W3 Economic and Global Conditions Compressed

Part I: Organization of a Business
Assessing Economic Conditions 1
Introduction to Business 3e
Jeff Madura
Copyright © South-Western. All rights reserved.
Business Environment
Copyright © South-Western. All rights reserved. 4–2

Learning Goals
• Identify macroeconomic factors that
affect business performance.
• Explain how market prices are
determined.
• Explain how the government influences
economic conditions.

Assessing Economic Conditions

Economic Conditions
• Reflect the level of production and
consumption for a particular country,
area, or industry
– Macroeconomic conditions
Ø Overall economic state of a country
– Microeconomic conditions
Ø Focus on conditions in a particular business or
industry

Impact of Economic Conditions
• Economic conditions can affect:
– Revenues of a business
– Expenses of a business
– Total value of a business
4–6
Impact of Economic Conditions
• Some firms are more sensitive to
changes in economic conditions than
others:
– Demand for fast food demand is not very
sensitive to declining economic conditions.
– Demand for new automobiles is more
sensitive to weak economic conditions than
food products.
4–7
Harley Davidson Example
• Demand for motorcycles is stronger
when:
– The economy is strong.
– Customers have more income to buy
motorcycles.
• High demand for Harley Davidson’s
motorcycles:
– Generates greater revenue.
– Improves company performance.
4–8
• Demand for motorcycles is weaker when:
– The economy is weak.
– Customers have less income to buy
motorcycles.
• Lower demand for Harley Davidson’s
motorcycles:
– Generates less revenue.
– Weakens company performance.
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• Harley Davidson tries to predict demand
so it will have a sufficient supply of
motorcycles to meet future demand.
– Demand for motorcycles depends on
– Number of motorcycles produced also
depends on economic conditions.
• Government policies also affect economic
conditions.
• Harley Davidson must determine:
– How prevailing economic conditions will
affect the demand for the motorcycles it
produces.
– How prevailing government policies will
affect the demand for its motorcycles.

Macroeconomic Effects
• The performance of most firms depends
on three macroeconomic factors:
– Economic growth
Ø Changes in the general level of economic activity
– Inflation
Ø Increases in general level of prices over specific
period of time
– Interest rates
Ø Changes in the cost of borrowed money

Economic Growth
• When the change in the general level of
economic activity is higher than normal:
– Total income level of all U.S. workers is
relatively high.
– There is a higher volume of spending on
products and services.
– Firms that sell products and services should
generate higher revenues.

Recession
• Occurs when economic growth is
negative for two consecutive quarters
• Lowers demand for products and services
– Reduces the revenue of firms that sell
products and services.
– Can cause firms to shut down factories in
response to low economic growth.
Ø General Motors
Ø Ford

Indicators of Economic Growth
• Gross Domestic Product (GDP)
– The level of total production of products and
services in the economy
– Total market value of all final products and
services produced in the U.S.
• Aggregate Expenditures
– Total amount of expenditures

Trend of INDONESIA Gross Domestic Product (GDP)

Exhibit 4.1
Indicators of Economic Growth
• In the U.S., these indicators are closely
related:
– High level of consumer spending reflects a
large demand for products and services.
– Total production level depends on total
demand for products and services.

Alternative Indicators
of Economic Growth
• Unemployment level
• Industrial production level
• New housing starts
• Personal income level

Unemployment Levels
• Frictional • Cyclical
unemployment unemployment
– People who are – People unemployed
between jobs. due to poor economic
• Seasonal conditions.
unemployment – Best indicator of
– People whose
services are not • Structural
needed during some unemployment
seasons. – People who do not
have adequate skills.
Inflation
• An increase in the general level of prices
of products and services over a specified
period of time.
– Estimated by measuring percentage
changes in the consumer price index (CPI).
– CPI is a market basket of prices on a wide
variety of consumer products:
Ø Grocery products, housing, gasoline, medical
services, electricity, etc.

Impact of Inflation
• Can affect a company’s operating
expenses
– Can increase cost of supplies and materials.
– Can impact indexed wages (labor cost).
– Higher inflation can cause large increases in
operating expenses.
• Can affect a company’s revenues
– Companies may charge higher prices to
compensate for their higher expenses.
Cost-Push Inflation
• Occurs when firms must charge higher
prices because their production (input)
costs are higher.
– Change in price of oil impacts gasoline
prices and transportation costs.
– Change in aluminum prices impacts
packaging cost of beer production.
– Change in pulp prices impacts the cost of
paper towel production.

Demand-Pull Inflation
• Occurs when product and services prices
are pulled up by consumer demand.
– Strong consumer demand can cause
shortages in the production of products.
Ø Firms that anticipate shortages may increase prices
for their products.
– Strong consumer demand may put pressure
on wages and reduce unemployment.
Ø Firms may increase prices to recover higher
operating expenses.

Interest Rates
• Represent the cost of borrowing money
– Firm’s interest expense is based on market
interest rates and can have significant
impact on a firm’s profitability.
Ø Firms may postpone expansion and other projects
when interest rates are too high.
– Interest rates also impact a firm’s revenue
Ø The increased cost of financing new homes reduces
demand for new homes.
Ø Revenues for construction firms and equipment
manufacturers also decline.

How Macroeconomic Factors
Affect a Firm’s Profits

Exhibit 4.5
Market Price Determination
• Market price of a product is influenced
by:
– The total demand for that product by all
customers
– Supply of that product produced by firms
• The interaction between demand and
supply determines the market price.

Demand and Supply
• Demand schedule
– Indicates the quantity of the product that
would be demanded by customers at each
possible price.
– Quantity demanded is higher when the price
is lower.

How the Equilibrium Price is
Determined by Supply and Demand

Exhibit 4.6a
Determined by Supply and Demand

Exhibit 4.6b
Demand and Supply (cont’d)
• Supply schedule
– Indicates the quantity of the product that
would be supplied (produced) by
manufacturers at each possible price.
– Quantity supplied (produced) is higher when
the price is higher.

Interaction of Supply and Demand
• Interaction of demand and supply
schedules determines the market price
– Surplus: the quantity supplied by firms is
more than the quantity demanded by
customers.
– Shortage: the quantity supplied by firms is
less than the quantity demanded by
customers.
– Equilibrium price: occurs when quantities
supplied and demanded are equal.
Impact of Shifts in Demand
• Changing conditions can cause a demand
schedule or supply schedule for a specific
product to change.
– Changes the equilibrium price of a product.
Ø Increased product popularity (demand) results in a
shortage of the product.
Ø The shortage is corrected when the price is
increased to the level at which the quantity supplied
equals the quantity demanded.

Affected by a Change in Demand

Exhibit 4.7
Affected by a Change in Demand

Exhibit 4.7
Impact of Shifts in Supply
• Change in supply can impact the
equilibrium price of the product.
– Technological improvements can lead to
reduced production costs causing firms to
produce a larger supply at any given price.
Ø The supply schedule changes and yields a surplus
which can be sold only by lowering the price.
Ø The surplus is eliminated when the price decreases
to a level at which the quantity supplied equals the
quantity demanded.

Affected by a Change in Supply

Exhibit 4.8
Affected by a Change in Supply

Exhibit 4.8
Factors Influencing Market Prices
• Consumer income
– Determines the amount of products and
services individuals can purchase
Ø High levels of economic growth result in more
income for consumers.
Ø Increased demand causes demand schedule shifts
and price increases.
– When consumer income declines:
Ø Demand decreases and creates a surplus as the
demand schedule shifts and prices decrease.

• Changes in consumer tastes and
preferences:
– Impact the quantity of products and services
demanded by consumers
Ø Increased demand leads to price increase.
Ø Decreased demand leads to price decrease.

• Change in production expenses
– A decrease in expenses can lead to increase
in quantity supplied and create a surplus.
Ø Firms must lower prices in order to eliminate the
surplus.
– An increase in expenses can lead to
decrease in quantity supplied and create a
shortage.
Ø Firms can increase prices until shortage is corrected.

Monetary Policy
Impacts Economic Conditions
• Monetary policy
– Made by the Federal Reserve System
Ø “Fed” is the central bank of the U.S.
– Decisions by Fed about the money supply:
Ø Impact interest rates.
Ø Impact firms’ interest expenses.
Ø Impact demand for products purchased with
borrowed funds.

Example of How a Budget Deficit Occurs

Exhibit 4.9
How Government Policies Affect
Business Performance

Exhibit 4.10
Chapter Summary
• Firm performance depends on three
macroeconomic factors: economic
growth, inflation, and interest rates.
• Demand and supply conditions determine
market prices.
• Federal government uses monetary and
fiscal policies to influence macroeconomic
conditions.

Recent Development

Recent Development

Part I: Organization of a Business
Assessing Global Conditions 1
Introduction to Business 3e
Jeff Madura
Copyright © 2004 South-Western. All rights reserved.
Learning Goals
• Explain motives for engaging in international
business.
• Describe global opportunities.
• Describe how firms conduct international
business.
• Explain influence of foreign characteristics on a
firm’s international business.
• Explain how movements in exchange rates can
affect business performance.
Assessing Global Conditions

Motives to Engage in
International Business
• Attract foreign demand
– Competition may prevent firm from
increasing market share in U.S.
– Changes in consumer tastes may decrease
demand in U.S.
• Capitalize on technology
– Expand into countries where technology is
not as advanced.
The Coca-Cola Company’s Global Expansion

Exhibit 6.1
Approximate Hourly Compensation Costs
for Manufacturing across Countries

Exhibit 6.2
Minimum wage vs Living Wage
1–53
Motives to Engage in
International Business (cont’d)
• Use inexpensive resources
– Find locations where land and labor are
inexpensive.
• Diversify internationally
– Reduce risk and increase performance
stability by selling in other countries.
– Geographic diversification reduces exposure
to economic risk in U.S.
Global Opportunities
• Opportunities in Europe
– Single European Act
Ø Created more uniform regulations
Ø Removed taxes on goods traded between member
countries
Ø Increased competition
– Removal of the Berlin Wall (1989)
Ø Encouraged free enterprise and privatization of
businesses
– Inception of the Euro
Ø Allows single monetary policy
Ø Eliminates transaction costs
• Opportunities in Latin America
– NAFTA
Ø Eliminated trade barriers between U.S.,
Mexico, and Canada.
Ø U.S. firms have moved production to
Mexico to reduce costs.
Ø U.S. firms now export products to Mexico.
– Uruguay Round GATT

Ø Removed import trade restrictions over 10
years among 117 countries.
Ø World Trade Organization (WTO)
• Opportunities in Asia
– Large population base
– In 1990s many Asian countries reduced their
excessive restrictions on foreign investment
Ø Easier for foreign firms to acquire Asian
companies or negotiate licensing
agreements with Asian firms.
– Asian economic crisis
Ø Forced many local firms into bankruptcy
Ø Created opportunities for foreign firms to
acquire struggling Asian companies
Foreign Expansion in the U.S.
• Foreign firms expanded into the U.S. by:
– Establishing new subsidiaries.
– Acquiring U.S. firms.
• U.S. industries are susceptible to foreign
competition
– U.S. firms in labor-intensive industries must
compete with foreign firms’ lower labor costs.
– Foreign-made products may be perceived as
higher quality than U.S.-made products.
International Business
• Importing
– The purchase of foreign products or services
• Exporting
– The sale of products or services to purchasers
residing in other countries
• Direct foreign investment
– A means of acquiring or building subsidiaries in one
or more foreign countries
• Strategic alliances
– A business agreement between firms whereby
resources are shared to pursue mutual interests
Importing
• Involves the purchase of foreign products
or services:
– U.S. consumers purchase foreign
automobiles, clothing, cameras, etc.
– U.S. firms import materials or supplies that
are used to produce products.
• Trade barriers restrict importing
– Tariffs are taxes on imported products.
– Quotas limit the amounts of specific products
that can be imported.
Exporting
• Involves the sale of products or services
to purchasers residing in other countries
• U.S. Balance of Trade
– The level of U.S. exports less the level of its
imports; if imports are greater than exports,
the result is a trade deficit.
• Internet facilitates exporting
– Provide information to prospective importers
– Accept orders online and track shipments
Foreign Direct Investment
• Investments in acquiring or building
subsidiaries in one or more foreign
countries to:
– Reduce transportation costs.
– Overcome trade barriers
– Acquire advanced technology by offering
incentives to firms to establish subsidiaries.
– Reduce labor costs by shifting production
facilities to a developing country with lower
labor costs.
Strategic Alliances
• Various types of alliances between U.S.
and foreign firms can be made:
– Joint venture involves an agreement
between two firms about a specific project
Ø U.S. firm makes the product, foreign firm sells the
product in their home country.
Ø Two firms share production of the product -
common in the auto industry.
– International licensing agreement
Ø Firm allows a foreign company (licensee) to produce
its product according to specific instructions in
exchange for a licensing fee.
Influence of Foreign Characteristics
• Culture
– Tastes, habits, and customs vary by country
– U.S. products might need to be adjusted to
fit the culture
• Economic systems
– Capitalism
– Communism
– Socialism
– Privatization

Influence of Foreign Characteristics
• Economic conditions
– Economic growth in foreign countries can
influence demand for U.S. products:
Ø Strong economy might increase demand.
Ø Weak economy might decrease demand.
– U.S. firm’s exposure to foreign country’s
economy depends on proportion of U.S.
firm’s business conducted in that country.

Comparing the Influence of the
Canadian Economy on Two U.S. Firms

Exhibit 6.5
Small Business Survey
Many successful small firms rely on international

sales for a significant portion of their business.
Political Risk
• Risk that a country’s political actions may
adversely affect a business
– Expropriation: extreme form of risk occurs
when foreign government takes over a U.S.
subsidiary without compensating the U.S.
firm.
Ø More common risk occurs when foreign
governments impose higher corporate tax rates on
foreign subsidiaries.
Ø Other risks impact costs of doing business in the
foreign country - stringent building codes, waste
disposal restrictions, and pollution controls.
Exchange Rates
• Exchange rates between the U.S. dollar
and other currencies fluctuate over time
– Number of dollars needed by a U.S. firm to
purchase foreign supplies may change, even
if the actual price does not change
Ø When U.S. dollar weakens - foreign currency
strengthens - U.S. firms need more dollars to
purchase a given amount of foreign supplies
Ø Exchange rate affects foreign demand for U.S.
products because they impact the actual price paid
by the foreign customer.

Impact of Exchange Rates
on Firm Performance
• International trade transactions usually
require the exchange of one currency for
another currency
– Exchange rates vary on a daily basis.
– Exchange rate fluctuations have a favorable
or unfavorable effect on firm performance.
Ø Impact on U.S. importers
Ø Impact on U.S. exporters

Hedging Against Exchange
Rate Movements
• Hedging means to take actions to protect
a firm against exchange rate movements
– Hedging future payments and future
receivables in foreign currencies
Ø Request forward contract at a specified exchange
rate on a future date.
Ø Rate is called a forward rate
– Reduces risk because firm knows in advance what the
exchange rate will be
– Prevents both favorable and unfavorable exchange rate
fluctuations
How Exchange
Rates Affect
the Degree of
Foreign
Competition

Exhibit 6.9
Chapter Summary
• U.S. firms engage in international business to
attract foreign demand, capitalize on
technology, use inexpensive resources or
diversify internationally.
• Reduction of trade barriers has increased global
expansion opportunities for U.S. firms.
• Firms conduct international business via
importing, exporting, direct foreign investment
and strategic alliances.

Chapter Summary
• Firms must assess culture, economic systems
and conditions, exchange rate risk and political
risk when entering foreign markets.
• Exchange rate fluctuations affect importers and
exporters in different ways.

W3 Economic and Global Conditions Compressed

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W3 Economic and Global Conditions Compressed

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Part I: Organization of a Business

Assessing Economic Conditions 1

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• New housing starts

• Personal income level

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Assessing Global Conditions 1

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– Uruguay Round GATT

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Many successful small firms rely on international

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