Management of the Enterprise
September 27 2011
Chapter 2: How Economic Issues Affect Business
What is Economics?
- Economics 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.
- Factors of Production resources such as land, labour, capital goods, entrepreneurship, and knowledge.
- Businesses may contribute to an economic system by inventing products that greatly increase available
resources such as discovering new energy sources, new ways of growing food.
- 2 major branches of economics:
- Macroeconomics looks at the operation of a nation’s economy as a whole.
- Microeconomics looks at how many jobs exist in the whole economy; examines how many people will be
hired in a particular industry or a particular region of the country.
- Resource Development the study of how to increase resources and to create the conditions that will make
better use of those resources. (example: recycling and oil conservation.)
- Outside of government, businesses may contribute to an aconomic system by inventing products that greatly
increase available resources such as discovering new energy sources (ex. Hydrogen), new ways of growing food
and new ways of creating needed goods and services.
How Economic conditions affect business
- Want to understand the underlying situation and conditions in which Canadian businesses operate, it is essential
Have some grasp of economics
Be aware of the impact of the global environment
Understand the role of the federal and provincial governments in Canada.
- Business firms use labour from other countries, export to and import from other countries, buy land in other
countries for their facilities, and receive money from foreign investors.
- A major part of business success is due to an economic and social climate that allows businesses to operate
Growth Economics and Adam Smith
- Adam Smith was one of the first people to imagine a system for creating wealth and improving the lives of
- He envisioned creating more resources so that everyone could become wealthier.
- An inquiry into the nations and causes of the wealth of nations (his book), was later considered the foundation
of the study and understanding of the newly developing capitalist industrial society. - Believed that freedom was vital to the survival of any economy, especially the freedom to own land or property
and the freedom to keep profits from working the land or owning a business.
- Made the desire for improving one’s condition in life the basis of his theory.
- According to Smith, as long as farmers, labourers, and business people (entrepreneurs) could see economic
rewards for their efforts (i.e receive enough money in the form of profits to support their families), they would
work long hours and work hard.
How Businesses Benefit the Community
- Business people work for their own prosperity and growth according to Adam Smith’s theory.
- Invisible hand a phrase coined by Adam Smith to describe the process that turns self-directed gain into social
and economic benefits for all.
- Example: Farmers in a given area can become wealthy is to sell their crops to other. To become wealthier they
must hire workers to produce more food. Therefore people in that area would have plenty of food available and
some would have jobs on the farms. So the farmers’ self-centered efforts to become wealthy lead to jobs for
some and food for almost all.
Understanding Free-Market Capitalism
- Basing their ideas on free-market principles, such as those of Adam Smith, business people began to create
more wealth than had ever been created before.
- The economic system that has led to wealth creation in much of the world is known as capitalism
- Capitalism an economic system in which all or most of the factors of production and distribution are privately
owned and operated for a profit.
- In capitalist countries, business people decide what to produce, how much to pay workers, how much to charge
for goods and services, where to sell these goods and services, and so on.
How free markets work
- The free market is one in which decisions about what to produce and in what quantities are made by the market
– that is by buyers and sellers negotiating prices for goods and services.
- Free markets work not just from the interaction of buyers and sellers, but also from government signals.
How prices are Determined
- In a free market, prices are not determined by sellers; they are determined by biyers and sellers negotiating in
- Example: A seller may want to receive $50 for a t-shirt, but the quantity demanded at that price may be quite
low. If the seller lowers the price, the quantity demanded is likely to increase. The economic Concept of Supply
- Supply the quality of products that manufacturers or owners are willing to sell at different prices at a specific
- The amount supplied will increase as the price increases because sellers can make more money with a higher
- 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.
The Economic Concept of Demand
- Demand the quantity of products that people are willing to buy at different prices at a specific time.
- The quantity demanded will increase as the price decreases.
- The equilibrium Point and the Market Price
- The key factor in determining the quantity supplied and the quantity demanded is price.
- The crossing point of a demand and supply graph would be where the quantity demanded and the quantity
supplied is equal, known as the equilibrium point or equilibrium price.
- Market price the price determined by supply and demand.
- If surpluses develop (i.e. if quantity supplied exceeds quantity demanded), a signal is sent to sellers to lower the
- If shortages develop (i.e. if quantity supplied is less than quantity demanded), a signal is sent to sellers to
increase the price.
- In countries without a free market, there is no sch mechanism to reveal to businesses (via price) what to
produce and in what amounts, so there are often shortages (not enough products) or surpluses (too many
- When the government interferes in otherwise free markets, such as when it subsidizes farm goods, surpluses
and shortages may also develop.
Competition within Free Markets
- Economists generally agree that 4 different degrees of competition exists:
- Perfect Competition the market solution in which there are many sellers in a market and no seller is large
enough to dictate the price of a product.
o Sellers produce products that appear to be identical.
o Examples: Agricultural products (Apples, corn, potatoes).
- Monopolistic Competition The market situation in which a large number of sellers produce products that are
very similar but that are perceived by buyers as different.
o Product differentiation (the creation of real or perceived product differences) is a key to success.
o Example: fast food industry - Oligopoly A form of competition in which just a few sellers dominate the market.
o Examples: produce products in area of oil and gas, tobacco, automobiles, etc.
o One reason some industries remain in the hands of a few sellers is that the initial investment required to
enter the business is tremendous.
o Prices for products different from different companies tend to be close to the same.
o Product differentiation, rather than price, is usually the major factor in market success.
- Monopoly a market in which there is only one seller for a product or service
o Common in areas such as water, electricity, and telephone services.
Benefits and limitations of Free Markets
- The free market – with its competition and incentives – was a major factor in creating the wealth that
industrialized countries now enjoy.
- Free-market capitalism, more than any other economic system, provides opportunities for poor people to work
their way out of poverty
- Business owners and managers make more money and have more wealth than workers. There is much poverty,
unemployment, and homelessness
- business people are becoming more concerned about social issues and their obligation to return to society some
of what they've earned
- Socialism 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 evenly distributed by the people.
- Examples: steel mills, coal mines, and utilities
- Entrepreneurs often own and run the smaller business but private businesses and individuals are taxed relatively
steeply to pay for social programs.
- Acknowledge that the major benefit of capitalism – wealth creation – but believe that wealth should be more
evenly distributed than occurs in free-market capitalism.
- Major benefit of socialism is supposed to be social equality as income is taken from the wealthier people, in the
form of taxes, and redistributed to the poorer members of the population through various government
- Will create more equality than capitalism, but it takes away some of business people’s incentives to work hard
as their profits will be heavily taxed.
- Karl Max decided that workers should take ownership of businesses and share in the wealth.
o He wrote the Communist Manifesto, outlining the proce