Chapter 1

Understanding the U.S. Business System

Chapter Overview
Businesses are organizations that produce or sell goods or services to make a
profit. Each business must operate in the context of its economic system.
Economic systems differ in terms of who owns or controls the five basic factors
of production: labor, capital, entrepreneurs, physical resources, and information
resources. In planned economies, the government controls all or most factors. In
market economies, individuals and businesses control the factors of production
and engage in free exchange.
he !.". is a market economy, based on the principles of capitalism, and
propelled by the forces of demand and supply. #emand is the willingness and
ability of buyers to purchase a good or service. "upply is the willingness and
ability of suppliers to offer goods and services for sale. $arket e%uilibrium is the
price at which the %uantity demanded and the %uantity supplied is e%ual.
&undamentally, the !.". economy is a private enterprise system, incorporating
four key elements: private property rights, freedom of choice, profits, and
competition. #egrees of competition vary from perfect competition, to
monopolistic competition, to oligopoly, to monopoly.
he basic goals of the !.". economic system are growth and stability.
'erformance indicators include aggregate output, standard of living, gross
domestic product, and productivity. (rowth and stability can be threatened by
inflation and unemployment, which the government influences through fiscal and
monetary policies.
Chapter Objectives
1. #efine the nature of !.". business and identify its main goals.
2. #escribe different types of global economic systems according to the
means by which they control the factors of production through input and
output markets.
3. "how how demand and supply affect resource distribution in the !.".
4. Identify the elements of private enterprise and explain the various degrees
of competition in the !.". economic system.
5. Explain the importance of the economic environment to business and
identify the factors used to evaluate the performance of an economic
system.
)
REFERENCE OU!"NE
*pening +ase: $egawatt ,aundering and *ther Bright Ideas
I. he +oncept of Business and the +oncept of 'rofit
-. +onsumer +hoice and #emand
B. *pportunity and Enterprise
+. .uality of ,ife
II. he !.". Economic "ystem
-. &actors of 'roduction
). ,abor
/. +apital
0. Entrepreneurs
1. 'hysical 2esources
3. Information 2esources
B. ypes of Economic "ystems
). 'lanned Economies
/. $arket Economies
a. Input and *utput $arkets
b. +apitalism
c. $ixed $arket Economies
d. "ocialism
III. he Economics of a $arket "ystem
-. #emand and "upply in a $arket Economy
B. he ,aws of #emand and "upply
). he #emand and "upply "chedule
/. #emand and "upply +urves
0. "urpluses and "hortages
+. 'rivate Enterprise and +ompetition in a $arket Economy
#. #egrees of +ompetition
). 'erfect +ompetition
/. $onopolistic +ompetition
0. *ligopoly
1. $onopoly
I4. !nderstanding Economic 'erformance
-. Economic (rowth
). -ggregate *utput and "tandard of ,iving
/. (ross #omestic 'roduct 5(#'6
0. 'roductivity
B. Economic "tability
+. $anaging the !.". Economy
). &iscal 'olicies
/. $onetary 'olicies
/
!ECURE OU!"NE
". he C#ncept #$ Business and the C#ncept #$ %r#$it &Use
%#wer%#int 1.'.(
- business is an organization that provides goods and services to earn
profits. %r#$its are the difference between a business7 revenues and
expenses.
). C#nsumer Ch#ice and *emand
In a capitalistic system like that of the !nited "tates, consumers
have freedom of choice. In turn, businesses must take into account
consumer demand in their pursuit of profits.
B. Opp#rtunity and Enterprise
!nmet consumer demands provide promising opportunities for
potential business success.
C. +ua,ity #$ !i$e
8ew forms of technology, service businesses, and international
opportunities keep production, consumption, and employment
growing indefinitely, creating a healthy business climate that
contributes directly to our %uality of life.
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"". he U.S. Ec#n#mic System
-n ec#n#mic system is a nation7s system for allocating its resources
among its individual citizens and organizations.
). Fact#rs #$ %r#ducti#n &Use %#wer%#int 1./.(
- basic difference between economic systems is the way in which
they manage their resources, known as $act#rs #$ pr#ducti#n.
1. !ab#r. he human resource element in businesses, ,ab#r
includes the physical and intellectual contributions people
make while engaged in economic production.
0
0. Capita,. he financial resources needed to operate an
enterprise are known as capita,.
1. Entrepreneurs. -n entrepreneur is an individual who
accepts the risks and opportunities entailed by creating
and operating a new business.
'. %hysica, Res#urces. he tangible things that
organizations use to conduct their business are physica,
res#urces.
/. "n$#rmati#n Res#urces. Businesses rely on
in$#rmati#n res#urces, such as market forecasts, the
specialized knowledge of people, and economic data.
B. ypes #$ Ec#n#mic Systems &Use %#wer%#int 1.23 1.43 1.53 1.63
1.17.(
Economic systems vary, depending on how the factors of
production are managed.
1. %,anned Ec#n#mies. hese systems rely on partial or
total government control of the factors of production.
9ith c#mmunism, as currently operating in +uba, 8orth
:orea, and the 'eople7s 2epublic of +hina ; all sources
of production are owned and operated by the government.
0. 8ar9et Ec#n#mies. 'roducers and consumers control
production and allocation decisions through supply and
demand.
a. "nput and Output 8ar9ets. &irms buy
resources from households in an input mar9et<
firms supply goods and services in response to
household demand in an #utput mar9et.
b. Capita,ism. he political basis of a market
economy is capita,ism, which sanctions the
private ownership of the factors of production and
encourages entrepreneurship by offering profits as
incentives.
c. 8i:ed 8ar9et Ec#n#mies. his type of
economy features characteristics of both planned
and market economies< many countries are
moving from planned systems to mixed market
1
systems through privati;ati#n, which involves
the transformation of government=controlled
businesses into privately owned enterprises.
d. S#cia,ism. In this partially planned system, the
government owns and operates selected ma>or
industries.
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""". he Ec#n#mics #$ a 8ar9et System &Use %#wer%#int 1.11.(
$arket systems allow businesses the flexibility to decide what to
produce, how much to produce, and what price to charge< customers
are a driving force in market systems since they decide what to buy
and at what price. #emand and supply are the predominant forces that
guide decisions about what to buy and what to sell.
). *emand and Supp,y in a 8ar9et Ec#n#my
Billions of exchanges take place every day between businesses and
individuals< between businesses< and among individuals,
businesses, and governments. Exchanges conducted in one area
often affect exchanges elsewhere.
B. he !aws #$ *emand and Supp,y &Use %#wer%#int 1.10 <
1.12.(
*emand is the willingness and ability of buyers to purchase a
product< supp,y is the willingness and ability of producers to offer
a good or service for sale. he ,aw #$ demand states that buyers
will purchase more of a product as its price drops< the ,aw #$
supp,y states that producers will offer more of a product for sale as
its price increases.
1. he *emand and Supp,y Schedu,e. he demand and
supp,y schedu,e indicates how much of a product will be
sold at various prices.
0. *emand and Supp,y Curves. - demand curve shows
how many products will be demanded at different prices<
a supp,y curve shows how many products will be
3
supplied at various prices. he point at which the curves
intersect is the e=ui,ibrium price.
1. Surp,uses and Sh#rtages. 9ith a surp,us, the %uantity
supplied exceeds the %uantity demanded< %uantity
demanded exceeds %uantity supplied with a sh#rtage.
C. %rivate Enterprise and C#mpetiti#n in a 8ar9et Ec#n#my
&Use %#wer%#int 1.143 1.15.(
Individuals pursue their own interests with minimal government
restriction in a private enterprise system< such a system re%uires
private property rights, freedom of choice, profits, and
competition. C#mpetiti#n occurs when two or more businesses
vie for the same resources or customers.
*. *egrees #$ C#mpetiti#n &Use %#wer%#int 1.16.(
Economists have identified four degrees of competition in a private
enterprise system.
1. %er$ect C#mpetiti#n. $any small firms exist in an
industry< no single firm is powerful enough to influence
price.
0. 8#n#p#,istic C#mpetiti#n. &ew sellers but many
buyers exist, so buyers focus on numerous differentiation
strategies, such as brand names, design, and advertising.
1. O,ig#p#,y. -n industry has only a handful of sellers<
market entry is difficult because large capital investment
is needed.
'. 8#n#p#,y. -n industry or market has only one producer<
that producer en>oys complete control over price.
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">. Understanding Ec#n#mic %er$#rmance
wo goals of the !.". economic system are ec#n#mic gr#wth and
ec#n#mic stabi,ity.
). Ec#n#mic ?r#wth &Use %#wer%#int 1.073 1.01.(
?
Economic growth can be measured with the following tools:
1. )ggregate Output and Standard #$ !iving. )ggregate
#utput is the total %uantity of goods and services
produced by an economic system during a given period<
an increase in the amount of goods and services that
consumers can purchase with their currency represents an
increase in the standard #$ ,iving.
0. ?r#ss *#mestic %r#duct &?*%(. he ?*% is the total
value of all goods and services produced within a given
period through domestic factors of production< (#' is a
measurement of aggregate output.
1. %r#ductivity. %r#ductivity compares how much a
system produces with the resources needed to produce it<
increases in productivity yield increases in the standard of
living.
a. Ba,ance #$ rade. his represents the difference
between a country7s imports and exports. -
favorable balance results when the value of a
country7s exports is greater than its imports< that is,
more money is flowing into the country as a result
of exporting.
b. Nati#na, *ebt. - country7s nati#na, debt is the
amount of money that is owed to creditors. he
!nited "tates has been spending more money than
what it has taken in, creating a budget deficit.
B. Ec#n#mic Stabi,ity &Use %#wer%#int 1.003 1.013 1.0'.(
Stabi,ity results when the amount of money available in an
economic system and the %uantity of goods and services produced
in it are growing at about the same rate.
1. "n$,ati#n. "n$,ati#n occurs when widespread price
increases plague an economic system< the amount of
money in the economic system exceeds the amount of
actual output. Inflation can be measured by the
c#nsumer price inde: &C%"(, which weighs prices of
typical products purchased by consumers living in urban
areas.
@
0. Unemp,#yment. Unemp,#yment is the level of
>oblessness among people actively seeking work in an
economic system< when unemployment is high, a surplus
of available workers exists. !nemployment is sometimes
a symptom of a recessi#n, when aggregate output
declines, or of a depressi#n, a prolonged and deep
recession.
C. 8anaging the U.S. Ec#n#my &Use %#wer%#int 1.0/.(
1. Fisca, %#,icies. Fisca, p#,icies manage the collection
and spending of revenues< tax increases can function as
fiscal policies.
0. 8#netary %#,icies. 8#netary p#,icies focus on
controlling the size of the nation7s money supply. he
government can influence banks to lend money< it can
also influence the supply of money by manipulating
interest rates.
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)nswers t# +uesti#ns and E:ercises
+uesti#ns $#r Review
1. @hat are the $ive $act#rs #$ pr#ducti#nA "s #ne $act#r m#re imp#rtant
than the #thersA "$ s#3 which #neA @hyA
he five factors of production are labor, capital, entrepreneurs, physical
resources, and information resources. -ll five factors are crucial.
Aowever, their relative importance depends on the product and the
industry. In the software development business, for example, skilled labor
and information resources are especially important, but the business could
not survive without capital and physical resources, and it would not have
been launched without an entrepreneur.
0. @hat is a demand curveA ) supp,y curveA @hat is the term $#r the
p#int at which they intersectA
- demand curve shows how many products will be purchased at different
prices. - supply curve shows how many products will be offered for sale
at different prices. #emand increases as price decreases< whereas, supply
B
increases as price increases. 9hen both curves are plotted on the same
graph, the point at which they intersect is the e%uilibrium price< this is the
price at which the %uantity of goods demanded and the %uantity of goods
supplied are e%ual.
1. @hat is ?*%A Rea, ?*%A @hat d#es each measureA
(#' is gross domestic product, and it measures the total value of all
goods and services produced in a year by a nation7s economy through
domestic factors of production. 2eal (#' is (#' ad>usted for inflation.
Both measure annual performance of a given economy.
'. @hy is in$,ati#n b#th g##d and badA B#w d#es the g#vernment try t#
c#ntr#, itA
Inflation is both good and bad because it can lead to a spiral of rising
wages chasing rising prices, which decreases the standard of living. It is
good because at moderate levels, it can signal the beginning of a period of
growth for the economy. $onetary policy, particularly the ability to ad>ust
interest rates, is government7s most powerful tool to control inflation.
+uesti#ns $#r )na,ysis
/. "n recent years3 many c#untries have m#ved $r#m p,anned ec#n#mies
t# mar9et ec#n#mies. @hy d# y#u thin9 this has #ccurredA Can y#u
envisi#n a situati#n that w#u,d cause a resurgence #$ p,anned
ec#n#miesA
he failure of communism ; both politically and economically ; has led to
an increase in the number of mixed and market economies. -nswers will
vary as to what would cause a resurgence of planned economies, but the
factors might include a failure of capitalism to effectively distribute
society7s resources, or an unbearable level of crime and corruption.
2. Cite an instance in which a surp,us #$ a pr#duct ,ed t# decreased
prices. Cite an instance in which a sh#rtage ,ed t# increased prices.
@hat eventua,,y happened in each caseA @hyA
-nswers will vary. Aowever, the recent 'okemon craze provides a good
example of a shortage followed by a surplus. - few years ago, 'okemon
trading cards were big up to astronomical levels, often )C=/C times the list
price. 8ow, 'okemon cards and other products are selling for less than
half price as stores attempt to clear out their excess inventory. In fact, any
clearance sale illustrates the concept of surplus driving down prices. he
classic example of a shortage driving prices up was the oil shortage of the
)D@Cs. -nother example is scalpers selling concert tickets at inflated
D
prices. In all of these cases, the market eventually determines a price at
which all the supply can be sold.
4. E:p,ain h#w current ec#n#mic indicat#rs such as in$,ati#n and
unemp,#yment a$$ect y#u pers#na,,y. E:p,ain h#w they wi,, a$$ect y#u
as a manager.
-nswers will vary, but all students should obviously include prices paid
for consumer goods and the availability of desirable >obs. $anagers are
affected by inflation because it tends to drive up the wages they must pay,
and by unemployment because it affects their ability to find workers.
-lso, both inflation and unemployment affect consumer and industrial
demand, which play a key role in management.
5. )t $irst g,ance3 it might seem as th#ugh the g#a,s #$ ec#n#mic gr#wth
and stabi,ity are inc#nsistent with #ne an#ther. B#w can y#u rec#nci,e
this apparent inc#nsistencyA
- nation7s economic growth can be measured through its aggregate output,
resulting standard of living, gross domestic product, and productivity.
Each of these elements can directly impact each other. Economic stability,
on the other hand, refers to the condition in which the amount of money
available in an economic system and the %uantity of goods and services
produced in it are growing at the same rate.
)pp,icati#n E:ercises
6. >isit a ,#ca, sh#pping ma,, #r sh#pping area. !ist each st#re that y#u
see and determine what degree #$ c#mpetiti#n it $aces in the
immediate envir#nment. F#r e:amp,e3 i$ there is #n,y #ne st#re in the
ma,, that se,,s sh#es3 that st#re represents a m#n#p#,y. N#te the
businesses with direct c#mpetit#rs &e.g. tw# jewe,ry st#res( and
describe h#w they c#mpete with #ne an#ther.
-nswers will vary. "tudents should focus on the criteria for competition
discussed in the chapter.
17. "nterview a business #wner #r seni#r manager. )s9 this individua, t#
describe $#r y#u the $#,,#wing things- &1( what business $uncti#ns3 i$
any3 he #r she #uts#urcesC &0( whether #r n#t he #r she is $#cusing
m#re attenti#n #n business pr#cess managementC and &1( h#w the
events #$ September 113 07713 have a$$ected his #r her w#r9.
"tudents7 answers will vary. "tudents will learn that operations for
customized products are less likely to be outsourced than those of
standardized products. In addition, the effects of "eptember )) on
)C
businesses geographically distant from 8ew Eork may have been more
directly felt by their customers or suppliers nearer to 8ew Eork, though
businesses across the country and around the world felt the economic
repercussions of the event.
)nswers t# E:ercising D#ur Ethics
1. @hat are the r#,es #$ supp,y3 demand3 and c#mpetiti#n in this
scenari#A
"ince prescription drugs are essentially the same regardless of the supplier,
the market has determined an e%uilibrium price at which supply and
demand are e%ual. +ompetition keeps the price in check. *ne or the other
of the pharmacies could raise its prices only if it offered additional
services that differentiated its products enough that consumers were
willing to pay extra. Aowever, the owner of the competing pharmacy
needs to keep in mind that if he raises prices too high, other suppliers will
find a way into the market.
0. @hat are the under,ying ethica, issuesA
he success of our economic system is based on competition and choice.
By engaging in collusion the pharmacy owners are inhibiting the fair
operation of the market. his is especially ugly, given that for many
people prescription drugs are crucial to achieving or maintaining health.
By colluding, the pharmacy owners would be forcing the weakest
residents of the town to pay exorbitant prices, at least in the short term.
1. @hat w#u,d y#u d# i$ y#u were actua,,y $aced with this situati#nA
-nswers will vary, but students should at least acknowledge the ethical
issues.
)nswers t# Bui,ding D#ur Business S9i,,s
1. *iscuss the r#,e that vari#us inducements #ther than price might p,ay
in a$$ecting demand and supp,y in this mar9et.
"uppliers who provide extras such as email, web pages, chat rooms,
instant messaging, news, weather, travel directions, shopping networks,
etc. will be able to pump up demand. In order to provide these additional
services, suppliers will need to invest in the necessary technology,
e%uipment, and staff. hey would do well to focus their spending on those
extras that would create loyalty, making it more difficult for consumers to
change services based on price alone.
))
0. "s it a,ways in a c#mpanyEs best interest t# $eature the ,#west pricesA
8o, not when competition is based on speed of delivery, %uality of goods
or services, wide selection, personalized service, premium image, or some
other non=monetary factor.
1. Eventua,,y3 what $#rm #$ c#mpetiti#n is ,i9e,y t# characteri;e this
mar9etA
It may be difficult to speculate. "tudents7 answers will vary.
C,assr##m )ctivities
). -sk each student to identify three or four businesses in his or her
community. hen ask each student to identify the degree of competition,
as discussed in class, which is associated with each business. "tudents
should also identify the number of immediate competitors, the ease of
entry into the market, the similarity of goods and services offered by each
business, and the level of control each business has over price.
/. $any mixed andFor planned economies have adopted elements of
capitalism in recent years. -sk students to research one such country and
discuss the changing focus on the elements of private enterprise ; private
property rights, freedom of choice, profits, and competition ; after the
transition in the country. Aungary, 'oland, the former "oviet !nion, and
the +zech 2epublic are a few suggestions to consider.
)/