Introduction to Business

Introduction to Business

2nd Edition

H. James Williams, Ph.D., C.P.A., C.M.A., J.D., L.L.M.

Seidman College of Business

Grand Valley State University

Grand Rapids, MI

Marvelle S. Colby, D.P.A.

Selig Alcon, M.B.A.

Contributing Editor

Kipling M. Pirkle, Ph.D.

Williams School of Commerce, Economics, and Politics

Washington and Lee University

Lexington, VA

Contents

Cover

Title Page

Part 1: The Foundations of Business in the Global Economy

Chapter 1 Understanding Basic Economics

Chapter 2 The Role of Government

Chapter 3 Business Law and Ethics

Chapter 4 Business Sustainability: Economic, Environmental, and Social Responsibilities

Chapter 5 The Global Marketplace

Part 2: Business Formation and Structure

Chapter 6 The Legal Forms of Business

Chapter 7 Small Business, Entrepreneurship, and Franchising

Chapter 8 Organizational Structure

Chapter 9 Management Fundamentals

Part 3: Managing Personnel and Production

Chapter 10 Human Resources Management

Chapter 11 Labor-Management Relations

Chapter 12 Producing Goods and Services

Part 4: Marketing Management

Chapter 13 The Marketing Concept

Chapter 14 Product and Pricing Strategies

Chapter 15 Supply Chains, Channels of Distribution, and Logistics

Chapter 16 Promotional Strategy

Part 5: Management Tools

Chapter 17 Management Information and Statistical Analysis

Chapter 18 Accounting and Financial Statements

Part 6: Financial Management

Chapter 19 Money, Banking, and Credit

Chapter 20 Financial Strategies: Short- and Long-Term Financing

Chapter 21 Risk Management and Insurance

Chapter 22 The Securities Markets

Part 7: The Challenge of the Future

Chapter 23 Business Careers

Glossary

Searchable Terms

Copyright

About the Publisher

Part 1: The Foundations of Business in the Global Economy

CHAPTER 1

Understanding Basic Economics

Economics is the study of rational human behavior in trying to meet basic wants and needs. This is especially important because humans live in an environment of limited resources to fulfill those wants and needs. The better you understand economics the better you will be able to satisfy those basic wants and needs. In the final analysis, economics focuses on how individuals and nations make choices, in a world of limited resources, to meet basic wants and needs. Business is one important component of economics.

WHAT IS BUSINESS?

A business is an organized effort of individuals to produce and sell goods and services for a profit. Businesses vary in size, as measured by number of employees or by sales volume. Large companies such as ExxonMobil and General Motors count their employees in the hundred thousands and their sales revenues in the billions. But most (98 percent) of the businesses in the United States are small businesses—independently owned and operated and having fewer than twenty employees. The key people responsible for creating businesses, either as a result of their original ideas or willingness to bear the inherent risks—or both—are called entrepreneurs.

All businesses, whether they employ one person working at home, 100 working in a retail store, 10,000 working in a plant or factory, or 100,000 working in branch offices nationwide, share the same basic definition and are generally organized for the same primary purpose: to earn profits. Profit is the money that remains after the costs of a business (expenses and taxes) are subtracted from the revenue received from the sales of goods and services.

Goods and Services

The source of a business’s revenues and, therefore, of its profits, is its goods and services. Goods are tangible items; that is, products such as automobiles, shoes, iPods, computers, and cellular phones. Services are intangible items, such as the professional advice and assistance provided by lawyers, doctors, electricians, accountants, and hairdressers. Consumers and businesses will buy only those goods and services they need or want. Therefore, to be successful, businesses must provide goods and services that satisfy consumers’ and businesses’ needs and wants. Consumers need shoes and will buy shoes. Consumers may not need expensive high-tech sports shoes, but they may purchase them if they want them. In the same way, businesses need manufacturing and other materials to produce goods and services.. Thus, identifying consumer and business needs and wants are key factors in business success.

Factors of Production

All goods and services are produced from five specific resources: land, labor, capital, information resources, and entrepreneurs. These resources, known as the factors of production, are the basic elements a business uses to produce goods and services.

Land

Land includes not only real estate but the resources associated with land—water, minerals, and timber.

Labor

Labor, sometimes called human resources, refers to the mental and physical skills and abilities of employees. Labor includes all the employees, from top-level executives to truck drivers, who produce and distribute the goods and services a business sells.

Capital

All businesses require capital (money) to operate. Businesses need capital to buy buildings, machinery, and tools, all of which are also considered capital. In addition, they need capital to hire labor, distribute finished products, and so on.

Information Resources

Information resources supply the facts, intelligence, and knowledge needed to manage and operate a business. Because information resources enable managers to control and to effectively use all other resources, its value as a factor of production has increased greatly in recent years. In fact, the era in which we find ourselves is often referred to as the Information Age, emphasizing the importance of information access, processing, and utilization.

Entrepreneurs

Entrepreneurs are the risk-takers who create businesses; the persons who assemble all the other factors of production in an effort to start and operate a business and to make a profit. Entrepreneurs have vision. Recognizing consumers’ needs and wants for certain goods and services, they risk their time and financial resources, gather capital, and apply their information resources to create and manage a business enterprise.

AVAILABILITY OF RESOURCES

Economics is the study of how goods and services are produced, distributed, and consumed. In any society, the resources that are available are limited, and economics is concerned with (1) how one segment of society—that is, businesses—uses those limited resources to create and distribute goods and services; and (2) how the other segment of society—consumers, which includes individuals and other organizations, including other businesses—consume those goods and services.

Economics can be partitioned into two fields: macroeconomics and microeconomics. Macroeconomics addresses the broader, big picture of the behavior of the nation’s economy. Microeconomics has a narrower focus; it studies the behavior of individual organizations or people in particular markets. Business is applied economics. Moreover, because resources are limited, businesses must consider factors related to resource limitations, including scarcity and opportunity cost.

Scarcity

All resources, those related to humans as well as those related to nature, are limited in some ways. Here are several examples: (1) skilled labor may not be plentiful in a particular location; (2) capital is not free; (3) some natural resources, such as timber, are renewable, but others, such as oil, are nonrenewable. The scarcity of resources forces society, including businesses, to make choices.

Opportunity Cost

Opportunity cost is the foregone value of the next best alternative use of a resource. For example, one important opportunity cost of your attending college is the money you could otherwise earn if attending college prevented you from working full-time. You cannot receive the wages or salary (e.g., $12,000) you could earn from the alternative use of selling your services to an employer if you were not in college. Consequently, the total cost of your education is the actual cost (tuition, fees, and room and board), plus the $12,000 opportunity cost. Similarly, if you spend your last $100 dollars on an outfit, you cannot spend that $100 on another desirable product, say a pair of $100 shoes. The opportunity cost of purchasing the outfit is the value (presumed to be at least $100) you would place on owning the pair of shoes. The total cost of purchasing the outfit is, then, $200 ($100 actual purchase price plus the $100 opportunity cost). Note that every decision includes an opportunity cost component, yet few decision-makers explicitly consider the opportunity cost when considering the total cost of a purchase.

A business that purchases, for instance, new production-line equipment instead of hiring additional employees, must consider the opportunity cost (i.e., the value of that alternative use for that particular resource). Consequently, either explicitly or implicitly, opportunity cost shapes every decision.

ECONOMIC SYSTEMS

Every society must answer these three economic questions.

1. What will be produced? What goods and services will be produced, and in what quantity will each be produced?

2. How will these goods and services be produced? Who will produce these goods and services, and which resources will be used to produce them?

3. For whom will these goods and services be produced? Who gets what?

How a society answers these economic questions determines its economic system—that is, its methods for distributing resources to meet the needs of its people. Keep in mind that an economic system includes the production and distribution of goods and services, while a political system, for example, comprises the organization of government, ideology, conduct of public affairs, and the pursuit of national interests.

Three economic systems worth noting are the market economy, the planned economy, and the mixed economy.

In a market economy, individuals control all or most of the factors of production and make all or most of the production decisions. The market economy (capitalism) is also called the free-market or free-enterprise system.

In a planned economy (e.g., a communist system), the government controls all or most of the factors of production and makes all or most production decisions.

In a mixed economy (e.g., a socialist system), as its name suggests, the system shares some of the features of both the market and planned economies.

Most countries do not rigidly follow one economic system but, rather, tend to mix to varying degrees some features of communism, socialism, and capitalism. For example, Britain, France, India, and other free-enterprise societies incorporate a degree of socialism. Most of the remaining communist societies (e.g., China) have incorporated elements of free-enterprise systems into their economies.

Capitalism

Capitalism is a market economy. It relies on free markets, not on government, to determine what, how, and for whom goods and services will be produced. In a market economy, businesses are owned by individuals and are controlled by owners or by managers who are accountable to the owners. The profits flow to the owners and investors. Market economies place a high premium on entrepreneurship. The economy is driven by the profit motive, the desire to maximize profits.

Socialism

In a socialist economy, the government controls key industries such as transportation, communications, banking, utilities, and steel as well as major natural resources. Private ownership of businesses that are not in vital industries is permitted to varying degrees, depending on the country. The government establishes national goals for utilizing the country’s resources. Socialist countries place a high priority on achieving an equitable distribution of income and on providing a high level of social and medical services. The public welfare programs underwritten by socialist countries such as Sweden are financed by high taxes. In the last twenty years many socialist countries have encouraged privatization, which is the selling of government-controlled industries to private investors.

Communism

Communism is both a political and an economic system based on the doctrines of Karl Marx, whose goal was to achieve a more equitable distribution of wealth than that found in capitalist systems. Communist governments control economic decisions through their centralized state planning committees, which set, for example, wages and prices. Communist economic systems emphasize producing capital goods such as machinery rather than consumer goods. Countries that remain communist today include China, North Korea, and Cuba.

ECONOMIC FORCES

A number of forces and conditions interact to determine the price of goods and services in the market. The theory of supply, demand, and equilibrium helps explain the interaction of these forces and their effects on the economy.

Supply

Economists define supply as the amount of output of a good or service that producers are willing and able to make available to the market at a given price at a given time. The law of supply states that producers are willing to produce and offer for sale more goods at a higher price than at a lower price.

Demand

Demand is the willingness of purchasers to buy specific quantities of a good or service at a given price at a given time. The law of demand states that people will buy more of a product at a lower price than at a higher price.

Equilibrium

According to the laws of supply and demand, the lower the price, the more consumers will want to buy, but the less producers will be willing to supply. If the price is so low that producers cannot make a sufficient profit, some suppliers will not produce, and the supply will drop. The satisfaction of both the buyer and the seller will balance at some point called the equilibrium. At the point of equilibrium, demand (the number of units buyers are willing to buy at a given price) equals supply (the number of units the producer is willing to produce at that price). The point of equilibrium, in theory, is the market price.

If the supply is greater than the demand, there is a surplus, and the price will fall. If the supply is less than the demand, there is a shortage, and the price will rise. It is important to note that supply and demand work simultaneously. As the price of a product goes up, suppliers produce more, and at the same time, consumers buy less. As the price goes down, suppliers produce less, and consumers then demand more.

COMPETITION

Competition describes the degree of rivalry among businesses for sales to potential customers. At the same time, it describes the constant effort on the part of a business to operate efficiently so as to keep its costs low, develop new and improved products, and make a profit. The intensity of competition varies from one industry to another. Economists identify four basic degrees of competition: pure competition, monopoly, monopolistic competition, and oligopoly.

Pure Competition

Pure competition describes a situation in which a large number of firms are producing identical, or nearly identical, products. Because consumers consider the product identical from company to company and because both consumers and producers know the price in the marketplace, no one firm has the power to affect the price. As a result, the price is set by supply and demand. In pure competition situations, producers can enter or leave the industry very easily. Except for the fact that it enjoys government price supports, the agricultural industry is a good example of pure competition. Corn from one farm is the same as corn from another farm, and both producers and buyers are aware of the market price.

Monopoly

A company has a pure monopoly when it is the only producer in a market, an industry, or an area. Because of its absolute control, the company can set prices as it wishes and prevent other companies from competing. The company’s only constraint on pricing is how much consumer demand will fall as prices rise. Monopolies are discouraged by law with one exception: utility companies such as water and electric companies enjoy monopolies. However, such natural monopolies, as they are known, are regulated by the government to prevent exploitation of society.

Monopolistic Competition

Monopolistic competition exists when (1) there are many buyers and few sellers, and (2) the sellers’ products appear at least slightly different from those of their competitors. In such situations, product differentiation and brand names give sellers some control over the price. The market for light bulbs is an example of monopolistic competition.

Oligopoly

In an oligopoly, a small number of very large firms has the power to influence the price of the firms’ products. Would-be competitors are restricted from entering the market because doing so requires huge amounts of capital. The automobile, steel, and aircraft manufacturing industries are examples of oligopolies. The actions of one firm in an oligopoly are usually copied by the other firms. For example, when one steel company lowers its prices, the others are usually forced to lower their prices. As another example, when one automobile manufacturer offers a rebate program, the other automakers also offer rebate programs. Because substantial price reductions would adversely affect profits, the competition is usually based on product differentiation.

THE FREE-ENTERPRISE SYSTEM

The American economy thrives on competition. It is based on a system of voluntary association and exchange and is called a free-enterprise or a free-market system. The voluntary nature of association and exchange in the marketplace depends on individuals having the freedom and power to make their own choices, both in what they produce and what they buy.

Basic Freedoms

The free-enterprise system, as its name implies, offers a number of freedoms, including the freedom of choice, the freedom to own property, the freedom to earn a profit, and the freedom to go out of business. Freedom of choice is every individual’s right to choose his or her occupation and place of employment. Freedom to own property permits a business or an individual to buy or sell land, machines, or buildings and to use these assets to generate income. Freedom to earn a profit allows individuals (1) to decide what to make, how to make it, and how to sell it; and (2) to keep the profits that result from their risk-taking. The freedom to go out of business cannot be restricted by the government. If a business cannot make a profit, the government cannot prevent it from declaring bankruptcy. Thus, businesses have free exit from the market. Land and material resources earn rent. Labor earns wages. Capital earns interest. Entrepreneurs earn profits.

Entrepreneurs enjoy a special place in the business world. Although lenders receive interest and stockholders receive dividends, only entrepreneurs receive profits. Profit is the difference between the selling price of a good or service and the cost of producing and marketing that good or service. For example, if all the costs of producing and marketing a toy total $2.50 and the manufacturer sells that toy for $3.15, the profit is $0.65 for each toy. Profits are entrepreneurs’ rewards for their risks, their work, and their investment of time and money—in other words, for their success in creating and operating a business.

THE DEVELOPMENT OF THE AMERICAN ECONOMIC SYSTEM

Originally, America’s economy was agricultural and land-based. Then, as a result of the Industrial Revolution, the American economy began to rely heavily on industry. In recent years, the American economy has changed once again; it is now a service-oriented, information-based economy. The origins of the American economic system help explain these transitions.

The Colonial Era

European kings financed the first settlements in America. Their goal was to harvest the raw materials of this vast new continent abounding with natural resources. But the settlers had goals of their own as well as their own views of how the raw materials around them should be put to use. Because many had fled oppressive governments, settlers resisted control and, instead, sought freedom, liberty, and independence in all things religious and political. The richness of their surroundings offered them great opportunities to achieve their goals.

Colonial Values

Almost all the early settlers lived on farms. Each family member contributed to the struggle for survival and shared in the tasks of obtaining food, shelter, and clothing. Their lifestyles reinforced the belief that hard work, resourcefulness, courage, independence, and self-reliance were the keys to success. These values form the foundation of the American free-enterprise system and still support that structure today.

Bartering

Colonists relied on bartering; that is, exchanging goods and services for others’ goods and services, a system that did not require money. As colonial society expanded, colonial trade increased. Settlers began to open small individual enterprises—sole proprietorships (i.e., businesses owned by one person), and then small partnerships (i.e., businesses owned jointly by two or more persons). By the 1700s, the colonial business world included shipbuilding, fishing, lumber, fur trading, and rum production for export to Britain (with tax and tariff policies heavily favoring Britain). Some entrepreneurial colonists reaped profits from the domestic system. Under this system, entrepreneurs (by definition, enterprising individuals) distributed raw materials to persons who worked in their homes to process the materials into finished goods, which the entrepreneurs then sold at a profit.

Politics and Economics

In 1776, the United States gained its independence. Its political system, developed by the Founding Fathers, was democratic, based on freedom from government oppression, private ownership of resources, and free enterprise. In 1776 in Scotland, Adam Smith published The Wealth of Nations, which set forth his theory of laissez-faire, an economic system that called for private ownership of property, free entry into markets, and an absence of government intervention. Clearly, America’s political system and Smith’s economic system were compatible and complementary, and their merging signaled the beginning of remarkable growth in the American economy.

The Growth of Trade

Beginning around the time of the Revolutionary War, domestic trade grew. Colonists began producing a wider variety of goods for domestic consumption and built roads to transport those goods. At the same time, export trade also flourished. While European countries were at war between 1793 and 1812, neutral America found ready markets for its exports. America’s export trade to Europe thrived until near the end of this period. English and French trade restrictions, embargoes, and finally, America’s war with England in 1812 all contributed to the decline of the export trade to Europe and the resulting emphasis on and growth of domestic trade.

The Industrial Revolution

The Industrial Revolution refers to a series of events and inventions that dramatically changed the way people worked, moved their workplace, improved their work efficiency, and raised their standards of living.

Key Events

The first key event occurred around 1750 in England as a result of Sir Richard Arkwright’s development of a water-powered spinning machine to replace the hand-operated spinning wheel. In the United States, the effects were felt later, early in the nineteenth century, when textile mills began using Arkwright’s invention to spin cotton.

As the new machinery gained in use, the workplace shifted from the home to the textile mills and factories where all the materials, machinery, and workers were assembled. At the same time, the factories began dividing manufacturing procedures into separate tasks, each task assigned to different workers. This division of labor, known as specialization, not only changed the way people worked, but also improved their productivity. Thus, the Industrial Revolution was characterized by these three key changes: (1) the replacement of human labor with newly invented machines (mechanization); (2) a shifting of the workplace from home to factory; and (3) the division of labor into smaller work tasks (specialization).

Many early factories were in New England, where labor, waterpower, and capital were available. The new principles worked so well that they spread from textiles to other products and from New England to other parts of the growing nation. More inventions followed, increasing the mechanization of work. Eli Whitney’s cotton gin, Elias Howe’s sewing machine, and John Deere’s and Cyrus McCormick’s farm machinery all increased the mechanization of work, widened the variety of American products, and contributed to economic expansion.

Economic Expansion

A number of key factors contributed to the growth and success of American industry. The push westward greatly expanded the market for American goods. During the mid-1800s, railroad systems grew dramatically, connecting markets throughout the country as they transported increasing amounts of factory-produced goods. The steam engine further opened river transportation by steamboat. Waves of immigrants provided a continuous source of hard-working, inexpensive labor and at the same time increased the number of consumers of the country’s goods. Also contributing to the expansion were the inventions of Thomas Edison, Alexander Graham Bell, and others, along with the buildup of industrial empires by Andrew Carnegie (steel), John D. Rockefeller (oil), Gail Borden (dairy products), Frederick Weyerhaeuser (lumber), and the railroad barons.

Government Regulation

Until shortly after the Civil War, laissez-faire had consistently been the federal government’s policy toward business. After the Civil War, for the first time the federal government departed from its laissez-faire attitude and enacted antitrust laws to curb the power of the trusts (the groups that controlled vast industrial empires) and to promote a free-market economy. Government regulation of business was born.

During the Great Depression (1929–1939), the government once again regulated economic affairs in an effort to help the nation rebound from a number of problems that affected its economy: bank failures, the stock market crash, business scandals, an extremely severe drought that turned Midwestern states into a dust bowl, and a worldwide economic crisis. As the situation worsened and continued over a longer period, the government and the people felt the need for government intervention.

After Franklin Roosevelt’s election as president in 1932, and under his leadership, Congress enacted a number of laws regulating the securities markets, labor, banking, and business. Economic conditions improved. Then, in 1939, as the country was emerging from the depression, World War II began. In order to control, plan, and organize the war effort, every sector of the economy was subject to government controls.

Deregulation

From the first, reaction to government regulation has never been neutral. There are strong opponents to regulation, especially from the business community, and some presidents have taken steps toward deregulation. In 1977, for example, President Jimmy Carter began the deregulation of the transportation and banking industries. His successor, President Ronald Reagan, greatly accelerated and expanded the deregulation process. More recently, telecommunications and energy transmission have been deregulated. Deregulation has had a number of unintended consequences; for example, the collapse of the savings and loan industry. The debate on regulation versus deregulation continues.

The New Economy

Since the 1970s, the American economy has undergone a number of shocking changes. Smokestack industries—shipbuilding, coal, and steel—declined. Oil crises occurred. Inflation and a series of recessions followed. Foreign-made electronics and automobiles became increasingly competitive with American-made products, in some cases displacing them altogether. At the same time, American scientific and technological power combined to offset these economic shocks. Research in both product development and marketing techniques expanded, and two sectors grew rapidly: the service sector and the information sector.

The Service Sector

Businesses in the service sector do not produce goods; they provide intangible professional assistance, advice, and other forms of help. The service sector covers all the professions (doctors, lawyers, and accountants, for example), restaurants, banks, airlines, retailers, health care, education, and government. A growing number of persons are engaged in producing services rather than goods.

The Information Sector

The information sector is a specialized (and a very fast-growing) part of the service sector. The information sector includes persons employed in the computing and systems development areas. All businesses highly value any information that improves production and distribution and increases efficiency and profitability. Thus the accumulation, manipulation, and dissemination of customer credit histories, financial data, sales statistics, and similar information is essential to business, and these tasks fall to the information sector. The information sector now claims a substantial segment of the labor market.

Globalization

All businesses today, American and others, operate in a global economy. American trade with foreign countries has increased tremendously. American businesses have expanded their trade relations with traditional partners such as the United Kingdom and Japan; at the same time, American trade has spread to new partners, for example, the People’s Republic of China, India, and Eastern European countries. The result is that American companies compete in foreign markets, trade regularly with foreign companies (often with critical foreign supply chains), and, in many instances, operate production facilities in foreign countries. And the reverse is also true: Foreign-based (for example, Japanese, German, and Korean) businesses actively compete in American markets with products such as automobiles, electronic goods, and services.

The growth of foreign markets and competition, most notably those in China and India, is having a tremendous impact on the manner in which companies conduct business all over the globe. In fact, the advent of outsourcing (the contracting out of previously inside activities and services to persons and companies outside the business to realize efficiencies and cost-savings) and off-shoring (the shifting of production to sites outside the United States), which helped place China and India on the economic map, have created quite a debate in the United States and abroad as to whether economic globalization is a good or an evil. Many, however, suggest that globalization is a good thing, and that outsourcing and offshoring are simple manifestations of the economic theory of comparative advantage, which holds that everyone gains when each country specializes in what it does best (i.e., engages in those activities in which it has a comparative advantage over the rest of the world).

ECONOMIC GOALS AND PERFORMANCE

Several performance indicators provide key methods for measuring how well an economy has achieved its goals and how much it has grown.

Economic Goals

Nearly all economic systems share the same goals: stability, full employment, and growth.

Stability

Stability is a condition in which the relationship among money, goods and services, and labor remains relatively constant. A major threat to stability is inflation (especially when it manifests itself in rising prices). Other threats are recession, which decreases employment, income, and production, and depression, which is a severe, prolonged recession characterized by high unemployment.

Full Employment

Full employment, meaning that everyone who wishes to work has a job, is an ideal, but never a reality. Realistically, even in the best of times, some workers will be unemployed for a variety of reasons.

Frictional unemployment describes workers who have left one job but have not yet found another.

Seasonal unemployment includes all seasonal workers who are unemployed due to the seasonality of their work (e.g., those employed in agriculture and other seasonal industries).

Structural unemployment identifies unemployment precipitated by the very makeup of the economy. Demand may be down across the economy for certain goods or services. Similarly, unemployed persons may not possess skills necessary for the existing economy.

Cyclical unemployment includes workers who are temporarily unemployed due to a downturn in business activity.

Thus, the realistic goal is not full employment but minimal unemployment. Indeed, the phrase full employment now implies as much as 5 percent unemployment.

Measuring Growth

Growth is an increase in the amount of goods and services produced by the total economy in a given period, in comparison with another period. With specific measurement tools, businesspeople can evaluate economic performance. Among the most useful economic measurement tools are gross domestic product, productivity rate, the balance of trade, economic growth, inflation or deflation, and federal deficits. These are discussed in the following sections.

Gross Domestic Product

For more than 50 years (approximately 1941 though 1992), gross national product (GNP) was the preferred measure of the country’s economic growth. However, due to economic globalization, goods and services as well as capital, labor, and information, flow much more easily and steadily across borders. As a result, gross domestic product (GDP) has now supplanted GNP as the measure of choice. The difference between the two is significant.

GNP measures the total market value of all goods and services produced by U.S. companies, whether inside or outside the country. GDP, on the other hand, measures the total market value of all goods and services produced in the United States, irrespective of the source.

GDP includes profits earned by foreign companies inside the United States, but excludes profits earned by U.S. companies abroad. Ultimately, then, the focus has turned to the economic activity that occurs within the borders of the United States.

Productivity Rate

The productivity rate measures efficiency by comparing how much is produced with the resources consumed in the process. For example, if Company A uses 2,000 pounds of raw materials to produce a certain product and Company B produces the same product with only 1,850 pounds of raw materials, Company B has a higher productivity rate. Total productivity includes all inputs necessary to produce a certain amount of products: Total productivity = Specified output/Total inputs.

Balance of Trade

Each country exports goods, for which it receives money, and imports goods, for which it pays money. The phrase balance of trade refers to a country’s total exports minus its total imports. A positive balance of trade, or trade surplus, is favorable; it indicates a net flow of money into the country. A negative balance, or trade deficit, is not favorable; it indicates a net flow of money out of the country.

Inflation

Inflation is a rise in the general prices of goods and services. One cause of inflation is the relationship between productivity and wages. Productivity is the output per worker. When workers’ wages increase faster than their productivity, consumers (which include workers) have more money available to buy goods, so the price of goods inches up. The most commonly quoted measurement of inflation is the consumer price index (CPI), which measures the effect of price increases and inflation on the buying power of a typical American household. The producer price index (PPI) measures inflation from the point of view of business wholesalers.

Deflation

Deflation is a general decline in the prices of goods and services. Since the Great Depression, deflation has not been a serious nationwide problem, but at times it has affected specific industries and specific regions. The collapse of oil prices in 1986, for example, had a profound impact on the domestic oil industry and the economy of Texas for a period of time.

Federal Deficits

The federal deficit is the measure of the excess of money spent over money received by the federal government. Federal deficits affect interest rates. The government finances its deficits by borrowing money (i.e., by issuing and selling treasury securities, primarily bonds). The more money the government borrows, the less money is available for businesses. To compete for these reduced funds, businesses must bid higher, raising the cost of credit and compounding the effects of interest rates. Higher rates, in turn, make it more difficult (and more expensive) for businesses to borrow money for new factories or machinery. Thus federal deficits provide an important means of measuring the economy and can affect business activity and productivity. Increasingly, foreign investors, including foreign governments (notably India and China) are purchasing federal government securities. That helps the federal government address its deficits, but raises nationalistic concerns and fears.

This chapter has presented the development of the business environment in the United States and described other economic systems. Basic economic principles, types of businesses, and resource utilization serve as stanchions as we continue to examine the foundations of business.

Selected Readings

Boone, Louis E., and David L. Kurtz. Contemporary Business. 2006.

Ben-Ner, Avner, and Louis G Putterman. Economics, Values, and Organization. 2000.

Chandler, Alfred D., Jr. Strategy and Structure: Chapters in the History of American Industrial Enterprise. 1962.

Freidman, Thomas L., The World is Flat: A Brief History of the Twenty-First Century. 2005.

Heilbroner, Robert L., and Lester C. Thurow. Economics Explained. 1987.

Madison, James, Alexander Hamilton, and John Jay; Isaac Kramnick, editor. The Federalist Papers. 1987.

Marx, Karl. Capital: A Critique of Political Economy, Volume 1. 1977.

Samuelson, Paul A., and William D. Nordhaus. Economics. 1989.

Schumpeter, Joseph A. Capitalism, Socialism, and Democracy. 1983.

Schumpeter, Joseph A. Theory of Economic Development: An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle. 1934.

Silk, Leonard. Economics in Plain English. Simon and Schuster. 1978.

Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. Reproduction of 1776 edition.

Smith, Steven, and Subrata Ghatak. Introduction to Development Economics. 2003.

Sowall, Thomas. Basic Economics: A Citizen’s Guide to the Economy. 2004.

Varian, Hal R., Joseph Farrell, and Carl Shapiro. Economics of Information Technology: An Introduction. 2004.

Test Yourself

1) What are the five factors of production?

2) Yvette can work an extra hour as a security guard and earn $10, or she can leave early and go to a free movie showing. What is the opportunity cost of seeing the movie?

3) What does the law of demand say will happen when demand decreases?

4) What are the four degrees of competition, what characterizes the products of each degree, and how prevalent is the degree in the U.S. economy?

5) Axio Corporation produces high-performance mufflers. What competition does it likely face? Can it set its own price?

6) We tend to think of monopolies as bad for consumers. When do monopolies make sense? Please provide an example.

7) Why will full unemployment never be a reality?

8) How do federal deficits impact business growth? Explain in terms of supply and demand.

Test Yourself Answers

1) Land, labor, capital, information resources, and entrepreneurs.

2) $10. Since the hour could have produced $10 of revenue, which she is giving up to see the movie, the opportunity cost is $10. Therefore, the total cost of going to the movies is $10, even though the movie is free.

3) Price will decrease, and supply will follow.

4) Pure competition reflects many firms producing the same product in a manner that precludes any one firm from affecting the price of the product. A monopoly, on the other hand, occurs