How economic conditions affect businesses
Economics is the study of how society chooses to employ resources to produce goods and
services and distribute them for consumption among various competing groups and
individuals. There are two major branches of economics: macroeconomics looks at the operation
of a nation’s economy as a whole (the whole United States), and microeconomics looks at the ta
of people and organizations in markets for particular products or services. Macroeconomic
topics in this chapter include gross domestic product (GDP), the unemployment rate, and price
In Adam Smith’s view, businesspeople don’t necessarily deliberately set out to help others. They
work primarily for their own prosperity and growth. Yet as people try to improve their own
situation in life, Smith said, their efforts serve as an “invisible hand” that helps the economy
grow and prosper through the production of needed goods, services, and ideas. Thus, the
phrase invisible hand is used to describe the process that turns self-directed gain into social and
economic benefits for all.
Understanding free market capitalism
The economic system that has led to wealth creation in much of the world is known as
capitalism. Under capitalism all or most of the factors of production and distribution—such as
land, factories, railroads, and stores—are owned by individuals.
No country is purely capitalist, however. Often the government gets involved in issues such as
determining minimum wages, setting farm prices, and lending money to some failing
businesses—as it does in the United States. But capitalism is the foundation of the U.S. economic
system, and of the economies of England, Australia, Canada, and most other industrialized
The right to own private property, the right to own a business and keep all of its profits, the right
to freedom of competition, the right to freedom of choice
A free market is one in which decisions about what and how much to produce are made by the
market—by buyers and sellers negotiating prices for goods and services. You and I and other
consumers send signals to tell producers what to make, how many, in what color, and so on. We
do that by choosing to buy (or not to buy) certain products and services.
Supply refers to the quantities of products manufacturers or owners are willing to sell at
different prices at a specific time. Generally speaking, the amount supplied will increase as the
price increases, because sellers can make more money with a higher price.
Economists show this relationship between quantity supplied and price on a graph. Figure
2.1 shows a simple supply curve for T-shirts. The price of the shirts in dollars is shown vertically
on the left of the graph. The quantity of shirts sellers are willing to supply is shown horizontally
at the bottom of the graph. The various points on the curve indicate how many T-shirts sellers
would provide at different prices. For example, at a price of $5 a shirt, a T-shirt vendor would
provide only 5 shirts, but at $50 a shirt the vendor would supply 50 shirts. The supply curve
indicates the relationship between the price and the quantity supplied. All things being equal, the
higher the price, the more the vendor will be willing to supply. Demand refers to the quantity of products that people are willing to buy at different
prices at a specific time. Generally speaking, the quantity demanded will increase as the
price decreases. Again, we can show the relationship between price and quantity
demanded in a graph. Figure 2.2 shows a simple demand curve for T-shirts. The various
points on the graph indicate the quantity demanded at various prices. For example, at
$45, buyers demand just 5 shirts, but at $5, the quantity demanded would increase to 35
shirts. All things being equal, the lower the price, the more buyers are willing to buy.
You might realize from Figures 2.1 and 2.2 that the key factor in determining the quantities
supplied and demanded is price. If you were to lay the two graphs one on top of the other, the
supply curve and the demand curve would cross where quantity demanded and quantity
supplied are equal.Figure 2.3 illustrates that point. At a price of $15, the quantity of T-shirts
demanded and the quantity supplied are equal (25 shirts). That crossing point is known as
the equilibrium point or equilibrium price. In the long run, that price will become the market
price. Market price, then, is determined by supply and demand. It is the price toward which the
market will trend.
Economists generally agree there are four different degrees of competition: (1) perfect
competition, (2) monopolistic competition, (3) oligopoly, and (4) monopoly.
Perfect competition exists when there are many sellers in a market and none is large enough to
dictate the price of a product. Sellers’ products appear to be identical, such as agricultural
products like apples, corn, and potatoes. There are no true examples of perfect competition.
Today, government price supports and drastic reductions in the number of farms make it hard
to argue that even farming represents perfect competition.
Under monopolistic competition a large number of sellers produce very similar products that
buyers nevertheless perceive as different, such as hot dogs, sodas, personal computers, and T-
shirts. Product differentiation—the attempt to make buyers think similar products are different
in some way—is a key to success. Think about what that means. Through advertising, branding,
and packaging, sellers try to convince buyers that their products are different from competitors’,
though they may be very similar or even interchangeable. The fast-food industry, with its pricing
battles among hamburger offerings and the like, offers a good example of monopolistic
An oligopoly is a degree of competition in which just a few sellers dominate a market, as we see
in tobacco, gasoline, automobiles, aluminum, and aircraft. One reason some industries remain
in the hands of a few sellers is that the initial investment required to enter the business often is
tremendous. Think, for example, of how much it would cost to start a new airplane
manufacturing facility. In an oligopoly, products from different companies tend to be priced
about the same. The reason is simple: Intense price competition would lower profits for
everyone, since a price cut by one producer would most likely be matched by the others. As in
monopolistic competition, product differentiation, rather than price, is usually the major factor
in market success in an oligopoly. Note, for example, that most cereals are priced about the
same, as are soft drinks. Thus, advertising is a major factor determining which of the few
available brands consumers buy, because often it is advertising that creates the perceived
differences. A monopoly occurs when one seller controls the total supply of a product or service, and sets the
price. In the United States, laws prohibit the creation of monopolies. Nonetheless, the U.S. legal
system has permitted monopolies in the markets for Page 40public utilities that sell natural gas,
water, and electric power. These companies’ prices and profits are usually controlled by public
service commissions to protect the interest of buyers.
Socialism is an economic system based on the premise that some, if not most, basic businesses
(e.g., steel mills, coal mines, and utilities) should be owned by the government so that profits
can be more evenly distributed among the people. Entrepreneurs often own and run smaller
businesses, and individuals are often taxed relatively steeply to pay for social programs.
As a consequence, many of them leave socialist countries for capitalistic countries with lower
taxes, such as the United States. This loss of the best and brightest people to other countries is
called a brain drain
Communism is an economic and political system in which the government makes almost all
economic decisions and owns almost all the major factors of product