Chapter Terms

The profit-seeking activities of those engaged in purchasing or selling goods and services to satisfy society’s needs and wants.

Services are the intangible offerings of businesses that can’t be held, touched, or stored.

A country’s output of goods and services that people can buy with the money they have.

The general level of human happiness based on such things as life expectancy, educational standards, health, sanitation, and leisure time.

The potential to lose time and money or otherwise not be able to accomplish an organization’s goals.

The money a company earns from providing services or selling goods to customers.

The financial rewards received by a businessperson for taking the risks involved in creating and marketing want-satisfying goods and services.

An organization that exists to achieve some goal other than the usual business goal of profits.

The basic inputs into the private enterprise system, including natural resources, human resources, capital, and entrepreneurship.

Natural Resources include all productive inputs that are useful in their natural states, including agricultural land, building sites, forests, and mineral deposits. …Natural resources are the basic inputs required by any economic system.

Human resources are also critical inputs in all economic systems. Human resources include anyone who work, from the chief executive officer of a huge corporation to a self-employed auto mechanic. This category encompasses both the physical labor and the intellectual inputs contributed by workers.

Capital, another key resource, includes technology, tools, information, and physical facilities. These elements frequently determine whether a fledgling computer firm like Compaq or Microsoft, becomes an industry leader or remains a small operation. Technology is a broad term that refers to such machinery and equipment as production lines, telecommunications, and basic inventions. Information frequently improved by technological innovations, is another critical success factor, since both managers and operating employees require accurate, timely information for effective performance of their assigned tasks.

Money is necessary to acquire, maintain, and upgrade a firms capital. These funds may come from investments by company owners, profits, or loans extended by others. Money then goes to work building factories; purchasing raw materials and component parts; and hiring, training, and compensating workers. People that capital receive factor payments in the form of interest.

Entrepreneurship is the willingness to take risks to create and operate a business. An entrepreneur is someone who sees a potentially profitable opportunity and then devises a plan to earn those profits, much like David Marcheschi did with Water Joe. Some entrepreneurs set up new companies and ventures; others, such as Martha Stewart, revitalize established firms by keeping the organizations open to market changes and expansion possibilities.

A number of outstanding managers and noted academics are beginning to emphasize a fifth factor of production—knowledge. Knowledge is the combined talents and skills of the workforce.

…This invisible hand concept is a basic premise of the private enterprise system. In the United States, competition regulates economic life. To compete successfully, each firm must find a basis for competitive differentiation, the unique combination or organizational abilities and approaches that sets a company apart from competitors in the minds of consumers. Eyeglass retailer Lenscrafters has differentiated itself from competitors through service. Customers get their new glasses in about an hour. Wal-Mart uses discount pricing on brand name products to attract customers.

People in the United States today are piecing together component lifestyles. A lifestyle is a mode of living; it is the way people decide to live their lives. A component lifestyle is a lifestyle made up of a complex set of interests and choices. In other words, people are choosing products and services that meet diverse needs and interests rather than conforming to traditional stereotypes.

Demographic trends—another uncontrollable factor in the business environment—are also extremely important to managers. Demography is the study of people’s vital statistics, such as their age, race and ethnicity, and location. Demographics are significant because the basis for any market is people. Demographics also determine the size and competition of the workforce. Let’s begin by taking a look at key age groups.

Today there are about 58 million Americans age 16 and under. These people—those born after 1982—make up generation Y. And though generation Y is much smaller than the baby boom, which lasted nearly 20 years and produced 78 million children, its members are plentiful enough to put their own footprints on society.

There are approximately 47 million people between the ages of 20 and 31. These people—those born between 1968 and 1979—have been labeled Generation X. They are the first generation of latchkey children—products of dual-career households or, in roughly half the cases, of divorced or separated parents.

People born between 1946 and 1964 are called baby boomers. Many baby boomers are now over 50, but they cling to their youth. Most continue to live a very active life. This group cherishes convenience, which has resulted in a growing demand for home delivery of large appliances, furniture, groceries, and other items. In addition, the spreading culture of convenience explains the tremendous appeal of prepared take-out foods, VCRs, portable telephones, and the Internet.

Diversity leads to new ideas, new ways of doing things, and greater income equality among ethnic groups.

Multiculturalism exists when all major ethnic groups in an area—such as a city, county, or censes tract—are roughly equally represented. Because of the current demographic transition, the trend in the United States is toward greater multiculturalism, although the degree varies in different parts of the country.

An economic system that rewards firms based on how well they match and counter the offerings of competitors to serve the needs and demands of customers.

Capitalism, also known as the private enterprise system, is based on competition in the marketplace and private ownership of the factors of production (resources). In a competitive economic system, a large number of people and businesses buy and sell products freely in the marketplace. In pure capitalism all the factors of production are owned privately, and the government does not try to set prices or coordinate economic activities.

A command economy, or communism, is characterized by government ownership of virtually all resources and economic decision making by central government planning. The government decides what will be produced, where it will be produced, how much will be produced, where the raw materials and supplies will come from, and who will get the output.

Socialism is an economic system in which the basic industries are owned by the government or by the private sector under strong government control. A socialist state controls critical, large-scale industries such as transportation, communications, and utilities. Smaller businesses may be privately owned. To varying degrees the state also determines the goals of businesses, the prices and selection of goods, and the rights of workers. Socialist countries typically provide their citizens with a higher level of services, such as health care and unemployment benefits, than do most capitalist countries.

Canada, Great Britain, and Sweden, among others, are also called mixed economies; that is, they use more than one economic system. Sometimes, the government is basically socialist and owns basic industries. In Canada, for example, the government owns the communications, transportation, and utilities industries, as well as some of the natural resource industries. It also supplies health care to its citizens. But most other activity is carried on by private enterprises, as in a capitalist system.

The application of technology can stimulate growth under capitalism or any other economic system. Technology is the application of science and engineering skills and knowledge to solve production and organizational problems. New machines that improve productivity and reduce costs can be one of a firm’s most valuable assets.

Productivity is the amount of goods and services one worker can produce. Our ability, as a nation, to maintain and build wealth depends in large part on the speed and effectiveness with which we invent and adopt machines that lift productivity.

Certain rights critical to the operation of capitalism are available to citizens living in a private enterprise economy. These include the rights to private property, profits, freedom of choice, and competition.

The right to private property is the most basic freedom under the private enterprise system. Every participant enjoys the right to own, us, buy, sell, and bequeath most forms of property, including land, buildings, machinery, equipment, inventions, and various intangible kinds of property.

Gross domestic product, or GDP, is the total market value of all final goods and services produced within a nation’s boarders in a year. World gross domestic product is the sum of all countries’ GDP.

American goods and services have a reputation for quality around the world. Quality goods and services offer customer value and satisfaction.

Consumer value is the ratio of benefits to the sacrifices necessary to obtain those benefits. Consumers receive value in the form of well-known brand names, durability, design, ease of use, and customer service. To receive these benefits, they give up money, time, and effort.

The Malcolm Bridge National Quality Award, named for a former secretary of commerce, was established by the U.S. congress in 1987 to recognize U.S. companies that offer goods and services of world-class quality. The award also promotes awareness of quality and transfers information about quality to others in the business community.

Competition in the global marketplace now requires more and more companies to meet ISO standards. ISO 9000 (pronounced “ice-o-nine thousand”) is a standard of quality management, hugely popular in Europe, that is rapidly taking hold in the United States and around the globe. The ISO 9000 series was created in the late 1980s by the International Organization for Standardization. The set of five technical standards, known collectively as ISO 9000, was designed to offer a uniform way of determining whether manufacturing plants and service organizations have sound quality procedures. To register, a company must undergo an audit of its manufacturing and customer service processes, covering everything from how it designs, produces, and installs its goods to how it inspects, packages, and markets them.

The latest standards are ISO 14000, which are designed to help ensure clean production processes to reduce growing environmental problems such as global warming, depletion of the ozone layer, and water pollution. To meet ISO 14000 standards, the executive of a firm must commit to (1) continue to improve environmental management, (2) prevent pollution, (3) obey the laws of the particular country and be a good citizen, (4) manage activities with serious consideration of their effect on the environment, and (5) announce to employees and the public the firm’s environmental protection policy. IBM, for example, has met the ISO worldwide.

Demand for all kinds of consumer goods exploded after World War II. Suddenly consumers were buying again. At the same time, however, competition also heated up. Soon businesses began to think of marketing as more than just selling; they envisioned a process of determining what consumers wanted and needed and then designing products to satisfy those needs. In short, they developed a consumer orientation.

Businesses throughout the United States formed marketing research departments to analyze consumer’s desires before beginning actual production. Consumers choice skyrocketed. Today’s automobiles no longer come just in black; instead, car buyers can choose from a wide range of colors.

Businesses also have discovered that they need to distinguish their goods and services from those of competitors. Branding, the process of creating an identity in consumers’ minds for a good, service, or company, is one tool used by marketing oriented companies.

A brand can be a name, term, sign, symbol, design, or some combination of that identifies the products of one firm and differentiates them from competitors’ offerings.

A worldwide network of interconnected computers that, within limits, lets anyone with access to a personal computer send and receive images and data anywhere.

A nation’s economic system is the combination of policies, laws, and choices made by its government to establish the systems that determine what goods and services are produced and how they are allocated. Capitalism and a planned economy, which were discussed earlier, are examples of economic systems.

Economics is the study of how a society uses scarce resources to produce and distribute goods and services. The resources of a person, firm, or a nation are limited. Hence, economics is the study of choices—what people, firms, or nations choose from among the available resources. Every economy is concerned with what types and amounts of goods and services should be produced, how they should be produced, and for whom. These decisions are made by the marketplace, the government, or both. In the United States the government and the free market system together guide the economy.

Economics has two main sub areas. Macroeconomics is the study of the economy as a whole. It looks at aggregate data, data for large groups of people, companies, or products considered as a whole.

In contrast, microeconomics focuses on individual parts of the economy, such as households or firms.

Both macro and micro economics offer a valuable outlook on the economy. For example, Ford might use both to decide whether to introduce a new line of cars, like the Smart Car from Europe.

The company would consider such macroeconomic factors as the national level of personal income, the unemployment rate, interest rates, fuel costs, and the national level of sales of imported cars. From a microeconomic viewpoint, Ford would judge consumer demand for new cars verses the existing supply, competing models, labor and material costs and availability, and current prices and sales incentives.

Another way to see how the sectors of the economy interact is to examine the circular flow of inputs and outputs among households, businesses, and governments. Let’s review the exchanges by following the purple circle around the inside of the diagram. Households provide inputs (natural resources, labor, capital, entrepreneurship) to businesses, which convert these inputs into outputs (goods and services) for consumers. In return, consumers receive income from rent, wages, interest, and ownership profits (green circle). Businesses receive income from consumer purchases of goods and services.

The other important exchange in Exhibit 2-1 takes place between governments (federal, state, and local) and both individuals and businesses. Governments supply many types of publicly provided goods and services (highways, schools, police, courts, health services, unemployment insurance, Social Security) that benefit individuals and businesses. Government purchases from businesses also contribute to the business profits. The contractor who repairs a local stretch of highway, for example, is paid by government for the work. As the diagram shows, governments receive taxes from individuals and businesses to complete the flow.

Changes in on flow affect the others. If government raises taxes, households have less to spend on goods and services. Lower consumer spending causes businesses to reduce production, and economic activity declines; unemployment may rise. In contrast, cutting taxes can stimulate economic activity. Keep the circular flow in mind as we continue our study of economics.

Perhaps the most important way to judge a nation’s economic health is to look at its production of goods and services. The more the nation produces, the higher its standard of living. An increase in a nation’s output of goods and services is economic growth.

As we saw in Chapter 1, the most basic measure of economic growth is the gross domestic product (GDP). GDP is the total market value of final goods and services produced within a nation’s boarders each year. It is reported quarterly and is used to compare trends in national output. When GDP rises, the economy is growing.

The rate of growth in real GDP (GDP adjusted for inflation) is also important. Recently, the U.S. economy has been growing at about 3 to 4 percent annually. This growth rate has meant a slow steady increase in output of goods and services and low unemployment. When the growth rate slides toward zero, the economy will begin to stagnate and perhaps decline.

The level of economic activity is constantly changing. These upward and downward changes are called business cycles. Business cycles vary in length, in how high or low the economy moves, and in how much the economy is affected. Changes in GDP trace the patterns as economic activity expands and contracts. An increase in business activity results in rising output, income, employment, and prices. Eventually, these all peak, and output, income, and employment decline.

A decline in GDP that lasts for two consecutive quarters (each a three-month period) is called a recession. It is followed by a recovery period when economic activity once again increases. The most recent recession began in 1990 and ended in March 1991. Since that time the United States has enjoyed a long period of steady growth and prosperity. (oh really?)

The housing industry is a leading economic indicator. A rise in new home construction typically translates into a robust economy.

Another macroeconomic goal is full employment, or having jobs for all who want to and can work. Full employment doesn’t actually mean 100 percent employment. Some people choose not to work for personal reasons (attending school, raising children) or are temporarily unemployed while they wait to start a new job. Thus, the government defines full employment as the situation when about 94 to 95 percent of those available to work actually have jobs. During the early 2000s, the economy operated at close to full employment.

To determine how close we are to full employment, the government measures the unemployment rate. This rate indicates the percentage of the total work labor force that is not working but is actively looking for work. It excludes “discouraged workers,” those not seeking jobs because they think no one will hire them. Each month the Department of Labor releases statistics on employment. These figures help us to understand how well the economy is doing. In the past two decades, unemployment rose as high as 9.7 percent in 1982, which was a recession year. It then declined steadily through the remainder of the 1980s and most of the 1990s. In 2000, the rate fell to under 4 percent, which was the lowest rate in almost 30 years.

Economists classify unemployment into four types: frictional, structural, cyclical, and seasonal. The categories are of small consolidation to someone who is unemployed, but they help economists understand the problem of unemployment in our economy.

Frictional unemployment is short-term unemployment that is not related to the business cycle. It includes people who are unemployed while waiting to start a better job, those who are reentering the job market, and those entering for the first time such as new college graduates. This type of unemployment is always present and has little impact on the economy.

Structural unemployment is also unrelated to the business cycle but is involuntary. It is caused by a mismatch between available jobs and the skills of available workers in an industry or region. For example, if the birthrate declines, fewer teachers will be needed. Or the available workers in an area may lack the skills that employers want. Retraining and skill-building programs are often required to reduce structural unemployment.

Cyclical unemployment, as the name implies, occurs when a downturn in the business cycle reduces the demand for labor throughout the economy. In a long recession, cyclical unemployment is widespread, and even people with good job skills can’t find jobs. The government can partly counteract cyclical unemployment with programs that boost the economy.

In the past, cyclical unemployment affected mainly less skilled workers and those in heavy manufacturing. Typically, they would be rehired when economic growth increased. During the 1990s, however, competition forced many American companies to downsize so they could survive in the global marketplace. Motorola cut 15,000 jobs, or 10 percent of its workforce, to lower costs so that it could complete with Asian, European, and other U.S. semiconductor and telecommunications firms.

The last type is seasonal unemployment, which occurs during specific seasons in certain industries. Employees subject to seasonal unemployment include retail workers hired for the Christmas buying season, lettuce pickers in California, and restaurant employees in Aspen during the summer.

The third macroeconomic goal is to keep overall prices for goods and services fairly steady. The situation in which the average of all prices of goods and services is rising is called inflation.

Inflation’s higher prices reduce purchasing power, the value of what money can buy. If prices go up but income doesn’t rise or rises at a slower rate, a given amount of income buys less. For example, if the price of a basket of groceries rises from $30 to $40 but your salary remains the same, you can buy only 75 percent as many groceries ($30 ¸ $40). Your purchasing power declines by 25 percent ($10 ¸ $40).

Inflation affects both personal and business decisions. When prices are rising, people tend to spend more—before their purchasing power declines further. Businesses that expect inflation often increase their supplies, and people often speed up planned purchases of cars and major appliances.

During the early 2000s and 1990s, inflation in the United States was in the 2 to 4 percent range. This level is generally viewed as quite low. In the 1980s we had periods of inflation in the 12 to 13 percent range. Some nations have had triple-digit inflation or even higher in recent years. In the late 1990s, Bulgaria had an annual rate of inflation of 123 percent; Turkmenistan, 992 percent; and Angola, 4,145 percent!

Demand-pull inflation occurs when the demand for goods and services is greater than the supply. Would-be buyers have more money to spend than the amount needed to buy available goods and services. Their demand, which exceeds supply, tends to pull prices up. This situation is sometimes described as “too much money chasing too few goods and services.” The higher prices lead to greater supply, eventually creating a balance between demand and supply.

Cost-push inflation is triggered by increases in production costs, such as expenses for materials and wages. These increases push up the prices of final goods and services. Wage increases are a major cause of cost-push inflation, creating a “wage-price spiral.” For example, assume the United Auto Workers union negotiates a three-year labor agreement that raises wages 3 percent per year and increases overtime pay. Car makers will then raise car prices to cover for their higher labor costs. Also, the higher wages will give auto workers more money to buy goods and services, and this increased demand may pull up other prices. Workers in other industries will demand higher wages to keep up with the increased prices, and the cycle will push prices even higher.

The rate of inflation is most commonly measured by looking at changes in the consumer price index (CPI), an index of the prices of a “market basket” of goods and services purchased by typical urban consumers. It is published monthly by the Department of labor. Major components of the CPI, which are weighted by importance, are food, clothing, transportation, housing, health, and recreation. Data are collected from about 23,000 retail and service businesses in 87 areas around the country.

The CPI sets prices in a base period at 100. The base period, which is now 1982-1984, is chosen for its price stability. Current prices are then expressed as a percentage of prices in the base period. A rise in CPI means prices are increasing. For example, the CPI was 172.6 percent in July 2000, meaning that prices had increased 72.6 percent from the 1982-1984 base period.

Changes in wholesale prices are another important indicator of inflation. The producer price index (PPI) measures the prices paid by producers and wholesalers for such commodities as raw materials, partially finished goods, and finished products. The PPI is actually a family of indexes for many different product categories. For example, the PPI for finished goods was 134.7 in June 2000. Examples of other PPI indexes include containers, fuels, and lubricants, and construction. Because the PPI measures prices paid by producers for raw materials, energy, and other commodities, it may foreshadow subsequent price changes for businesses and consumers.

Inflation has several negative effects on people and businesses. For one thing, inflation penalizes people who live on fixed incomes. Let’s say that a couple receives $1,000 a month retirement income beginning in 2002. If inflation is 10 percent in 2003, then the couple can buy only 90 percent of what they could purchase in 2002. Similarly, inflation hurts savers. As prices rise, then the real value, or purchasing power, of a nest egg of savings deteriorates.

Monetary policy refers to a government’s programs for controlling the amount of money circulating in the economy and interest rates. Changes in the money supply affect both the level of economic activity and the rate of inflation.

The Federal Reserve System (the Fed), the central banking system, prints money and controls how much of it will be in circulation. The money supply is also controlled by the Fed’s regulation of certain bank activities.

When the Fed increases or decreases the amount of money in circulation, it affects interest rates (the cost of borrowing money and the reward for lending it). The Fed can change the interest rate on money it lends to banks to signal the banking system and financial markets that it has changed its monetary policy. Banks, in turn, may pass along this change to customers and businesses that receive loans from banks. If the cost of borrowing increases, the economy slows because interest rates affect consumer and business decisions to spend or invest. The housing industry, business, and investments react most to changes in interest rates.

As you can see, the Fed can use monetary policy to contract or expand the economy. With contractionary money policy, the Fed restricts, or tightens, the money supply by selling government securities or raising interest rates. The result is slower economic growth and higher unemployment. Thus, contractionary policy reduces spending, and ultimately, lowers inflation.

With expansionary policy, the Fed increases, or loosens, growth in the money supply. An expansionary policy stimulates the economy. Interest rates drop as businesses expand. But increasing the money supply also has a negative side: more spending pushes prices up, increasing the inflation rate.

The other economic tool used by the government is fiscal policy, its program of taxation and spending. By increasing it’s spending or by cutting taxes, the government can stimulate the economy. Look again at Exhibit 2-1. The more government buys from businesses, the greater business revenues and output are. Likewise, if consumers or businesses have to pay less in taxes, they will have moreincome to spend for goods and services. Tax policies in the United States therefore affect business decisions. High corporate taxes can make it harder for U.S. firms to compete with companies in countries with lower taxes. As a result, companies may choose to locate facilities overseas to reduce their tax burden.

…Taxes are, of course, the major source of revenue for our government. Every year the president prepares a budget for the coming year based upon estimated revenues and expenditures. Congress receives the president’s report and recommendations and then, typically, debates and analyzes the proposed budget for several months. The president’s original proposal is always modified in numerous ways. Exhibit 2-3 shows sources of revenue and expenses for the U.S. budget.

While fiscal policy has a major impact on businesses and consumers, continual increases in government spending raise another important issue. When government takes more money from businesses and consumers (the private sector) and uses these funds for increased government spending (the public sector), a phenomenon known as crowding out occurs. Here are three examples of crowding out.

1. The government spends more on public libraries, and individuals by fewer books

3. The government spends more on public transportation, and individuals spend less

If the government spends more for programs (social services, education, defense) than it collects in taxes, the result is a federal budget deficit. To balance the budget, the government can cut its spending, increase taxes, or some combination of the two. When it cannot balance the budget, the government must make up for any shortfalls by borrowing (just like any other business or household).

In 1998, for the first time in a generation, there was a federal budget surplus (revenue exceeded spending) of about $70 billion. This surplus is expected to grow to over $150 billion annually by 2002 [yeah, right…]. When ever the government finds itself with a surplus, Congress begins an often heated debate about what to do with the money. Some members of Congress, for example, want to spend more on social programs or for defense. Others say that this money belongs to the people and should be returned in the form of tax cuts. Another alternative is to reduce the national debt.

Despite the recent federal budget surplus, the U.S. government has run budget deficits for many years. The accumulative total of these past deficits is the national debt, which now amounts to about $5 trillion or about $20,000 for every man, woman, and child in the United States. Interest on the debt is more than $360 billion a year. To cover the deficit, the U.S. government borrows money from people and businesses in the form of Treasury bills, Treasury notes, and Treasury bonds. These are federal IOUs that pay interest to the owners.

One issue is who actually bears the burden of national debt. If only the rich were bondholders, then they alone would receive the interest payments. Depending on how many bonds they held, they could end up receiving more in interest than they paid in taxes. In the meantime, poorer people, who held no bonds, would end up paying taxes that would be transferred to the rich as interest. Under those conditions, the debt would indeed be burdensome to others.

The government is very conscious of this burden effect and has kept a watchful eye on who holds what bonds. For example, it has at times instructed commercial banks to reduce their total debt by divesting some of their bond holdings. That’s also why the Treasury created savings bonds. Because these bonds are issued in relatively small denominations, they allow more people to buy and hold government debt.

Another concern is the effect of the national debt on private investment. If, to sell its bonds, the government raises the interest rate on the bonds it offers, it forces private businesses, which must stay competitive as suppliers of bonds in the market, to raise the rates they offer on their corporate bonds (long-term debt obligations issued by a company). In other words, financing government spending by government debt makes it more costly for private industry to finance its own investment. As a result, government debt may end up crowding out private investment and slowing economic growth in the private sector.

Demand is the quantity of a good or service that people are willing to buy at various prices. The higher the price, the lower the quantity demanded, and visa versa.

Let’s assume you own a store that sells jackets for snowboarders. From past experience you know how many jackets you can sell at different prices. The demand curve in Exhibit 2-4 page 46, depicts this information. The x-axis (horizontal axis) shows the quantity of jackets, and the y-axis (vertical axis) shows the related price of those jackets. For example, at a price of $60, customers will buy (demand) 500 snowboard jackets.

In the graph the demand curve slopes downward and to the right. This means that as the price falls, people will buy more jackets. Some people who were not going to buy a jacket will purchase one at the lower price. Also, some snowboarders who already have a jacket will buy a second one. The graph also shows that if you put a large number of jackets on the market, you will have to reduce the price to sell them.

Demand alone is not enough to explain how the market sets prices. We must also look at supply, the quantity of a good or service that businesses will make available at various prices. The higher the price, the greater the amount a jacket manufacturer is willing to supply, and visa versa.

A graph of the relationship between various prices and the quantities a manufacturer will supply is a supply curve.

We can again plot the quantity of jackets on the x-axis and the price on the y-axis. As Exhibit 2-5, page 47, shows, 900 jackets will be available at a price of $60. Note that the supply curve slopes upward and to the right, the opposite of the demand curve. If snowboarders are willing to pay higher prices, manufacturers of jackets will buy more inputs (Goretex, dye, machinery, labor) and produce more jackets. The quantity supplied will be higher at higher prices, because producers can earn higher profits.

In a stable economy, the number of jackets that snowboarders demand depends on the jacket’s price. Likewise, the number of jackets that suppliers provide depends on the price. But at what price will the consumer demand for jackets match the quantity suppliers will produce?

To answer this question, we need to look at what happens when demand and supply interact. By plotting both the demand curve and the supply curve on the same graph in Exhibit 2-6, page 48, we can see that they cross at a certain quantity and price. At that point, labeled E, the quantity demanded equals the quantity supplied.

This is the point of equilibrium. The equilibrium price is $50; the equilibrium quantity is 700 jackets. At that point there is a balance between the amount consumers will buy and the amount the manufacturers will supply.

Market equilibrium is achieved through a series of quantity and price adjustments that occur automatically. If the price increases to $70, suppliers produce more jackets than consumers are willing to buy, and a surplus results. To sell more jackets, prices will have to fall. Thus, a surplus pushes prices downward until equilibrium is reached. when the price falls to $40, the quantity of jackets demanded rises above the available supply. The resulting shortage forces prices upward until equilibrium is reached at $50.

The number of snowboarder jackets produced and bought at $50 will tend to rest at equilibrium unless there is a shift in either demand or supply. If demand increases, more jackets will be purchased at every prices, and the demand curve shifts to the right (as illustrated by line D₂ in Exhibit 2-7, page 49). If demand decreases, less will be bought at every price, and the demand curve shifts to the left (D₁). When demand decreased, snowboarders bought 500 jackets at $50 instead of 700 jackets. When demand increased, they purchased 800.

A number of things can increase or decrease demand. For example, if snowboarders’ incomes go up, they may decide to buy a second jacket. If incomes fall, a snowboarder who was planning to purchase a jacket may wear an old one instead. Changes in fashion tastes can also influence demand. If snowboarding were suddenly to go out of fashion, demand for jackets would decrease quickly. A change in the price of related products can also influence demand. For example, if the average price of a snowboard rises to $1000, people will quit snowboarding and jacket demand will fall. Another factor that can shift demand is expectations about future prices. If you expect jacket prices to increase significantly in the future, you may decide to go ahead and get one today. If you think prices will fall, you will postpone your purchase. Finally, changes in the number of buyers will affect demand. Snowboarding is a young person’s sport. The number of teenagers will increase in the next few years. Therefore, the demand for snowboarding jackets should increase.

New technology typically lowers the cost of production. For example, North Face, a manufacturer of ski and snowboarding jackets, has just purchased laser-guided pattern-cutting equipment and computer-aided pattern making equipment. Each jacket is now cheaper to produce, resulting in a higher profit per jacket. This becomes an incentive to supply more jackets at every price. If the price of resources such as labor or fabric goes up, North Face will earn a smaller profit on each jacket, and the amount supplied will decrease at every price. The reverse is also true. Changes in the prices of other goods can also effect supply. Let’s say that snow skiing becomes a really hot sport. The number of skiers jumps dramatically and the price of ski jackets soars. North Face can use its machines and fabrics to produce either ski or snowboard jackets. If the company can make more profit from ski jackets, it will produce fewer snowboarding jackets at every price. Also, simply a change in the number of producers will shift the supply curve. If the number of manufacturers increases, more jackets will be placed on the market at every price and vice versa. Taxes can also affect supply. If government decides, for some reason, to tax the manufacturer for every snowboard jacket produced, then profits will fall and fewer jackets will be offered at every price. Exhibit 2-8, page 50 (also below), summarizes the factors that can shift demand and supply curves.

Shift Demand

Factor To the Right if: To the left if:

Buyer’s incomes increase decrease

Buyer’s preferences/tastes increase decrease

Prices of substitute products increase decrease

Expectations about future prices will rise will fall

Number of buyers increase decrease

Shift Supply

Technology lowers costs increases costs

Resource prices fall increase

Changes in prices of other profit of other profit of other

products than can be produced product falls product increases

with same resources

Number of suppliers increases decreases

Taxes lowered increased

One of the characteristics of a free market system is that suppliers have the right to compete with one another. The number of suppliers in a market is called market structure. Economists identify four types of market structures (1) perfect competition, (2) pure monopoly, (3) monopolistic competition, and (4) oligopoly.

A market structure in which a large number of small firms sell similar products, buyers and sellers have good information, and businesses can be easily opened or closed.

A market structure in which a single firm accounts for all industry sales and in which there are barriers to entry.

Factors, such as technological or legal conditions, that prevent new firms from competing equally with a monopoly.

A market structure in which many firms offer products that are close substitutes and in which entry is relatively easy.

A market structure in which a few firms produce most or all of the output and in which large capital requirements or other factors limit the number of firms.

The customer’s perception of the ratio of benefits (functionality, performance, durability, design, ease of use, and serviceability) to the sacrifice (of money, time, and effort) necessary to obtain those benefits.

The practice of building, maintaining, and enhancing interactions with customers and other parties in order to develop long-term satisfaction through mutually beneficial partnerships.

A cooperative agreement between business firms; sometimes called a strategic partnership.

>lg 1 What is economics, and how are the three factors of the economy linked?

areas in economics are macroeconomics and microeconomics, the study of the economy as a whole, and the study of the particular markets, respectively. The individual, business, and government sectors of the economy are linked by a series of two-way flows. The government provides public goods and services for the other two sectors and receives income in the form of taxes. Changes in one flow affect the other sectors.

>lg 2 How do economic growth, full employment, and price stability indicates a

A nation’s economy is growing when the level of business activity, as measured by gross domestic product, is rising. GDP is the total value of all goods and services produced in a year. The goal of full employment is to have a job for all who can and want to work. How well a nation is meeting its employment goals is measured by the unemployment rate. There are four types of unemployment: frictional, structural, cyclical, and seasonal. With price stabilities, the overall prices of goods and services are not moving very much either up or down.

Inflation is the general upward movement of prices. When prices rise, purchasing power falls. The rate of inflation is measured by changes in the consumer price index (CPI) and the producer price index (PPI). There are two main causes of inflation. If the demand for goods and services exceeds the supply, prices will rise. This is called demand-pull inflation. With cost-push inflation, higher production costs, such as expenses for materials and wages, increase the final prices of goods and services.

>lg 4 How does the government use monetary policy and fiscal policy to achieve its

Monetary policy refers to actions by the Federal Reserve System to control the money supply. When the Fed restricts the money supply, interest rates rise, the inflation drops, and economic growth slows. By expanding the money supply, the Fed stimulates economic growth.

The government also uses fiscal policy—changes in levels of taxation and spending—to control the economy. Reducing taxes or increasing spending stimulates the economy; raising taxes or decreasing spending does the opposite. When the government spends more than it receives in tax revenues, it must borrow to finance the deficit. Some economists favor deficit spending as a way to stimulate the economy; other’s worry about our high level of national debt.

>lg 5 What are the basic microeconomic concepts of demand and supply, and how

Demand is the quantity of a good or service that people will buy at a given price. Supply is the quantity of a good or service that firms will make available at a given price. When the price increases, the quantity demanded falls but the quantity supplied rises. A price decrease leads to increased demand but a lower supply. At the point where the quantity demanded equals the quantity supplied, demand and supply are in balance. This equilibrium point is achieved by market adjustments of quantity and price.

Market structure is the number of suppliers in a market. Perfect competition is characterized by a large number of buyers and sellers, very similar products, good market information for both buyers and sellers, and the ease of entry and exit into the market. In a pure monopoly, there is a single seller in a market. In monopolistic competition, many firms sell close substitutes in a market that is fairly easy to enter. In an oligopoly, a few firms produce most or all of the industry’s output. An oligopoly is also difficult to enter and what one firm does will influence others.

One micro trend is that firms are placing more emphasis on delivering value and quality to the consumer. Companies are also establishing short-term relationships with both customers and suppliers. To compete in today’s environment, companies and industries must build a competitive workforce. At the macro level, budding entrepreneurial spirit in former command economies is sparking wealth among individual business owners and fueling the growth of capitalism.

Ownership of Business	Businesses are privately owned with minimal govern- ment ownership or interference	Government owns all or most enterprises	Basic industries such as railroads and utilities are owned by the government. Very high taxation as government redistributes income from successful private businesses and entrepreneurs	Private ownership of land and businesses but government control of some enterprises. The private sector is typically the large
Control of Markets	Complete freedom of trade. No or little government control	Complete government control of markets	Some markets are controlled and some are free. Significant central government planning. State enterprises are managed by bureaucrats. These enterprises are rarely profitable	Some markets such as nuclear energy and the post office are controlled or highly regulated
Worker Incentives	Strong incentive to work and innovate because profits are retained by owners	No incentive to work hard or produce quality products	Private sector incentives the same as capitalism and public sector incentives the same as planned economy	Private sector incentives the same as capitalism. Limited incentives in the public sector
Management of Enterprises	Each enterprise is managed by owners or professional managers with little government interference	Centralized management by the government bureaucracy. Little or no flexibility in decision making at the factory level	Significant government planning and regulation. Bureaucrats run government enterprises.	Private sector management similar to capitalism. Public sector similar to socialism
Forecast for 2020	Continued steady growth	No growth and perhaps disappearance	Stable with probable slight growth	Continued growth