equilibrium
TEXT FIGURE 2.3
The Equilibrium Point
EQUILIBRIUM
2-25
LO 2-2
• Market Price (Equilibrium Point) -- Determined
by supply and demand, this is the negotiated price.
critical thinking
exercise 2-3
FINDING THE EQUILIBRIUM POINT
How does the equilibrium price of a product change when
forces in the economy change? (See the complete exercise on
page 2.72 of this manual.)
Chapter 02 - Understanding Economics and How It Affects Business
2-21
b. If SHORTAGES (not enough products) devel-
op, a signal is sent to sellers to INCREASE the
price.
c. Eventually, supply will again equal demand.
3. In countries without a free-market system, there is
no such mechanism, so there are often SHORT-
AGES OR SURPLUSES.
4. When government interferes in free markets, sur-
pluses and shortages may develop.
H. COMPETITION WITHIN FREE MARKETS
1. Competition exists in different degrees, ranging
from perfect to nonexistent.
2. PERFECT COMPETITION is the degree of com-
petition in which there are many sellers in a market
and none is large enough to dictate the price of a
product.
a. Sellers produce products that appear to be
IDENTICAL.
b. There are no true examples of perfect competi-
tion, but agricultural products are often used as
an example.
3. MONOPOLISTIC COMPETITION is the degree of
competition in which a large number of sellers
produce very similar products that buyers never-
theless perceive as different.
a. PRODUCT DIFFERENTIATION, making buy-
ers think similar products are different, is a key
to success.
b. The fast-food industry is an example.
Chapter 02 - Understanding Economics and How It Affects Business
2-22
SPOTLIGHT ON
small business
PPT 2-26
Bugs Bug Orange Farmers and
Drive Prices Up
BUGS BUG ORANGE FARMERS
and DRIVE PRICES UP
2-26
• The 2013 Florida orange crop
experienced a major disruption
because of bugs.
• As a result, orange prices rose
as much as 16%!
• With circumstances out of their
control, farmers have to hope
that nothing else harms their
crops.
PPT 2-27
Four Degrees of Competition
FOUR DEGREES
of COMPETITION
2-27
LO 2-2
1. Perfect
Competition
2. Monopolistic
Competition
3. Oligopoly
4. Monopoly
Chapter 02 - Understanding Economics and How It Affects Business
2-23
4. An OLIGOPOLY is a degree of competition in
which just a few sellers dominate a market.
a. The INITIAL INVESTMENT required to enter
the market is usually high.
b. Prices among competing firms tend to be close
to the same.
c. Examples include breakfast cereal and soft
drinks.
5. A MONOPOLY is a degree of competition in which
only one seller controls the total supply of a prod-
uct or service, and sets the price.
a. U.S. laws prohibit the creation of monopolies,
but do permit APPROVED MONOPOLIES in
markets for public utilities.
b. New laws have ended the monopoly status of
utilities in some areas, creating intense compe-
tition among utility companies.
c. DEREGULATION is meant to increase compe-
tition and lower prices for consumers.
I. BENEFITS AND LIMITATIONS OF FREE MARKETS
1. The free market allows open competition among
companies.
2. Free-market capitalism provides opportunities for
poor people to work their way out of poverty.
3. Capitalism also creates INEQUITIES between
those who have gained wealth and those who are
not able to.
4. Not all businesspeople agree on how to deal with
this INEQUITY.
Chapter 02 - Understanding Economics and How It Affects Business
2-24
critical thinking
exercise 2-4
STANDARD OF LIVING
COMPARISON
This exercise asks students to research key economic indi-
cators for a capitalist country, a socialist country, and a com-
munist country. (See the complete exercise on page 2.74 of
this manual.)
PPT 2-28
Free Market Benefits and
Limitations
FREE MARKET BENEFITS
and LIMITATIONS
2-28
LO 2-2
Benefits:
• It allows for open
competition among
companies.
• Provides opportunities for
poor people to work their
way out of poverty.
Limitations:
• People may start to let
greed drive them.
PPT 2-29
The Government Needs . . .
Source: Worldwide Tax, www.worldwide-tax.com, accessed October 2014.
The GOVERNMENT NEEDS…
Individual Tax Rates from Around the World
2-29
LO 2-2
PPT 2-30
Atypical Taxes
Source: Forbes.com, accessed October 2014.
ATYPICAL TAXES
Strange Taxes in Some U.S. States
2-30
State Tax
California
Tax exclusion if you were
persecuted by the Ottoman Empire
and won a settlement.
Maryland
An aquaculture float credit is
available for oyster fisheries, but
not other shellfish.
Minnesota
(and others) Marijuana tax of $3.50 per gram.
New York
Sales-tax exemption for musical
comedies and operas if the tickets
are over 10¢, can’t be used by
haunted houses with music.
LO 2-2
Chapter 02 - Understanding Economics and How It Affects Business
2-25
5. Greed has led some businesspeople to engage in
UNETHICAL PRACTICES and deceive the public.
6. Some government REGULATIONS ARE NECES-
SARY to protect stockholders and vulnerable citi-
zens.
learning objective 3
Compare socialism and communism.
III. UNDERSTANDING SOCIALISM
A. SOCIALISM is an economic system based on the
premise that some, if not most, basic businesses
should be owned by the government so that profits can
be distributed among the people.
1. Entrepreneurs can own small businesses, but their
profits are STEEPLY TAXED to pay for social pro-
grams.
2. Advocates of socialism acknowledge the major
benefits of capitalism, but believe that WEALTH
SHOULD BE MORE EVENLY DISTRIBUTED.
B. The MAJOR BENEFIT of socialism is SOCIAL
EQUALITY.
1. Income is taken from the wealthier people and re-
distributed to the poorer members of the popula-
tion.
2. Workers in socialist countries are given free edu-
cation, free health care, free child care, and more
employee benefits.
C. THE NEGATIVE CONSEQUENCES OF SOCIALISM
1. Socialism may create EQUALITY, but it TAKES
AWAY SOME WORK INCENTIVES.
Chapter 02 - Understanding Economics and How It Affects Business
2-26
test
prep
PPT 2-31
Test Prep
TEST PREP
2-31
• What are the four basic rights that people have
under free-market capitalism?
• How do businesspeople know what to produce
and in what quantity?
• How are prices determined?
• What are the four degrees of competition and
what are some examples of each?
PPT 2-32
Socialism
SOCIALISM
2-32
LO 2-3
• Socialism -- An economic system based on the
premise that some basic businesses, like utilities,
should be owned by the government in order to more
evenly distribute profits among the people.
• Entrepreneurs run smaller businesses.
• Citizens are highly taxed.
• Government is more involved in protecting the
environment and the poor.
PPT 2-33
Benefits of Socialism
BENEFITS of SOCIALISM
2-33
LO 2-3
• Social equality
• Free education
• Free healthcare
• Free childcare
• Longer vacations
• Shorter work weeks
• Generous sick leave
Chapter 02 - Understanding Economics and How It Affects Business
2-27
2. Tax rates in some nations once reached 83%.
3. Because wealthy professionals have very high tax
rates, many of them leave socialist countries for
countries with lower taxes.
4. The loss of the best and brightest people to other
countries is called BRAIN DRAIN.
5. Socialist systems can result in FEWER INVEN-
TIONS AND LESS INNOVATION.
IV. UNDERSTANDING COMMUNISM
A. COMMUNISM is an economic and political system in
which the government makes almost all economic de-
cisions and owns almost all the major factors of pro-
duction.
B. PROBLEMS WITH COMMUNISM
1. The government has no way of knowing what to
produce because prices don’t reflect SUPPLY and
DEMAND.
2. SHORTAGES of many items may develop.
3. Communism doesn’t inspire businesspeople to
work hard, and is slowly disappearing as an alter-
native economic form.
C. Most communist countries today are SUFFERING
SEVERE ECONOMIC DEPRESSION, including North
Korea and Cuba.
1. Some countries, such as Venezuela, are moving
toward communism.
2. The former Soviet Union is moving toward free
markets.
Chapter 02 - Understanding Economics and How It Affects Business
2-28
PPT 2-34
Negatives of Socialism
NEGATIVES of SOCIALISM
2-34
LO 2-3
• Few incentives for businesspeople to take risks.
• Brain Drain: Some of a country
’
s best and brightest
workers (i.e. doctors, lawyers and business owners)
move to capitalistic countries.
• Fewer inventions and innovations because the
reward is not as great as in capitalistic countries.
PPT 2-35
Communism
COMMUNISM
2-35
LO 2-3
• Communism -- An economic and political system in
which the government makes almost all economic
decisions and owns almost all the major factors of
production.
• Prices don’t reflect demand which may lead to
shortages of items, including food and clothing.
• Most communist countries today suffer severe
economic depression and citizens fear the
government.
Chapter 02 - Understanding Economics and How It Affects Business
2-29
3. Russia now has a flat tax of 13%, a much lower
tax rate than the U.S. has.
4. The trend toward free markets is growing.
learning objective 4
Analyze the trend toward mixed economies.
V. THE TREND TOWARD MIXED ECONOMIES
A. There are two dominant economic systems:
1. FREE-MARKET ECONOMIES
a. FREE-MARKET ECONOMIES are economic
systems in which the market largely deter-
mines what goods and services get produced,
who gets them, and how the economy grows.
b. This system is commonly known as CAPITAL-
ISM.
2. COMMAND ECONOMIES
a. COMMAND ECONOMIES are economic sys-
tems in which the government largely decides
what goods and services will be produced, who
will get them, and how the economy will grow.
b. These economies are known as SOCIALISM
and COMMUNISM.
B. No one economic system is perfect by itself.
1. Free-market mechanisms haven’t been responsive
enough to a nation’s social and economic needs
and haven’t adequately protected the environ-
ment.
2. Socialism and communism haven’t always created
enough jobs or wealth to keep economies growing
Chapter 02 - Understanding Economics and How It Affects Business
2-30
PPT 2-36
Two Major Economic Systems
TWO MAJOR
ECONOMIC SYSTEMS
2-36
LO 2-4
• Free-Market Economies -- The market largely
determines what goods and services are
produced, who gets them, and how the economy
grows.
• Command Economies -- The government
largely determines what goods and services are
produced, who gets them, and how the economy
will grow.
