Chapter 2

Business Management: A Malaysian Perspective Oxford University Press Malaysia, 2008
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2 1
CHAPTER TWO
Influence of Economics on Business
BUSINESS MANAGEMENT: A Malaysian Perspective (Second Edition) Oxford Fajar Sdn. Bhd. (008974-T), 2012
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LEARNING OUTCOMES
In this chapter, you will learn to:
Explain the major differences between a free market system and a centrally-planned system.
Discuss why many economies of the world have adopted the mixed economic system. Explain how a free market works. Elaborate on the different types of market structure. Relate the impact of economic growth, unemployment, inflation and globalization on businesses. Define fiscal and monetary policy and explain how they are used by the government to regulate the economy. Analyze and assess the performance of the Malaysian economy from 20002010 by relating it to the key indicators of economic growth.
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INTRODUCTION TO ECONOMICS
Economics as a study of scarcity and choice. Scarcitya situation whereby human

wants/needs are forever greater than the supply of time, goods and resources.
The two branches of economics are

microeconomics and macroeconomics
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FACTORS OF PRODUCTION
Land
Labour
Capital
Entrepreneurship
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ALL ECONOMIES HAVE TO ADDRESS THREE ISSUES
What goods and services to produce? How to produce the goods and services? For whom are these goods and services going to
be produced?
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EARLY ECONOMIC THEORIES
Thomas Malthuss economic theory

Control the population so that people are able to enjoy more goods and services.
Adam Smiths economic theory

Wealth creation among individuals is healthy and it will improve the lives of everyone.
Freedom to accumulate wealth and make profits are vital for the survival of an economy.
BUSINESS MANAGEMENT: A Malaysian Perspective (Second Edition) Oxford Fajar Sdn. Bhd. (008974-T), 2012 All Rights Reserved
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ECONOMIC SYSTEMS
The free market system The centrally-planned system The mixed system
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FREE MARKET SYSTEM
Also referred to as capitalism. A system where all economic decisions are taken
by individual households and firms with no government intervention.
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FREE MARKET SYSTEM (cont.)
Individuals have four basic rights:

1. 2.
To own private property. To own a business and keep all its profits after taxes. Freedom to compete in wealth accumulation and consumption of goods and services.
3.
4.
Freedom of choice on ability to pay.

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FREE MARKET SYSTEM (cont.)
The system recognizes the importance of private

sector to drive economic growth through competition. Customers have the power to determine and influence the types and quantities of goods to be produced.
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SOME LIMITATIONS OF FREE MARKET SYSTEMS
Inequality of income and wealth distribution

A national and global concern
Greed compromises ethics Individuals become materialistic to fulfil selfinterests rather than social interests.
Potential environmental damage
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CENTRALLY-PLANNED SYSTEM
It adopts the ideology of Karl Marx. Government makes almost all economic
decisions and owns all factors of production.
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SOME LIMITATIONS OF CENTRALLY-PLANNED SYSTEMS
Public ownership. Does not promote entrepreneurship. Choices of goods and services are limited.
Reduces individual incentiveBrain Drain.
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MIXED ECONOMIC SYSTEM
A cross-breed between the free-market and

centrally-planned systems.
Many economies of the world have adopted

this system due to limitations of the free market and centrally-planned systems.
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MIXED ECONOMIC SYSTEM (cont.)
The mixed economy promotes freedom of

individual choice and decisions to maximize satisfaction.
However, when markets fail, the government will

intervene.
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FREE MARKETS IN OPERATION
What is a market?
Any arrangement where buyers and sellers interact to determine the quantity and price of goods to be exchanged at a certain period.
What is demand?
The choice making behaviour of consumers.
What is supply?
The choice making behaviour of producers or firms.
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DEMAND AND SUPPLY
The law of demand
when price increases, quantity demanded will reduce, vice versa.
The law of supply
when price increases, quantity supplied will increase, vice versa.
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DEMAND CURVE
Price (P)
D
Quantity (Q)
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SUPPLY CURVE
Price (P)
S
Quantity (Q)
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MARKETS IN OPERATION: EQUILIBRIUM POINT
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TYPES OF MARKET STRUCTURE
Perfect Competition Monopoly Monopolistic Competition Oligopoly
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COMPARISON OF MARKET STRUCTURES
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INTRODUCTION TO MACROECONOMICS
Macroeconomics looks at the economy as a whole

or in aggregates.
There are four key players in the economy:

households, firms, the government and the rest of the world (i.e. international trade).
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THE CIRCULAR FLOW OF INCOME AND EXPENDITURE
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MACROECONOMIC CONCERNS
Economic growth
Inflation Unemployment Globalization
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UNDERSTANDING BASIC MACROECONOMIC CONCEPTS
The business cycle has four phases:

1. 2.
Boom Recession
3.
4.
Depression Recovery
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BUSINESS CYCLE
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KEY ECONOMIC INDICATORS
Gross Domestic Product (GDP) Unemployment Rate Price Indices

Consumer Price Index (CPI) Producer Price Index (PPI)
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KEY ECONOMIC INDICATORS (cont.)
To measure economic growth of a nation, the

following may be used: Gross Domestic Product Gross National Product Gross National Income
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MALAYSIA GDP (%) 20002011

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 8.3 0.3 4.1 5.3 7.1 5.2 5.9 6.2 4.6 -1.7 (negative) 7.2 6.0 (estimated)
Source: http://www.epu.gov.my
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MALAYSIA UNEMPLOYMENT RATE (%) 20002011

2000 3.1 2001 3.6 2002 3.5 2003 3.6 2004 3.5 2005 3.5 2006 3.3 2007 3.3 2008 3.4 2009 3.6 2010 3.3 2011 3.0 (as of Oct 2011) Source: http://www.indexmundi.com/malaysia/unemployment_rate.html
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PRICE INDICES
They are mainly used to measure inflation. The commonly used price indices are Consumer
Price Index (CPI) and Producer Price Index (PPI).
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CONSUMER PRICE INDEX (CPI)
CPI is commonly used to measure the impact of

inflation on households.
This index is based on a standard market basket

of goods and services purchased by a typical urban family, e.g. food, clothing and utilities.
CPI is a weighted average of a number of

component price indexes of the basket of goods and services above.
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CPI FOR MALAYSIA

The basket of goods covers a wide range of goods and services, classified in the following 12 groups:
Food and non-alcoholic beverages Alcoholic beverages and tobacco Clothing and footwear Housing, water, electricity, gas and other fuels
Furnishings, household equipment and routine maintenance

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CPI FOR MALAYSIA (cont.)
Health Transport Communication
Recreation services and culture

Education Restaurants and hotels Miscellaneous goods and services
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MALAYSIA CPI JAN DEC 2007
CPI from JanuaryDecember 2007 increased to

105.7 compared to 103.6 in the same period last year.
The 2% increase was brought about by increases

observed in the main groups of high weights, i.e. food and non-alcoholic beverages (+3%), transport (+2.3%), housing, water, electricity and gas fuels (+1.3%).
Base year: 2005

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MALAYSIA INFLATION RATE (%) 20002011

2000 1.6
2001 1.4 2002 1.8 2003 1.2 2004 3.0 2005 3.0 2006 4.0 2007 3.8 2008 2.0 2009 5.4 2010 2.9 2011 3.2 (as of Nov 2011) Source: Economic Reports, Prime Ministers Department.
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PRODUCER PRICE INDEX (PPI)
PPI measures prices at wholesale level. For example, in the first quarter of 2006, PPI was
170.3 compared to 156.1 in same period last year for Malaysia.
This indicates that wholesale prices have been

increasing over the one year period.
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OTHER ECONOMIC INDICATORS
Per capita income

average income received by an individual person or citizen.
Productivity
the amount of output that can be produced by a worker in an hour.
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MALAYSIA INCOME PER CAPITA (RM)

2000 13,333 2001 12,867 2002 13,722 2003 14,838 2004 16,538 2005 17,741 2006 20,841 2007 22,150 2008 26,043 2009 23,841 2010 26,420 2011 27,747
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HOW DOES THE GOVERNMENT REGULATE AND STABILIZE THE ECONOMY?

The government applies a combination of monetary and fiscal policies. Monetary policy affect aggregate demand by controlling the supply of money through the Central Bank. Fiscal policy affect aggregate demand through government expenditure and taxation.
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MALAYSIA : ECONOMIC PERFORMANCE: 20002010
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MALAYSIA : ECONOMIC PERFORMANCE: 20002010 (cont.)
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Business Management: A Malaysian Perspective Oxford University Press Malaysia, 2008

All Rights Reserved

Influence of Economics on Business

All Rights Reserved

Economics as a study of scarcity and choice. Scarcitya situation whereby human

The two branches of economics are

All Rights Reserved

All Rights Reserved

ALL ECONOMIES HAVE TO ADDRESS THREE ISSUES

All Rights Reserved

EARLY ECONOMIC THEORIES

Thomas Malthuss economic theory

Adam Smiths economic theory

All Rights Reserved

FREE MARKET SYSTEM

All Rights Reserved

FREE MARKET SYSTEM (cont.)

Individuals have four basic rights:

Freedom of choice on ability to pay.

FREE MARKET SYSTEM (cont.)

The system recognizes the importance of private

All Rights Reserved

SOME LIMITATIONS OF FREE MARKET SYSTEMS

Inequality of income and wealth distribution

Potential environmental damage

All Rights Reserved

All Rights Reserved

SOME LIMITATIONS OF CENTRALLY-PLANNED SYSTEMS

All Rights Reserved

MIXED ECONOMIC SYSTEM

A cross-breed between the free-market and

Many economies of the world have adopted

All Rights Reserved

MIXED ECONOMIC SYSTEM (cont.)

The mixed economy promotes freedom of

However, when markets fail, the government will

All Rights Reserved

FREE MARKETS IN OPERATION

DEMAND AND SUPPLY

The law of demand

when price increases, quantity demanded will reduce, vice versa.

The law of supply

when price increases, quantity supplied will increase, vice versa.

All Rights Reserved

MARKETS IN OPERATION: EQUILIBRIUM POINT

All Rights Reserved

TYPES OF MARKET STRUCTURE

Perfect Competition Monopoly Monopolistic Competition Oligopoly

All Rights Reserved

COMPARISON OF MARKET STRUCTURES

All Rights Reserved

Macroeconomics looks at the economy as a whole

There are four key players in the economy:

All Rights Reserved

THE CIRCULAR FLOW OF INCOME AND EXPENDITURE

All Rights Reserved

All Rights Reserved

UNDERSTANDING BASIC MACROECONOMIC CONCEPTS

The business cycle has four phases:

All Rights Reserved

All Rights Reserved

KEY ECONOMIC INDICATORS

Gross Domestic Product (GDP) Unemployment Rate Price Indices