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Learning Activity #1 1. Read Chapter 1. Review the 1.8 Cases and Problems (page 40) and complete the questions. ( 2. Post your answer to #4 and 5. The ?Economy section of the CNNMoney Web site provides current information on a number of economic indicators. Go to http://money.cnn.com and click on ?Economy and then on ?Jobs, and find answers to the following questions: 1. Is the current level of unemployment rising or falling? 2. What do economists expect will happen to unemployment rates in the near future? 3. Is the current level of unemployment a burden or an asset to the economy? In what ways? 4. Do you remember the first dollar you earned? 5. Maybe you earned it delivering newspapers, shoveling snow, mowing lawns, or babysitting. How much do you think that dollar is worth today? Go to the WestEgg site athttp://www.westegg.com/inflation and find the answer to this question. After determining the current value of your first dollar, explain how the calculator was created. (Hint: Apply what you know about CPI.) —————————————————————————————————————————————————————————— 1. Read Chapter 2. Review and complete the Exercises on page 34. (Due Thursday, 11:59pm) 2. Post a summary of your answers to items 1-6 of your Business Conduct and Ethics 1. (AACSB) Analysis You‘re the CEO of a company that sells golf equipment, including clubs, bags, and balls. When your company was started and had only a handful of employees, you were personally able to oversee the conduct of your employees. But with your current workforce of nearly fifty, it‘s time to prepare a formal code of conduct in which you lay down some rules that employees must follow in performing job-related activities. As a model for your own code, you‘ve decided to use Macy‘s Code of Business Conduct and Ethics. Go to the company‘s Web site (http://www.federated- fds.com/investors/governance/documents/code_of_business_conduct_and_ethics.pdf) to view its posted code of business conduct. Your document won‘t be as thorough as Macy‘s, but it will cover the following areas: (1) conflicts of interest; (2) acceptance of gifts, services, or entertainment; (3) protection of confidential information; (4) use of company funds or assets for personal purposes; (5) competing fairly and ethically; and (6) adherence to code. Draw up a code of conduct for your company. 2. (AACSB) Reflective Skills Think of someone whom you regard as an ethical leader. It can be anyone connected with you—a businessperson, educator, coach, politician, or family member. Explain why you believe the individual is ethical in his or her leadership. This text was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 License without attribution as requested by the work’s original creator or licensee. 1 2 Chapter 1 The Foundations of Business Why Is Apple Successful? In 1976 Steve Jobs and Steve Wozniak created their first computer, the Apple I. They invested a mere $1,300 and set up business in Jobs’s garage. Three decades later, their business—Apple Inc.—has become one of the world’s most influential and successful companies. Did you ever wonder why Apple flourished while so many other young companies failed? How did it grow from a garage start-up to a company generating $65 billion in sales? How was it able to transform itself from a nearly bankrupt firm to a multinational corporation with locations all around the world? You might conclude that it was the company’s products, such as the Apple I and II, the Macintosh, or more recently its wildly popular iPod, iPhone, and iPad. Or you might decide that it was its people: its dedicated employees and loyal customers. Perhaps you will decide it was luck—Apple simply was in the right place at the right time. Or maybe you will attribute the company’s success to management’s willingness to take calculated risks. Perhaps you will attribute Apple’s initial accomplishments and reemergence to its cofounder, the late Steve Jobs. After all, Jobs was instrumental in the original design of the Apple I and, after being ousted from his position with the company, returned to save the firm from destruction and lead it onto its current path. Before we decide what made Apple what it is today and what will propel it into a successful future, let’s see if you have all the facts about the possible choices: its [1] products, its customers, luck, willingness to take risks, or Steve Jobs. We’re confident that you’re aware of Apple’s products and understand that ?Apple customers are a loyal bunch. Though they’re only a small percentage of all computer users, they make up for it with their passion and outspokenness.? 3 [2] We believe you can understand the role that luck or risk taking could play in Apple’s success. But you might like to learn more about Steve Jobs, the company’s cofounder and former CEO, before arriving at your final decision. Growing up, Jobs had an interest in computers. He attended lectures at HewlettPackard after school and worked for the company during the summer months. He took a job at Atari after graduating from high school and saved his money to make a pilgrimage to India to search for spiritual enlightenment. Following his India trip, he attended Steve Wozniak’s ?Homebrew Computer Club? meetings, where the idea for building a personal computer surfaced. [3] ?Many colleagues describe Jobs as a brilliant man who could be a great motivator and positively charming. At the same time his drive for perfection was so strong that employees who did not meet his demands are faced with blistering verbal attacks.? [4] Not everyone at Apple appreciated Jobs’s brilliance and ability to motivate. Nor did they all go along with his willingness to do whatever it took to produce an innovative, attractive, high-quality product. So at age thirty, Jobs found himself ousted from Apple by John Sculley, whom Jobs himself had hired as president of the company several years earlier. It seems that Sculley wanted to cut costs and thought it would be easier to do so without Jobs around. Jobs sold $20 million of his stock and went on a two-month vacation to figure out what he would do for the rest of his life. His solution: start a new personal computer company called NextStep. In 1993, he was invited back to Apple (a good thing, because neither his new company nor Apple was doing well). Steve Jobs was definitely not humble, but he was a visionary and had a right to be proud of his accomplishments. Some have commented that ?Apple’s most successful days have occurred with Steve Jobs at the helm.? 4 [5] Jobs did what many successful CEOs and managers do: he learned, adjusted, and improvised. [6] Perhaps the most important statement that can be made about him is this: he never gave up on the company that once turned its back on him. So now you have the facts. Here’s a multiple-choice question that you’ll likely get right: Apple’s success is due to (a) its products, (b) its customers, (c) luck, (d) willingness to take risks, (e) Steve Jobs, or (f) some combination of these options. [1] This vignette is based on an honors thesis written by Danielle M. Testa, ?Apple, Inc.: An Analysis of the Firm’s Tumultuous History, in Conjunction with the Abounding Future? (Lehigh University), November 18, 2007. [2] Ellen Lee, ?Faithful, sometimes fanatical Apple customers continue to push the boundaries of loyalty,? San Francisco Chronicle, March 26, 2006. [3] Lee Angelelli, ?Steve Paul Jobs,? http://ei.cs.vt.edu/~history/Jobs.html (accessed January 21, 2012). [4] Lee Angelelli, ?Steve Paul Jobs,? http://ei.cs.vt.edu/~history/Jobs.html (accessed January 21, 2012). [5] Cyrus Farivar, ?Apple’s first 30 years; three decades of contributions to the computer industry,? Macworld, June 2006, 2. [6] Dan Barkin, ?He made the iPod: How Steve Jobs of Apple created the new millennium’s signature invention,? Knight Ridder Tribune Business News, December 3, 2006, 1. 1.1 Introduction As the story of Apple suggests, today is an interesting time to study business. Advances in technology are bringing rapid changes in the ways we produce and deliver goods and services. The Internet and other improvements in communication (such as smartphones, video conferencing, and social networking) now affect the way we do business. Companies are expanding international operations, and the workforce is more diverse than ever. Corporations are being held responsible for the behavior of their executives, and more people share the opinion that companies should be good corporate citizens. Plus—and this is a big plus—businesses today are facing the lingering effects of what many economists believe is the worst financial crisis since the Great Depression. [1] Economic turmoil that began in the housing and mortgage industries as a result of troubled subprime mortgages quickly spread to the rest of the economy. In 2008, credit markets froze up and banks stopped making loans. Lawmakers tried to get money flowing again by passing a $700 billion Wall Street bailout, yet businesses and individuals were still denied access to needed credit. Without money or credit, consumer confidence in the economy dropped and consumers cut back their spending. Businesses responded by producing fewer products, and their sales and profits dropped. Unemployment rose as troubled companies shed the most jobs in five years, and 760,000 Americans marched to the unemployment lines. The stock market reacted to the financial crisis and its stock prices dropped by 44 percent while millions of Americans watched in shock as their savings and retirement accounts took a nose dive. In fall 2008, even Apple, a company that had enjoyed strong sales growth over the past five years, began to cut production of its popular iPhone. Without jobs or cash, consumers would no longer flock to Apple’s fancy retail stores or buy a prized iPhone. [3] Things have turned around for Apple, which reported blockbuster sales for 2011 in part because of strong customer response to the iPhone 4S. But not all companies or individuals are doing so well. The economy is still struggling, unemployment is high (particularly for those ages 16 to 24), and home prices remain low. As you go through the course with the aid of this text, you’ll explore the exciting world of business. We’ll introduce you to the various activities in which businesspeople engage—accounting, finance, information technology, management, marketing, and operations. We’ll help you understand the roles that these activities play in an organization, and we’ll show you how they work together. We hope that by exposing you to the things that businesspeople do, we’ll help you decide whether business is right for you and, if so, what areas of business you’d like to study further. 5 [2] [1] Jon Hilsenrath, Serena Ng, and Damian Paletta, ?Worst Crisis Since ’30s, With No End Yet in Sight,? Wall Street Journal, Markets, September 18, 2008,http://online.wsj.com/article/SB122169431617549947.html (accessed January 21, 2012). [2] ?How the Economy Stole the Election,? CNN.com,http://money.cnn.com/galleries/2008/news/0810/gallery.economy_election/index.html (accessed January 21, 2012). [3] Dan Gallagher, ?Analyst says Apple is cutting back production as economy weakens,?MarketWatch, November 3, 2008, http://www.marketwatch.com/news/story/apple-cutting-back-iphoneproduction/story.aspx?guid=%7B7F2B6F99-D063-4005-87ADD8C36009F29B%7D&dist=msr_1 (accessed January 21, 2012). 1.2 Getting Down to Business LEARNING OBJECTIVE 1. Identify the main participants of business, the functions that most businesses perform, and the external forces that influence business activities. A business is any activity that provides goods or services to consumers for the purpose of making a profit. When Steve Jobs and Steve Wozniak created Apple Computer in Jobs’s family garage, they started a business. The product was the Apple I, and the company’s founders hoped to sell their computers to customers for more than it cost to make and market them. If they were successful (which they were), they’d make a profit. Before we go on, let’s make a couple of important distinctions concerning the terms in our definitions. First, whereas Apple produces and sells goods (Mac, iPhone, iPod, iPad), many businesses provide services. Your bank is a service company, as is your Internet provider. Hotels, airlines, law firms, movie theaters, and hospitals are also service companies. Many companies provide both goods and services. For example, your local car dealership sells goods (cars) and also provides services (automobile repairs). Second, some organizations are not set up to make profits. Many are established to provide social or educational services. Such not-for profit (or nonprofit) 6 organizations include the United Way of America, Habitat for Humanity, the Boys and Girls Clubs, the Sierra Club, the American Red Cross, and many colleges and universities. Most of these organizations, however, function in much the same way as a business. They establish goals and work to meet them in an effective, efficient manner. Thus, most of the business principles introduced in this text also apply to nonprofits. Business Participants and Activities Let’s begin our discussion of business by identifying the main participants of business and the functions that most businesses perform. Then we’ll finish this section by discussing the external factors that influence a business’s activities. Participants Every business must have one or more owners whose primary role is to invest money in the business. When a business is being started, it’s generally the owners who polish the business idea and bring together the resources (money and people) needed to turn the idea into a business. The owners also hire employees to work for the company and help it reach its goals. Owners and employees depend on a third group of participants— customers. Ultimately, the goal of any business is to satisfy the needs of its customers in order to generate a profit for the owners. Functional Areas of Business The activities needed to operate a business can be divided into a number of functional areas: management, operations, marketing, accounting, and finance. Let’s briefly explore each of these areas. Management Managers are responsible for the work performance of other people. Management involves planning for, organizing, staffing, directing, and controlling a company’s resources so that it can achieve its goals. Managers plan by 7 setting goals and developing strategies for achieving them. They organize activities and resources to ensure that company goals are met. They staff the organization with qualified employees and direct them to accomplish organizational goals. Finally, managers design controls for assessing the success of plans and decisions and take corrective action when needed. Operations All companies must convert resources (labor, materials, money, information, and so forth) into goods or services. Some companies, such as Apple, convert resources into tangible products—Macs, iPhones, iPods, iPads. Others, such as hospitals, convert resources into intangible products—health care. The person who designs and oversees the transformation of resources into goods or services is called an operations manager. This individual is also responsible for ensuring that products are of high quality. Marketing Marketing consists of everything that a company does to identify customers’ needs and designs products to meet those needs. Marketers develop the benefits and features of products, including price and quality. They also decide on the best method of delivering products and the best means of promoting them to attract and keep customers. They manage relationships with customers and make them aware of the organization’s desire and ability to satisfy their needs. Accounting Managers need accurate, relevant, timely financial information, and accountants provide it. Accountants measure, summarize, and communicate financial and managerial information and advise other managers on financial matters. There are two fields of accounting. Financial accountants prepare financial statements to help users, both inside and outside the organization, assess the financial strength of the 8 company. Managerial accountants prepare information, such as reports on the cost of materials used in the production process, for internal use only. Finance Finance involves planning for, obtaining, and managing a company’s funds. Finance managers address such questions as the following: How much money does the company need? How and where will it get the necessary money? How and when will it pay the money back? What should it do with its funds? What investments should be made in plant and equipment? How much should be spent on research and development? How should excess funds be invested? Good financial management is particularly important when a company is first formed, because new business owners usually need to borrow money to get started. Figure 1.2 Business and Its Environment 9 External Forces that Influence Business Activities Apple and other businesses don’t operate in a vacuum: they’re influenced by a number of external factors. These include the economy, government, consumer trends, and public pressure to act as good corporate citizens. Figure 1.2 “Business and Its Environment” sums up the relationship among the participants in a business, its functional areas, and the external forces that influence its activities. One industry that’s clearly affected by all these factors is the fast-food industry. A strong economy means people have more money to eat out at places where food standards are monitored by a government agency, the Food and Drug Administration. Preferences for certain types of foods are influenced by consumer trends (eating fried foods might be OK one year and out the next). Finally, a number of decisions made by the industry result from its desire to be a good corporate citizen. For example, several fast-food chains have responded to environmental concerns by eliminating Styrofoam containers. As you move through this text, you’ll learn more about these external influences on business. (Section 1.3 “What Is Economics?” will introduce in detail one of these external factors—the economy.) KEY TAKEAWAYS ? The main participants in a business are its owners, employees, and customers. ? Businesses are influenced by such external factors as the economy, government, consumer trends, and public pressure to act as good corporate citizens. ? The activities needed to run a business can be divided into five functional areas: 1. Management involves planning, organizing, staffing, directing, and controlling resources to achieve organizational goals. 2. Operations transforms resources (labor, materials, money, and so on) into products. 3. Marketing works to identify and satisfy customers’ needs. 4. Finance involves planning for, obtaining, and managing company funds. 10 [1] 5. Accounting entails measuring, summarizing, and communicating financial and managerial information. EXERCISES 1. (AACSB) Analysis The Martin family has been making guitars out of its factory in Nazareth, Pennsylvania, factory for more than 150 years. In 2004, Martin Guitar was proud to produce its millionth instrument. Go to http://www.martinguitar.com to link to the Martin Guitar Web site and read about the company’s long history. You’ll discover that, even though it’s a family-run company with a fairly unique product, it operates like any other company. Identify the main activities or functions of Martin Guitar’s business and explain how each activity benefits the company. 2. (AACSB) Analysis Name four external factors that have an influence on business. Give examples of the ways in which each factor can affect the business performance of two companies: WalMart and Ford. [1] David Baron, ?Facing-Off in Public,? Stanford Business, April 15, 2006,http://www.gsb.stanford.edu/news/bmag/sbsm0308/feature_face_off.shtml (accessed January 21, 2012). 1.3 What Is Economics? LEARNING OBJECTIVES 1. Define economics and identify factors of production. 2. Explain how economists answer the three key economics questions. 3. Compare and contrast economic systems. 11 To appreciate how a business functions, we need to know something about the economic environment in which it operates. We begin with a definition of economics and a discussion of the resources used to produce goods and services. Resources: Inputs and Outputs Economics is the study of the production, distribution, and consumption of goods and services. Resources are the inputs used to produce outputs. Resources may include any or all of the following: ? Land and other natural resources ? Labor (physical and mental) ? Capital, including buildings and equipment ? Entrepreneurship Resources are combined to produce goods and services. Land and natural resources provide the needed raw materials. Labor transforms raw materials into goods and services. Capital (equipment, buildings, vehicles, cash, and so forth) are needed for the production process. Entrepreneurship provides the skill and creativity needed to bring the other resources together to produce a good or service to be sold to the marketplace. Because a business uses resources to produce things, we also call these resources factors of production. The factors of production used to produce a shirt would include the following: ? The land that the shirt factory sits on, the electricity used to run the plant, and the raw cotton from which the shirts are made ? The laborers who make the shirts ? The factory and equipment used in the manufacturing process, as well as the money needed to operate the factory ? The entrepreneurship skill used to coordinate the other resources to initiate the production process and the distribution of the goods or services to the marketplace 12 Input and Output Markets Many of the factors of production (or resources) are provided to businesses by households. For example, households provide businesses with labor (as workers), land and buildings (as landlords), and capital (as investors). In turn, businesses pay households for these resources by providing them with income, such as wages, rent, and interest. The resources obtained from households are then used by businesses to produce goods and services, which are sold to the same households that provide businesses with revenue. The revenue obtained by businesses is then used to buy additional resources, and the cycle continues. This circular flow is described in Figure 1.3 “The Circular Flow of Inputs and Outputs”, which illustrates the dual roles of households and businesses: ? Households not only provide factors of production (or resources) but also consume goods and services. ? Businesses not only buy resources but also produce and sell both goods and services. Figure 1.3 The Circular Flow of Inputs and Outputs 13 The Questions Economists Ask 14 Economists study the interactions between households and businesses and look at the ways in which the factors of production are combined to produce the goods and services that people need. Basically, economists try to answer three sets of questions: 1. What goods and services should be produced to meet consumers’ needs? In what quantity? When should they be produced? 2. How should goods and services be produced? Who should produce them, and what resources, including technology, should be combined to produce them? 3. Who should receive the goods and services produced? How should they be allocated among consumers? Economic Systems The answers to these questions depend on a country’s economic system—the means by which a society (households, businesses, and government) makes decisions about allocating resources to produce products and about distributing those products. The degree to which individuals and business owners, as opposed to the government, enjoy freedom in making these decisions varies according to the type of economic system. Generally speaking, economic systems can be divided into two systems: planned systems and free market systems. Planned Systems In a planned system, the government exerts control over the allocation and distribution of all or some goods and services. The system with the highest level of government control is communism. In theory, a communist economy is one in which the government owns all or most enterprises. Central planning by the government dictates which goods or services are produced, how they are produced, and who will receive them. In practice, pure communism is practically nonexistent today, and only a few countries (notably North Korea and Cuba) operate under rigid, centrally planned economic systems. Under socialism, industries that provide essential services, such as utilities, banking, and health care, may be government owned. Other businesses are owned privately. Central planning allocates the goods and services produced by government-run industries and tries to ensure that the resulting wealth is distributed equally. In contrast, privately owned companies are operated for the purpose of making a profit for their owners. In general, workers in socialist economies work fewer hours, have longer vacations, and receive more health care, education, and child-care benefits than do workers in capitalist economies. To offset the high cost of public services, taxes are generally steep. Examples of socialist countries include Sweden and France. Free Market System 15 The economic system in which most businesses are owned and operated by individuals is the free market system, also known as capitalism. As we will see next, in a free market, competition dictates how goods and services will be allocated. Business is conducted with only limited government involvement. The economies of the United States and other countries, such as Japan, are based on capitalism. How Economic Systems Compare In comparing economic systems, it’s helpful to think of a continuum with communism at one end and pure capitalism at the other, as in Figure 1.4 “The Spectrum of Economic Systems”. As you move from left to right, the amount of government control over business diminishes. So, too, does the level of social services, such as health care, child-care services, social security, and unemployment benefits. Figure 1.4 The Spectrum of Economic Systems Mixed Market Economy Though it’s possible to have a pure communist system, or a pure capitalist (free market) system, in reality many economic systems are mixed. A mixed market economy relies on both markets and the government to allocate resources. We’ve already seen that this is what happens in socialist economies in which the government controls selected major industries, such as transportation and health care, while allowing individual ownership of other industries. Even previously communist economies, such as those of Eastern Europe and China, are becoming more mixed as they adopt capitalistic characteristics 16 and convert businesses previously owned by the government to private ownership through a process called privatization. The U.S. Economic System Like most countries, the United States features a mixed market system: though the U.S. economic system is primarily a free market system, the federal government controls some basic services, such as the postal service and air traffic control. The U.S. economy also has some characteristics of a socialist system, such as providing social security retirement benefits to retired workers. The free market system was espoused by Adam Smith in his book The Wealth of Nations, published in 1776. [1] According to Smith, competition alone would ensure that consumers received the best products at the best prices. In the kind of competition he assumed, a seller who tries to charge more for his product than other sellers won’t be able to find any buyers. A job-seeker who asks more than the going wage won’t be hired. Because the ?invisible hand? of competition will make the market work effectively, there won’t be a need to regulate prices or wages. Almost immediately, however, a tension developed among free market theorists between the principle of laissez-faire—leaving things alone—and government intervention. Today, it’s common for the U.S. government to intervene in the operation of the economic system. For example, government exerts influence on the food and pharmaceutical industries through the Food and Drug Administration, which protects consumers by preventing unsafe or mislabeled products from reaching the market. To appreciate how businesses operate, we must first get an idea of how prices are set in competitive markets. Thus, Section 1.4 “Perfect Competition and Supply and Demand” begins by describing how markets establish prices in an environment of perfect competition. 17 KEY TAKEAWAYS ? Economics is the study of the production, distribution, and consumption of goods and services. ? Economists address these three questions: (1) What goods and services should be produced to meet consumer needs? (2) How should they be produced, and who should produce them? (3) Who should receive goods and services? ? The answers to these questions depend on a country’s economic system. The primary economic systems that exist today are planned and free market systems. ? In a planned system, such as communism and socialism, the government exerts control over the production and distribution of all or some goods and services. ? In a free market system, also known as capitalism, business is conducted with only limited government involvement. Competition determines what goods and services are produced, how they are produced, and for whom. EXERCISES 1. If you started a business that made surfboards, what factors of production would you need to make your product? Where would you get them? Where would you find the money you’d need to pay for additional resources? 2. Which three key questions do economists try to answer? Will answers to these questions differ, depending on whether they’re working in the United States or in Cuba? Explain your answer. [1] According to many scholars, The Wealth of Nations not only is the most influential book on freemarket capitalism but remains relevant today. 1.4 Perfect Competition and Supply and Demand 18 LEARNING OBJECTIVE 1. Describe perfect competition, and explain how supply and demand interact to set prices in a free market system. Under a mixed economy, such as we have in the United States, businesses make decisions about which goods to produce or services to offer and how they are priced. Because there are many businesses making goods or providing services, customers can choose among a wide array of products. The competition for sales among businesses is a vital part of our economic system. Economists have identified four types of competition—perfect competition, monopolistic competition, oligopoly, and monopoly. We’ll introduce the first of these—perfect competition—in this section and cover the remaining three in the following section. Perfect Competition Perfect competition exists when there are many consumers buying a standardized product from numerous small businesses. Because no seller is big enough or influential enough to affect price, sellers and buyers accept the going price. For example, when a commercial fisher brings his fish to the local market, he has little control over the price he gets and must accept the going market price. The Basics of Supply and Demand To appreciate how perfect competition works, we need to understand how buyers and sellers interact in a market to set prices. In a market characterized by perfect competition, price is determined through the mechanisms of supply and demand. Prices are influenced both by the supply of products from sellers and by the demand for products by buyers. 19 To illustrate this concept, let’s create a supply and demand schedule for one particular good sold at one point in time. Then we’ll define demand and create a demand curve and define supply and create a supply curve. Finally, we’ll see how supply and demand interact to create an equilibrium price—the price at which buyers are willing to purchase the amount that sellers are willing to sell. Demand and the Demand Curve Demand is the quantity of a product that buyers are willing to purchase at various prices. The quantity of a product that people are willing to buy depends on its price. You’re typically willing to buy less of a product when prices rise and more of a product when prices fall. Generally speaking, we find products more attractive at lower prices, and we buy more at lower prices because our income goes further. Figure 1.6 The Demand Curve 20 Using this logic, we can construct a demand curve that shows the quantity of a product that will be demanded at different prices. Let’s assume that the diagram in Figure 1.6 “The Demand Curve” represents the daily price and quantity of apples sold by farmers at a local market. Note that as the price of apples goes down, buyers’ demand goes up. Thus, if a pound of apples sells for $0.80, buyers will be willing to purchase only fifteen hundred pounds per day. But if apples cost only $0.60 a pound, buyers will be willing to purchase two thousand pounds. At $0.40 a pound, buyers will be willing to purchase twenty-five hundred pounds. Supply and the Supply Curve Supply is the quantity of a product that sellers are willing to sell at various prices. The quantity of a product that a business is willing to sell depends on its price. Businesses are more willing to sell a product when the price rises and less willing to sell it when prices fall. Again, this fact makes sense: businesses are set up to make profits, and there are larger profits to be made when prices are high. Figure 1.7 The Supply Curve 21 Now we can construct a supply curve that shows the quantity of apples that farmers would be willing to sell at different prices, regardless of demand. As you can see in Figure 1.7 “The Supply Curve”, the supply curve goes in the opposite direction from the demand curve: as prices rise, the quantity of apples that farmers are willing to sell also goes up. The supply curve shows that farmers are willing to sell only a thousand pounds of apples when the price is $0.40 a pound, two thousand pounds when the price is $0.60, and three thousand pounds when the price is $0.80. Equilibrium Price We can now see how the market mechanism works under perfect competition. We do this by plotting both the supply curve and the demand curve on one graph, as we’ve done in Figure 1.8 “The Equilibrium Price”. The point at which the two curves intersect is the equilibrium price. At this point, buyers’ demand for apples and sellers’ supply of apples is in equilibrium. Figure 1.8 The Equilibrium Price 22 You can see in Figure 1.8 “The Equilibrium Price” that the supply and demand curves intersect at the price of $0.60 and quantity of two thousand pounds. Thus, $0.60 is the equilibrium price: at this price, the quantity of apples demanded by buyers equals the quantity of apples that farmers are willing to supply. If a farmer tries to charge more than $0.60 for a pound of apples, he won’t sell very many and his profits will go down. If, on the other hand, a farmer tries to charge less than the equilibrium price of $0.60 a pound, he will sell more apples but his profit per pound will be less than at the equilibrium price. What have we learned in this discussion? We’ve learned that without outside influences, markets in an environment of perfect competition will arrive at an equilibrium point at which both buyers and sellers are satisfied. But we must be aware that this is a very simplistic example. Things are much more complex in the real world. For one thing, markets rarely operate without outside influences. Sometimes, sellers supply more of a product than buyers are willing to purchase; in that case, there’s a surplus. Sometimes, they don’t produce enough of a product to satisfy demand; then we have a shortage. Circumstances also have a habit of changing. What would happen, for example, if income rose and buyers were willing to pay more for apples? The demand curve would change, resulting in an increase in equilibrium price. This outcome makes intuitive sense: as demand increases, prices will go up. What would happen if apple crops were larger than expected because of favorable weather conditions? Farmers might be willing to sell apples at lower prices. If so, the supply curve would shift, resulting in another change in equilibrium price: the increase in supply would bring down prices. KEY TAKEAWAYS ? In a free market system, buyers and sellers interact in a market to set prices. ? When the market is characterized by perfect competition, many small companies sell identical products. Because no company is large enough to control price, each simply accepts the market price. The price is determined by supply and demand. ? Supply is the quantity of a product that sellers are willing to sell at various prices. ? Demand is the quantity of a product that buyers are willing to purchase at various prices. 23 ? The quantity of a product that people will buy depends on its price: they’ll buy more when the price is low and less when it’s high. ? Price also influences the quantity of a product that producers are willing to supply: they’ll sell more of a product when prices are high and less when they’re low. ? In a competitive market, the decisions of buyers and sellers interact until the market reaches an equilibrium price—the price at which buyers are willing to buy the same amount that sellers are willing to sell. EXERCISE (AACSB) Analysis You just ran across three interesting statistics: (1) the world’s current supply of oil is estimated to be 1.3 trillion barrels; (2) the worldwide use of oil is thirty billion barrels a year; and (3) at this rate of consumption, we’ll run out of oil in forty-three years. Overcoming an initial sense of impending catastrophe, you remember the discussion of supply and demand in this chapter and realize that things aren’t as simple as they seem. After all, many factors affect both the supply of oil and the demand for products made from it, such as gasoline. These factors will influence when (and if) the world runs out of oil. Answer the following questions, and provide explanations for your answers: 1. What’s the major factor that affects the supply of oil? (Hint: It’s the same major factor affecting the demand for oil.) 2. If producers find additional oil reserves, what will happen to the price of oil? 3. If producers must extract oil from more-costly wells, what will happen to the price that you pay to fill up your gas tank? 4. If China’s economy continues to expand rapidly, what will happen to the price of oil? 5. If drivers in the United States start favoring fuel-efficient cars over SUVs, will gas be cheaper or more expensive? 6. In your opinion, will oil producers be able to supply enough oil to meet the increasing demand for oil-related products, such as gasoline? 24 1.5 Monopolistic Competition, Oligopoly, and Monopoly LEARNING OBJECTIVE 1. Describe monopolistic competition, oligopoly, and monopoly. Economists have identified four types of competition—perfect competition, monopolistic competition, oligopoly, and monopoly. Perfect competition was discussed in the last section; we’ll cover the remaining three types of competition here. Monopolistic Competition In monopolistic competition, we still have many sellers (as we had under perfect competition). Now, however, they don’t sell identical products. Instead, they sell differentiated products—products that differ somewhat, or are perceived to differ, even though they serve a similar purpose. Products can be differentiated in a number of ways, including quality, style, convenience, location, and brand name. Some people prefer Coke over Pepsi, even though the two products are quite similar. But what if there was a substantial price difference between the two? In that case, buyers could be persuaded to switch from one to the other. Thus, if Coke has a big promotional sale at a supermarket chain, some Pepsi drinkers might switch (at least temporarily). How is product differentiation accomplished? Sometimes, it’s simply geographi cal; you probably buy gasoline at the station closest to your home regardless of the brand. At other times, perceived differences between products are promoted by advertising designed to convince consumers that one product is different from another—and better than it. Regardless of customer loyalty to a product, however, if its price goes too high, the seller will lose business to a competitor. Under monopolistic competition, therefore, companies have only limited control over price. Oligopoly Oligopoly means few sellers. In an oligopolistic market, each seller supplies a large portion of all the products sold in the marketplace. In addition, because the cost of starting a business in an oligopolistic industry is usually high, the number of firms entering it is low. Companies in oligopolistic industries include such large-scale enterprises as automobile companies and airlines. As large firms supplying a sizable portion of a market, these 25 companies have some control over the prices they charge. But there’s a catch: because products are fairly similar, when one company lowers prices, others are often forced to follow suit to remain competitive. You see this practice all the time in the airline industry: When American Airlines announces a fare decrease, Continental, United Airlines, and others do likewise. When one automaker offers a special deal, its competitors usually come up with similar promotions. Monopoly In terms of the number of sellers and degree of competition, monopolies lie at the opposite end of the spectrum from perfect competition. In perfect competition, there are many small companies, none of which can control prices; they simply accept the market price determined by supply and demand. In a monopoly, however, there’s only one seller in the market. The market could be a geographical area, such as a city or a regional area, and doesn’t necessarily have to be an entire country. There are few monopolies in the United States because the government limits them. Most fall into one of two categories: natural and legal. Natural monopolies include public utilities, such as electricity and gas suppliers. Such enterprises require huge investments, and it would be inefficient to duplicate the products that they provide. They inhibit competition, but they’re legal because they’re important to society. In exchange for the right to conduct business without competition, they’re regulated. For instance, they can’t charge whatever prices they want, but they must adhere to government controlled prices. As a rule, they’re required to serve all customers, even if doing so isn’t cost efficient. A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process. Patents are issued for a limited time, generally twenty years. [12] During this period, other companies can’t use the invented product or process without permission from the patent holder. Patents allow companies a certain period to recover the heavy costs of researching and developing products and technologies. A classic example of a company that enjoyed a patent-based legal monopoly is Polaroid, which for years held exclusive ownership of instant-film technology. 26 [13] Polaroid priced the product high enough to recoup, over time, the high cost of bringing it to market. Without competition, in other words, it enjoyed a monopolistic position in regard to pricing. K E Y T A K E A W A Y S ? There are four types of competition in a free market system: perfect competition, monopolistic competition, oligopoly, and monopoly. ? Under monopolistic competition, many sellers offer differentiated products— products that differ slightly but serve similar purposes. By making consumers aware of product differences, sellers exert some control over price. ? In an oligopoly, a few sellers supply a sizable portion of products in the market. They exert some control over price, but because their products are similar, when one company lowers prices, the others follow. ? In a monopoly, there is only one seller in the market. The market could be a geographical area, such as a city or a regional area, and does not necessarily have to be an entire country. The single seller is able to control prices. ? Most monopolies fall into one of two categories: natural and legal. ? Natural monopolies include public utilities, such as electricity and gas suppliers. They inhibit competition, but they’re legal because they’re important to society. ? A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process for a limited time, generally twenty years. E X E R C I S E Identify the four types of competition, explain the differences among them, and provide two examples of each. (Use examples different from those given in the text.) [12] United States Patent and Trademark Office, General Information Concerning Patents, April 15, 2006, http://www.uspto.gov/web/offices/pac/doc/general/index.html#laws (accessed January 21, 2012). [13] Mary Bellis, ?Inventors-Edwin Land-Polaroid Photography-Instant Photography/Patents,? April 15, 2006, http://inventors.about.com/library/inventors/blpolaroid.htm (accessed January 21, 2012). 1.6 Measuring the Health of the Economy LEARNING OBJECTIVE 1. Understand the criteria used to assess the status of the economy. Every day, we are bombarded with economic news. We’re told that the economy is struggling, unemployment is high, home prices are low, and consumer confidence is 27 down. As a student learning about business, and later as a business manager, you need to understand the nature of the U.S. economy and the terminology that we use to describe it. You need to have some idea of where the economy is heading, and you need to know something about the government’s role in influencing its direction. Economic Goals All the world’s economies share three main goals: 1. Growth 2. High employment 3. Price stability Let’s take a closer look at each of these goals, both to find out what they mean and to show how we determine whether they’re being met. Economic Growth One purpose of an economy is to provide people with goods and services—cars, computers, video games, houses, rock concerts, fast food, amusement parks. One way in which economists measure the performance of an economy is by looking at a widely used measure of total output called gross domestic product (GDP). GDP is defined as the market value of all goods and services produced by the economy in a given year. In the United States, it’s calculated by the Department of Commerce. GDP includes only those goods and services produced domestically; goods produced outside the country are excluded. GDP also includes only those goods and services that are produced for the final user; intermediate products are excluded. For example, the silicon chip that goes into a computer (an intermediate product) would not count, even though the finished computer would. By itself, GDP doesn’t necessarily tell us much about the state of the economy. But change in GDP does. If GDP (after adjusting for inflation) goes up, the economy is growing. If it goes down, the economy is contracting. 28 The Business Cycle The economic ups and downs resulting from expansion and contraction constitute the business cycle. A typical cycle runs from three to five years but could last much longer. Though typically irregular, a cycle can be divided into four general phases of prosperity, recession, depression (which the cycle generally skips), and recovery: ? During prosperity, the economy expands, unemployment is low, incomes rise, and consumers buy more products. Businesses respond by increasing production and offering new and better products. ? Eventually, however, things slow down. GDP decreases, unemployment rises, and because people have less money to spend, business revenues decline. This slowdown in economic activity is called a recession. Economists often say that we’re entering a recession when GDP goes down for two consecutive quarters. ? Generally, a recession is followed by a recovery in which the economy starts growing again. ? If, however, a recession lasts a long time (perhaps a decade or so), while unemployment remains very high and production is severely curtailed, the economy could sink into a depression. Though not impossible, it’s unlikely that the United States will experience another severe depression like that of the 1930s. The federal government has a number of economic tools (some of which we’ll discuss shortly) with which to fight any threat of a depression. Full Employment To keep the economy going strong, people must spend money on goods and services. A reduction in personal expenditures for things like food, clothing, appliances, automobiles, housing, and medical care could severely reduce GDP and weaken the economy. Because most people earn their spending money by working, an important goal of all economies is making jobs available to everyone who wants one. In principle, full employment occurs when everyone who wants to work has a job. In 29 practice, we say that we have ?full employment? when about 95 percent of those wanting to work are employed. The Unemployment Rate The U.S. Department of Labor tracks unemployment and reports the unemployment rate: the percentage of the labor force that’s unemployed and actively seeking work. The unemployment rate is an important measure of economic health. It goes up during recessionary periods because companies are reluctant to hire workers when demand for goods and services is low. Conversely, it goes down when the economy is expanding and there is high demand for products and workers to supply them. Figure 1.10 “The U.S. Unemployment Rate, 1970–2010” traces the U.S. unemployment rate between 1970 and 2010. If you want to know the current unemployment rate, go to the CNNMoney Web site (CNNMoney.com) and click on ?Economy? and then on ?Job Growth.? Figure 1.10 The U.S. Unemployment Rate, 1970–2010 30 Price Stability A third major goal of all economies is maintaining price stability. Price stability occurs when the average of the prices for goods and services either doesn’t change or changes very little. Rising prices are troublesome for both individuals and businesses. For individuals, rising prices mean you have to pay more for the things you need. For businesses, rising prices mean higher costs, and, at least in the short run, businesses might have trouble passing on higher costs to consumers. When the overall price level goes up, we have inflation. Figure 1.11 “The U.S. Inflation Rate, 1960–2010” shows inflationary trends in the U.S. economy since 1960. When the price level goes down (which rarely happens), we have deflation. Figure 1.11 The U.S. Inflation Rate, 1960–2010 The Consumer Price Index The most widely publicized measure of inflation is the consumer price index (CPI), which is reported monthly by the Bureau of Labor Statistics. The CPI measures the rate of inflation by determining price changes of a hypothetical basket of goods, such as food, housing, clothing, medical care, appliances, automobiles, and so forth, bought by a typical household. 31 The CPI base period is 1982 to 1984, which has been given an average value of 100. Table 1.1 “Selected CPI Values, 1950–2010” gives CPI values computed for selected years. The CPI value for 1950, for instance, is 24. This means that $1 of typical purchases in 1982 through 1984 would have cost $0.24 in 1950. Conversely, you would have needed $2.18 to purchase the same $1 worth of typical goods in 2010. The difference registers the effect of inflation. In fact, that’s what an inflation rate is—the percentage change in a price index. You can find out the current CPI by going to the CNNMoney Web site (CNNMoney.com) and click on ?Economy? and then on ?Inflation (CPI).? Table 1.1 Selected CPI Values, 1950–2010 Year 1950 1960 1970 1980 1990 2000 2001 2002 CPI 24.1 29.1 38.8 82.4 130.7 172.2 177.1 179.9 Year 2003 2004 2005 2006 2007 2008 2009 2010

Learning Activity #1

1. Read Chapter 1. Review the 1.8 Cases and Problems (page 40) and complete the questions. (

2. Post your answer to #4 and 5.


The ?Economy section of the CNNMoney Web site provides current information on a number of economic indicators. Go to http://money.cnn.com and click on ?Economy and then on ?Jobs, and find answers to the following questions:
1. Is the current level of unemployment rising or falling? 2. What do economists expect will happen to unemployment rates in the near future? 3. Is the current level of unemployment a burden or an asset to the economy? In what ways? 4. Do you remember the first dollar you earned? 5. Maybe you earned it delivering newspapers, shoveling snow, mowing lawns, or babysitting. How much do you think that dollar is worth today? Go to the WestEgg site athttp://www.westegg.com/inflation and find the answer to this question. After determining the current value of your first dollar, explain how the calculator was created. (Hint: Apply what you know about CPI.)

------------------------------------------------------------------------------------------------------------------------------------------------------------------------------


1. Read Chapter 2. Review and complete the Exercises on page 34. (Due Thursday, 11:59pm)

2. Post a summary of your answers to items 1-6 of your Business Conduct and Ethics

1. (AACSB) Analysis
You‘re the CEO of a company that sells golf equipment, including clubs, bags, and balls. When your company was started and had only a handful of employees, you were personally able to oversee the conduct of your employees. But with your current workforce of nearly fifty, it‘s time to prepare a formal code of conduct in which you lay down some rules that employees must follow in performing job-related activities. As a model for your own code, you‘ve decided to use Macy‘s Code of Business Conduct and Ethics.
Go to the company‘s Web site (http://www.federated- fds.com/investors/governance/documents/code_of_business_conduct_and_ethics.pdf) to view its posted code of business conduct.
Your document won‘t be as thorough as Macy‘s, but it will cover the following areas: (1) conflicts of interest; (2) acceptance of gifts, services, or entertainment; (3) protection of confidential information; (4) use of company funds or assets for personal purposes; (5) competing fairly and ethically; and (6) adherence to code. Draw up a code of conduct for your company.

2. (AACSB) Reflective Skills
Think of someone whom you regard as an ethical leader. It can be anyone connected with you—a businessperson, educator, coach, politician, or family member. Explain why you believe the individual is ethical in his or her leadership. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
This text was adapted by The Saylor Foundation under a Creative
Commons Attribution-NonCommercial-ShareAlike 3.0 License without 
attribution as requested by the work’s original creator or licensee.   
1
 



  
 
 
2
 
 
Chapter 1
The Foundations of 
Business 
Why Is Apple Successful? 
In 1976 Steve Jobs and Steve Wozniak created their first computer, the Apple I.
 They
invested a mere $1,300 and set up business in Jobs’s garage. Three decades later,
their business—Apple Inc.—has become one of the world’s most influential and
successful companies. Did you ever wonder why Apple flourished while so many other
young companies failed? How did it grow from a garage start-up to a company
generating $65 billion in sales? How was it able to transform itself from a nearly
bankrupt firm to a multinational corporation with locations all around the world? You
might conclude that it was the company’s products, such as the Apple I and II, the
Macintosh, or more recently its wildly popular iPod, iPhone, and iPad. Or you might
decide that it was its people: its dedicated employees and loyal customers. Perhaps you
will decide it was luck—Apple simply was in the right place at the right time. Or maybe
you will attribute the company’s success to management’s willingness to take calculated
risks. Perhaps you will attribute Apple’s initial accomplishments and reemergence to its
cofounder, the late Steve Jobs. After all, Jobs was instrumental in the original design of
the Apple I and, after being ousted from his position with the company, returned to save
the firm from destruction and lead it onto its current path.

Before we decide what made Apple what it is today and what will propel it into a
successful future, let’s see if you have all the facts about the possible choices: its 
[1]
 
products, its customers, luck, willingness to take risks, or Steve Jobs. We’re confident
that you’re aware of Apple’s products and understand that ?Apple customers are a loyal
bunch. Though they’re only a small percentage of all computer users, they make up for
it with their passion and outspokenness.? 
3
 
[2]
 We believe you can understand the role that
luck or risk taking could play in Apple’s success. But you might like to learn more about
Steve Jobs, the company’s cofounder and former CEO, before arriving at your final
decision.

Growing up, Jobs had an interest in computers. He attended lectures at HewlettPackard
after
school
and
worked
for
the
company
during
the
summer
months.
He
took

a
job
at
Atari
after
graduating
from
high
school
and
saved
his
money
to
make
a

pilgrimage
to
India
to
search
for
spiritual
enlightenment.
Following
his
India
trip,
he

attended
Steve
Wozniak’s
?Homebrew
Computer
Club?
meetings,
where
the
idea
for

building
a
personal
computer
surfaced.

[3]
?Many colleagues describe Jobs as a brilliant
man who could be a great motivator and positively charming. At the same time his drive
for perfection was so strong that employees who did not meet his demands are faced
with blistering verbal attacks.? 
[4]
 Not everyone at Apple appreciated Jobs’s brilliance
and ability to motivate. Nor did they all go along with his willingness to do whatever it
took to produce an innovative, attractive, high-quality product. So at age thirty, Jobs
found himself ousted from Apple by John Sculley, whom Jobs himself had hired as
president of the company several years earlier. It seems that Sculley wanted to cut
costs and thought it would be easier to do so without Jobs around. Jobs sold $20 million
of his stock and went on a two-month vacation to figure out what he would do for the
rest of his life. His solution: start a new personal computer company called NextStep. In
1993, he was invited back to Apple (a good thing, because neither his new company nor
Apple was doing well).

Steve Jobs was definitely not humble, but he was a visionary and had a right to be
proud of his accomplishments. Some have commented that ?Apple’s most successful 
 
days have occurred with Steve Jobs at the helm.? 
4
 
[5]
 Jobs did what many successful
CEOs and managers do: he learned, adjusted, and improvised.
[6]
 Perhaps the most
important statement that can be made about him is this: he never gave up on the
company that once turned its back on him. So now you have the facts. Here’s a
multiple-choice question that you’ll likely get right: Apple’s success is due to (a) its
products, (b) its customers, (c) luck, (d) willingness to take risks, (e) Steve Jobs, or (f)
some combination of these options.
 
[1] This vignette is based on an honors thesis written by Danielle M. Testa, ?Apple, Inc.: An Analysis of
the Firm’s Tumultuous History, in Conjunction with the Abounding Future? (Lehigh University), November
18, 2007.
[2] Ellen Lee, ?Faithful, sometimes fanatical Apple customers continue to push the boundaries of
loyalty,? San Francisco Chronicle, March 26, 2006.
[3] Lee Angelelli, ?Steve Paul Jobs,? http://ei.cs.vt.edu/~history/Jobs.html (accessed January 21, 2012).
[4] Lee Angelelli, ?Steve Paul Jobs,? http://ei.cs.vt.edu/~history/Jobs.html (accessed January 21, 2012).
[5] Cyrus Farivar, ?Apple’s first 30 years; three decades of contributions to the computer
industry,? Macworld, June 2006, 2.
[6] Dan Barkin, ?He made the iPod: How Steve Jobs of Apple created the new millennium’s signature
invention,? Knight Ridder Tribune Business News, December 3, 2006, 1. 
 


1.1 Introduction 
 
As the story of Apple suggests, today is an interesting time to study business. Advances
in technology are bringing rapid changes in the ways we produce and deliver goods and
services. The Internet and other improvements in communication (such as
smartphones, video conferencing, and social networking) now affect the way we do
business. Companies are expanding international operations, and the workforce is more
diverse than ever. Corporations are being held responsible for the behavior of their
executives, and more people share the opinion that companies should be good
corporate citizens. Plus—and this is a big plus—businesses today are facing the
lingering effects of what many economists believe is the worst financial crisis since the 
 
Great Depression. 
[1]
 Economic turmoil that began in the housing and mortgage
industries as a result of troubled subprime mortgages quickly spread to the rest of the
economy. In 2008, credit markets froze up and banks stopped making loans.
Lawmakers tried to get money flowing again by passing a $700 billion Wall Street
bailout, yet businesses and individuals were still denied access to needed credit.
Without money or credit, consumer confidence in the economy dropped and consumers
cut back their spending. Businesses responded by producing fewer products, and their
sales and profits dropped. Unemployment rose as troubled companies shed the most
jobs in five years, and 760,000 Americans marched to the unemployment lines. 
 The
stock market reacted to the financial crisis and its stock prices dropped by 44 percent
while millions of Americans watched in shock as their savings and retirement accounts
took a nose dive. In fall 2008, even Apple, a company that had enjoyed strong sales
growth over the past five years, began to cut production of its popular iPhone. Without
jobs or cash, consumers would no longer flock to Apple’s fancy retail stores or buy a
prized iPhone. 
[3]
 Things have turned around for Apple, which reported blockbuster
sales for 2011 in part because of strong customer response to the iPhone 4S. But not
all companies or individuals are doing so well. The economy is still struggling,
unemployment is high (particularly for those ages 16 to 24), and home prices remain
low.

As you go through the course with the aid of this text, you’ll explore the exciting world of
business. We’ll introduce you to the various activities in which businesspeople
engage—accounting, finance, information technology, management, marketing, and
operations. We’ll help you understand the roles that these activities play in an
organization, and we’ll show you how they work together. We hope that by exposing
you to the things that businesspeople do, we’ll help you decide whether business is right
for you and, if so, what areas of business you’d like to study further.
 
5
 
[2]
 
[1] Jon Hilsenrath, Serena Ng, and Damian Paletta, ?Worst Crisis Since ’30s, With No End Yet in
Sight,? Wall Street Journal, Markets, September 18,
2008,http://online.wsj.com/article/SB122169431617549947.html (accessed January 21, 2012).
[2] ?How the Economy Stole the
Election,? CNN.com,http://money.cnn.com/galleries/2008/news/0810/gallery.economy_election/index.html
(accessed January 21, 2012).
[3] Dan Gallagher, ?Analyst says Apple is cutting back production as economy weakens,?MarketWatch,
November 3, 2008, http://www.marketwatch.com/news/story/apple-cutting-back-iphoneproduction/story.aspx?guid=%7B7F2B6F99-D063-4005-87ADD8C36009F29B%7D&dist=msr_1
(accessed
January
21,
2012).



 

1.2 Getting Down to Business
 
LEARNING OBJECTIVE 
1. Identify the main participants of business, the functions that most businesses
perform, and the external forces that influence business activities. 

A business is any activity that provides goods or services to consumers for the purpose
of making a profit. When Steve Jobs and Steve Wozniak created Apple Computer in
Jobs’s family garage, they started a business. The product was the Apple I, and the
company’s founders hoped to sell their computers to customers for more than it cost to
make and market them. If they were successful (which they were), they’d make a profit.
Before we go on, let’s make a couple of important distinctions concerning the terms in
our definitions. First, whereas Apple produces and sells goods (Mac, iPhone, iPod,
iPad), many businesses provide services. Your bank is a service company, as is your
Internet provider. Hotels, airlines, law firms, movie theaters, and hospitals are also
service companies. Many companies provide both goods and services. For example,
your local car dealership sells goods (cars) and also provides services (automobile
repairs).
Second, some organizations are not set up to make profits. Many are established to
provide social or educational services. Such not-for profit (or nonprofit) 
6
 
 
organizations include the United Way of America, Habitat for Humanity, the Boys and
Girls Clubs, the Sierra Club, the American Red Cross, and many colleges and
universities. Most of these organizations, however, function in much the same way as a
business. They establish goals and work to meet them in an effective, efficient manner.
Thus, most of the business principles introduced in this text also apply to nonprofits.
 
Business Participants and Activities 
Let’s begin our discussion of business by identifying the main participants of business
and the functions that most businesses perform. Then we’ll finish this section by
discussing the external factors that influence a business’s activities.
 
Participants 
Every business must have one or more owners whose primary role is to invest money in
the business. When a business is being started, it’s generally the owners who polish the
business idea and bring together the resources (money and people) needed to turn the
idea into a business. The owners also hire employees to work for the company and help
it reach its goals. Owners and employees depend on a third group of participants—
customers. Ultimately, the goal of any business is to satisfy the needs of its customers
in order to generate a profit for the owners.
 
Functional Areas of Business 
The activities needed to operate a business can be divided into a number of functional
areas: management, operations, marketing, accounting, and finance. Let’s briefly
explore each of these areas.
 
Management 
Managers are responsible for the work performance of other
people. Management involves planning for, organizing, staffing, directing, and
controlling a company’s resources so that it can achieve its goals. Managers plan by 
7
 
 
setting goals and developing strategies for achieving them. They organize activities and
resources to ensure that company goals are met. They staff the organization with
qualified employees and direct them to accomplish organizational goals. Finally,
managers design controls for assessing the success of plans and decisions and take
corrective action when needed.
 
Operations 
All companies must convert resources (labor, materials, money, information, and so
forth) into goods or services. Some companies, such as Apple, convert resources
into tangible products—Macs, iPhones, iPods, iPads. Others, such as hospitals, convert
resources into intangible products—health care. The person who designs and oversees
the transformation of resources into goods or services is called an operations manager.
This individual is also responsible for ensuring that products are of high quality.
 
Marketing 
Marketing consists of everything that a company does to identify customers’ needs and
designs products to meet those needs. Marketers develop the benefits and features of
products, including price and quality. They also decide on the best method of delivering
products and the best means of promoting them to attract and keep customers. They
manage relationships with customers and make them aware of the organization’s desire
and ability to satisfy their needs.
 
Accounting 
Managers need accurate, relevant, timely financial information, and accountants provide
it. Accountants measure, summarize, and communicate financial and managerial
information and advise other managers on financial matters. There are two fields of
accounting. Financial accountants prepare financial statements to help users, both
inside and outside the organization, assess the financial strength of the 
8
 
 
company. Managerial accountants prepare information, such as reports on the cost of
materials used in the production process, for internal use only.
 
Finance 
Finance involves planning for, obtaining, and managing a company’s funds. Finance
managers address such questions as the following: How much money does the
company need? How and where will it get the necessary money? How and when will it
pay the money back? What should it do with its funds? What investments should be
made in plant and equipment? How much should be spent on research and
development? How should excess funds be invested? Good financial management is
particularly important when a company is first formed, because new business owners
usually need to borrow money to get started.


Figure 1.2 Business and Its Environment 
9
 
 
 

External Forces that Influence Business Activities 
Apple and other businesses don’t operate in a vacuum: they’re influenced by a number
of external factors. These include the economy, government, consumer trends, and
public pressure to act as good corporate citizens. Figure 1.2 "Business and Its
Environment" sums up the relationship among the participants in a business, its
functional areas, and the external forces that influence its activities. One industry that’s
clearly affected by all these factors is the fast-food industry. A strong economy means
people have more money to eat out at places where food standards are monitored by
a government agency, the Food and Drug Administration. Preferences for certain types
of foods are influenced by consumer trends (eating fried foods might be OK one year
and out the next). Finally, a number of decisions made by the industry result from
its desire to be a good corporate citizen. For example, several fast-food chains have
responded to environmental concerns by eliminating Styrofoam containers. 
 As you
move through this text, you’ll learn more about these external influences on business.
(Section 1.3 "What Is Economics?" will introduce in detail one of these external
factors—the economy.)
 
  KEY TAKEAWAYS 
? The main participants in a business are its owners, employees, and customers. 
? Businesses are influenced by such external factors as the economy, government,
consumer trends, and public pressure to act as good corporate citizens. 
? The activities needed to run a business can be divided into five functional areas:
1. Management involves planning, organizing, staffing, directing, and controlling 
resources to achieve organizational goals.
2. Operations transforms resources (labor, materials, money, and so on) into 
products.
3. Marketing works to identify and satisfy customers’ needs.
4. Finance involves planning for, obtaining, and managing company funds. 
10
 
[1]
 
5. Accounting entails measuring, summarizing, and communicating financial and
managerial information. 
  
EXERCISES 
1. (AACSB) Analysis
The Martin family has been making guitars out of its factory in Nazareth, Pennsylvania, 
factory for more than 150 years. In 2004, Martin Guitar was proud to produce its
millionth instrument. Go to http://www.martinguitar.com to link to the Martin Guitar Web
site and read about the company’s long history. You’ll discover that, even though it’s a
family-run company with a fairly unique product, it operates like any other company.
Identify the main activities or functions of Martin Guitar’s business and explain how each
activity benefits the company. 
2. (AACSB) Analysis
Name four external factors that have an influence on business. Give examples of the 
ways in which each factor can affect the business performance of two companies: WalMart
and
Ford.

  
[1] David Baron, ?Facing-Off in Public,? Stanford Business, April 15,
2006,http://www.gsb.stanford.edu/news/bmag/sbsm0308/feature_face_off.shtml (accessed January 21,
2012). 

 

1.3 What Is Economics?
 
LEARNING OBJECTIVES 
1. Define economics and identify factors of production.
2. Explain how economists answer the three key economics questions.
3. Compare and contrast economic systems. 
11
 
 
 
To appreciate how a business functions, we need to know something about the
economic environment in which it operates. We begin with a definition of economics and
a discussion of the resources used to produce goods and services.
 
Resources: Inputs and Outputs 
Economics is the study of the production, distribution, and consumption of goods and
services. Resources are the inputs used to produce outputs. Resources may include
any or all of the following: 
? Land and other natural resources 
? Labor (physical and mental) 
? Capital, including buildings and equipment 
? Entrepreneurship
Resources are combined to produce goods and services. Land and natural resources
provide the needed raw materials. Labor transforms raw materials into goods and
services. Capital (equipment, buildings, vehicles, cash, and so forth) are needed for the
production process. Entrepreneurship provides the skill and creativity needed to bring
the other resources together to produce a good or service to be sold to the marketplace.
Because a business uses resources to produce things, we also call these
resources factors of production. The factors of production used to produce a shirt would
include the following: 
? The land that the shirt factory sits on, the electricity used to run the plant, and the
raw cotton from which the shirts are made 
? The laborers who make the shirts 
? The factory and equipment used in the manufacturing process, as well as the money
needed to operate the factory 
? The entrepreneurship skill used to coordinate the other resources to initiate the
production process and the distribution of the goods or services to the marketplace 
 
12
 
 
Input and Output Markets 
Many of the factors of production (or resources) are provided to businesses by
households. For example, households provide businesses with labor (as workers), land
and buildings (as landlords), and capital (as investors). In turn, businesses pay
households for these resources by providing them with income, such as wages, rent,
and interest. The resources obtained from households are then used by businesses to
produce goods and services, which are sold to the same households that provide
businesses with revenue. The revenue obtained by businesses is then used to buy
additional resources, and the cycle continues. This circular flow is described in Figure
1.3 "The Circular Flow of Inputs and Outputs", which illustrates the dual roles of
households and businesses: 
? Households not only provide factors of production (or resources) but also consume
goods and services. 
? Businesses not only buy resources but also produce and sell both goods and
services. 
Figure 1.3 The Circular Flow of Inputs and Outputs 
13
 
 

The Questions Economists Ask 
14
 
 
Economists study the interactions between households and businesses and look at the
ways in which the factors of production are combined to produce the goods and
services that people need. Basically, economists try to answer three sets of questions:
1. What goods and services should be produced to meet consumers’ needs? In what 
quantity? When should they be produced?
2. How should goods and services be produced? Who should produce them, and what 
resources, including technology, should be combined to produce them?
3. Who should receive the goods and services produced? How should they be 
allocated among consumers?
 
Economic Systems 
 
The answers to these questions depend on a country’s economic system—the means
by which a society (households, businesses, and government) makes decisions about
allocating resources to produce products and about distributing those products. The
degree to which individuals and business owners, as opposed to the government, enjoy
freedom in making these decisions varies according to the type of economic system.
Generally speaking, economic systems can be divided into two systems: planned
systems and free market systems.
 
Planned Systems 
In a planned system, the government exerts control over the allocation and distribution
of all or some goods and services. The system with the highest level of government
control is communism. In theory, a communist economy is one in which the government
owns all or most enterprises. Central planning by the government dictates which goods
or services are produced, how they are produced, and who will receive them. In
practice, pure communism is practically nonexistent today, and only a few countries
(notably North Korea and Cuba) operate under rigid, centrally planned economic
systems.

Under socialism, industries that provide essential services, such as utilities, banking,
and health care, may be government owned. Other businesses are owned privately.
Central planning allocates the goods and services produced by government-run
industries and tries to ensure that the resulting wealth is distributed equally. In contrast,
privately owned companies are operated for the purpose of making a profit for their
owners. In general, workers in socialist economies work fewer hours, have longer
vacations, and receive more health care, education, and child-care benefits than do
workers in capitalist economies. To offset the high cost of public services, taxes are
generally steep. Examples of socialist countries include Sweden and France.
 
Free Market System 
15
 
 
The economic system in which most businesses are owned and operated by individuals
is the free market system, also known as capitalism. As we will see next, in a free
market, competition dictates how goods and services will be allocated. Business is
conducted with only limited government involvement. The economies of the United
States and other countries, such as Japan, are based on capitalism.
 
How Economic Systems Compare 
In comparing economic systems, it’s helpful to think of a continuum with communism at
one end and pure capitalism at the other, as in Figure 1.4 "The Spectrum of Economic
Systems". As you move from left to right, the amount of government control over
business diminishes. So, too, does the level of social services, such as health care,
child-care services, social security, and unemployment benefits.

Figure 1.4 The Spectrum of Economic Systems 
 
Mixed Market Economy 
Though it’s possible to have a pure communist system, or a pure capitalist (free market)
system, in reality many economic systems are mixed. A mixed market economy relies
on both markets and the government to allocate resources. We’ve already seen that this
is what happens in socialist economies in which the government controls selected major
industries, such as transportation and health care, while allowing individual ownership of
other industries. Even previously communist economies, such as those of Eastern
Europe and China, are becoming more mixed as they adopt capitalistic characteristics 
16
 
 
 
and convert businesses previously owned by the government to private ownership
through a process called privatization.
 
The U.S. Economic System 
Like most countries, the United States features a mixed market system: though the U.S.
economic system is primarily a free market system, the federal government controls
some basic services, such as the postal service and air traffic control. The U.S.
economy also has some characteristics of a socialist system, such as providing social
security retirement benefits to retired workers.

The free market system was espoused by Adam Smith in his book The Wealth of
Nations, published in 1776. 
[1]
 According to Smith, competition alone would ensure that
consumers received the best products at the best prices. In the kind of competition he
assumed, a seller who tries to charge more for his product than other sellers won’t be
able to find any buyers. A job-seeker who asks more than the going wage won’t be
hired. Because the ?invisible hand? of competition will make the market work effectively,
there won’t be a need to regulate prices or wages.

Almost immediately, however, a tension developed among free market theorists
between the principle of laissez-faire—leaving things alone—and government
intervention. Today, it’s common for the U.S. government to intervene in the operation
of the economic system. For example, government exerts influence on the food and
pharmaceutical industries through the Food and Drug Administration, which protects
consumers by preventing unsafe or mislabeled products from reaching the market.
To appreciate how businesses operate, we must first get an idea of how prices are set
in competitive markets. Thus, Section 1.4 "Perfect Competition and Supply and
Demand" begins by describing how markets establish prices in an environment
of perfect competition.
 
17
 
 
KEY TAKEAWAYS 
? Economics is the study of the production, distribution, and consumption of goods
and services. 
? Economists address these three questions: (1) What goods and services should be
produced to meet consumer needs? (2) How should they be produced, and who
should produce them? (3) Who should receive goods and services? 
? The answers to these questions depend on a country’s economic system. The
primary economic systems that exist today are planned and free market systems. 
? In a planned system, such as communism and socialism, the government exerts
control over the production and distribution of all or some goods and services. 
? In a free market system, also known as capitalism, business is conducted with
only limited government involvement. Competition determines what goods and
services are produced, how they are produced, and for whom. 
 
EXERCISES 
1. If you started a business that made surfboards, what factors of production would you
need to make your product? Where would you get them? Where would you find the
money you’d need to pay for additional resources? 
2. Which three key questions do economists try to answer? Will answers to these
questions differ, depending on whether they’re working in the United States or in
Cuba? Explain your answer. 
 
[1] According to many scholars, The Wealth of Nations not only is the most influential book on freemarket
capitalism
but
remains
relevant
today.


 
1.4 Perfect Competition and Supply and
Demand 
18
 
 
 
LEARNING OBJECTIVE 
1. Describe perfect competition, and explain how supply and demand interact to set
prices in a free market system. 
 
Under a mixed economy, such as we have in the United States, businesses make
decisions about which goods to produce or services to offer and how they are priced.
Because there are many businesses making goods or providing services, customers
can choose among a wide array of products. The competition for sales among
businesses is a vital part of our economic system. Economists have identified four types
of competition—perfect competition, monopolistic competition, oligopoly, and monopoly.
We’ll introduce the first of these—perfect competition—in this section and cover the
remaining three in the following section.
 
Perfect Competition 
Perfect competition exists when there are many consumers buying a standardized
product from numerous small businesses. Because no seller is big enough or influential
enough to affect price, sellers and buyers accept the going price. For example, when a
commercial fisher brings his fish to the local market, he has little control over the price
he gets and must accept the going market price.
 
The Basics of Supply and Demand 
To appreciate how perfect competition works, we need to understand how buyers and
sellers interact in a market to set prices. In a market characterized by perfect
competition, price is determined through the mechanisms of supply and demand. Prices
are influenced both by the supply of products from sellers and by the demand for
products by buyers.
 
19
 
 
To illustrate this concept, let’s create a supply and demand schedule for one particular
good sold at one point in time. Then we’ll define demand and create a demand
curve and define supply and create a supply curve. Finally, we’ll see how supply and
demand interact to create an equilibrium price—the price at which buyers are willing to
purchase the amount that sellers are willing to sell.
 
Demand and the Demand Curve 
Demand is the quantity of a product that buyers are willing to purchase at various
prices. The quantity of a product that people are willing to buy depends on its price.
You’re typically willing to buy less of a product when prices rise and more of a product
when prices fall. Generally speaking, we find products more attractive at lower prices,
and we buy more at lower prices because our income goes further.

Figure 1.6 The Demand Curve 
20
 
 
Using this logic, we can construct a demand curve that shows the quantity of a product
that will be demanded at different prices. Let’s assume that the diagram in Figure 1.6
"The Demand Curve" represents the daily price and quantity of apples sold by farmers 
 
at a local market. Note that as the price of apples goes down, buyers’ demand goes up.
Thus, if a pound of apples sells for $0.80, buyers will be willing to purchase only fifteen
hundred pounds per day. But if apples cost only $0.60 a pound, buyers will be willing to
purchase two thousand pounds. At $0.40 a pound, buyers will be willing to purchase
twenty-five hundred pounds.
 
Supply and the Supply Curve 
Supply is the quantity of a product that sellers are willing to sell at various prices. The
quantity of a product that a business is willing to sell depends on its price. Businesses
are more willing to sell a product when the price rises and less willing to sell it when
prices fall. Again, this fact makes sense: businesses are set up to make profits, and
there are larger profits to be made when prices are high.

Figure 1.7 The Supply Curve 
21
 
 
Now we can construct a supply curve that shows the quantity of apples that farmers
would be willing to sell at different prices, regardless of demand. As you can see 
 
in Figure 1.7 "The Supply Curve", the supply curve goes in the opposite direction from
the demand curve: as prices rise, the quantity of apples that farmers are willing to sell
also goes up. The supply curve shows that farmers are willing to sell only a thousand
pounds of apples when the price is $0.40 a pound, two thousand pounds when the price
is $0.60, and three thousand pounds when the price is $0.80.
 
Equilibrium Price 
We can now see how the market mechanism works under perfect competition. We do
this by plotting both the supply curve and the demand curve on one graph, as we’ve
done in Figure 1.8 "The Equilibrium Price". The point at which the two curves intersect
is the equilibrium price. At this point, buyers’ demand for apples and sellers’ supply of
apples is in equilibrium.

Figure 1.8 The Equilibrium Price 
22
 
 
You can see in Figure 1.8 "The Equilibrium Price" that the supply and demand curves
intersect at the price of $0.60 and quantity of two thousand pounds. Thus, $0.60 is the 
 
equilibrium price: at this price, the quantity of apples demanded by buyers equals the
quantity of apples that farmers are willing to supply. If a farmer tries to charge more than
$0.60 for a pound of apples, he won’t sell very many and his profits will go down. If, on
the other hand, a farmer tries to charge less than the equilibrium price of $0.60 a pound,
he will sell more apples but his profit per pound will be less than at the equilibrium price.

What have we learned in this discussion? We’ve learned that without outside influences,
markets in an environment of perfect competition will arrive at an equilibrium point at
which both buyers and sellers are satisfied. But we must be aware that this is a very
simplistic example. Things are much more complex in the real world. For one thing,
markets rarely operate without outside influences. Sometimes, sellers supply more of a
product than buyers are willing to purchase; in that case, there’s a surplus. Sometimes,
they don’t produce enough of a product to satisfy demand; then we have a shortage.
Circumstances also have a habit of changing. What would happen, for example, if
income rose and buyers were willing to pay more for apples? The demand curve would
change, resulting in an increase in equilibrium price. This outcome makes intuitive
sense: as demand increases, prices will go up. What would happen if apple crops were
larger than expected because of favorable weather conditions? Farmers might be willing
to sell apples at lower prices. If so, the supply curve would shift, resulting in another
change in equilibrium price: the increase in supply would bring down prices.
 
KEY TAKEAWAYS 
? In a free market system, buyers and sellers interact in a market to set prices. 
? When the market is characterized by perfect competition, many small companies
sell identical products. Because no company is large enough to control price, each
simply accepts the market price. The price is determined by supply and demand. 
? Supply is the quantity of a product that sellers are willing to sell at various prices. 
? Demand is the quantity of a product that buyers are willing to purchase at various
prices. 
23
 
 
? The quantity of a product that people will buy depends on its price: they’ll buy more
when the price is low and less when it’s high. 
? Price also influences the quantity of a product that producers are willing to supply:
they’ll sell more of a product when prices are high and less when they’re low.  
? In a competitive market, the decisions of buyers and sellers interact until the market
reaches an equilibrium price—the price at which buyers are willing to buy the same
amount that sellers are willing to sell. 
 
EXERCISE 
(AACSB) Analysis
You just ran across three interesting statistics: (1) the world’s current supply of oil is 
estimated to be 1.3 trillion barrels; (2) the worldwide use of oil is thirty billion barrels a
year; and (3) at this rate of consumption, we’ll run out of oil in forty-three years.
Overcoming an initial sense of impending catastrophe, you remember the discussion of
supply and demand in this chapter and realize that things aren’t as simple as they
seem. After all, many factors affect both the supply of oil and the demand for products
made from it, such as gasoline. These factors will influence when (and if) the world runs
out of oil.  
Answer the following questions, and provide explanations for your answers:
1. What’s the major factor that affects the supply of oil? (Hint: It’s the same major factor 
affecting the demand for oil.)
2. If producers find additional oil reserves, what will happen to the price of oil?
3. If producers must extract oil from more-costly wells, what will happen to the price 
that you pay to fill up your gas tank?
4. If China’s economy continues to expand rapidly, what will happen to the price of oil?
5. If drivers in the United States start favoring fuel-efficient cars over SUVs, will gas be 
cheaper or more expensive?
6. In your opinion, will oil producers be able to supply enough oil to meet the increasing 
 
 
 
demand for oil-related products, such as gasoline? 
24
 
 
1.5 Monopolistic Competition, Oligopoly, and
Monopoly
 
LEARNING OBJECTIVE 
1. Describe monopolistic competition, oligopoly, and monopoly. 
Economists have identified four types of competition—perfect competition, monopolistic
competition, oligopoly, and monopoly. Perfect competition was discussed in the last
section; we’ll cover the remaining three types of competition here. 
Monopolistic Competition 
In monopolistic competition, we still have many sellers (as we had under perfect
competition). Now, however, they don’t sell identical products. Instead, they
sell differentiated products—products that differ somewhat, or are perceived to differ,
even though they serve a similar purpose. Products can be differentiated in a number of
ways, including quality, style, convenience, location, and brand name. Some people
prefer Coke over Pepsi, even though the two products are quite similar. But what if
there was a substantial price difference between the two? In that case, buyers could be
persuaded to switch from one to the other. Thus, if Coke has a big promotional sale at a
supermarket chain, some Pepsi drinkers might switch (at least temporarily). 
How is product differentiation accomplished? Sometimes, it’s simply geographi cal; you
probably buy gasoline at the station closest to your home regardless of the brand. At
other times, perceived differences between products are promoted by advertising
designed to convince consumers that one product is different from another—and better
than it. Regardless of customer loyalty to a product, however, if its price goes too high,
the seller will lose business to a competitor. Under monopolistic competition, therefore,
companies have only limited control over price. 
 
Oligopoly 
Oligopoly means few sellers. In an oligopolistic market, each seller supplies a large
portion of all the products sold in the marketplace. In addition, because the cost of
starting a business in an oligopolistic industry is usually high, the number of firms
entering it is low. 
Companies in oligopolistic industries include such large-scale enterprises as automobile
companies and airlines. As large firms supplying a sizable portion of a market, these 
25
 
 
companies have some control over the prices they charge. But there’s a catch: because
products are fairly similar, when one company lowers prices, others are often forced to
follow suit to remain competitive. You see this practice all the time in the airline industry:
When American Airlines announces a fare decrease, Continental, United Airlines, and
others do likewise. When one automaker offers a special deal, its competitors usually
come up with similar promotions. 
 
Monopoly 
In terms of the number of sellers and degree of competition, monopolies lie at the
opposite end of the spectrum from perfect competition. In perfect competition, there are
many small companies, none of which can control prices; they simply accept the market
price determined by supply and demand. In a monopoly, however, there’s only one
seller in the market. The market could be a geographical area, such as a city or a
regional area, and doesn’t necessarily have to be an entire country. 
There are few monopolies in the United States because the government limits them.
Most fall into one of two categories: natural and legal. Natural monopolies include
public utilities, such as electricity and gas suppliers. Such enterprises require huge
investments, and it would be inefficient to duplicate the products that they provide. They
inhibit competition, but they’re legal because they’re important to society. In exchange
for the right to conduct business without competition, they’re regulated. For instance,
they can’t charge whatever prices they want, but they must adhere to government controlled
prices.
As
a
rule,
they’re
required
to
serve
all
customers,
even
if doing
so
isn’t

cost
efficient.

A legal monopoly arises when a company receives a patent giving it exclusive use of
an invented product or process. Patents are issued for a limited time, generally twenty
years.
[12]
During this period, other companies can’t use the invented product or process
without permission from the patent holder. Patents allow companies a certain period to
recover the heavy costs of researching and developing products and technologies. A
classic example of a company that enjoyed a patent-based legal monopoly is Polaroid,
which for years held exclusive ownership of instant-film technology.
26
 
[13]
 Polaroid priced
the product high enough to recoup, over time, the high cost of bringing it to market.
Without competition, in other words, it enjoyed a monopolistic position in regard to
pricing. 
K E Y  T A K E A W A Y S  
? There are four types of competition in a free market system: perfect competition,
monopolistic competition, oligopoly, and monopoly. 
 
? Under monopolistic competition, many sellers offer differentiated products—
products that differ slightly but serve similar purposes. By making consumers aware
of product differences, sellers exert some control over price. 
? In an oligopoly, a few sellers supply a sizable portion of products in the market.
They exert some control over price, but because their products are similar, when
one company lowers prices, the others follow. 
? In a monopoly, there is only one seller in the market. The market could be a
geographical area, such as a city or a regional area, and does not necessarily have
to be an entire country. The single seller is able to control prices. 
? Most monopolies fall into one of two categories: natural and legal. 
? Natural monopolies include public utilities, such as electricity and gas suppliers.
They inhibit competition, but they’re legal because they’re important to society.  
? A legal monopoly arises when a company receives a patent giving it exclusive use
of an invented product or process for a limited time, generally twenty years. 
E X E R C I S E  
Identify the four types of competition, explain the differences among them, and provide
two examples of each. (Use examples different from those given in the text.) 

[12] 
United States Patent and Trademark Office, General Information Concerning Patents, April 15,
2006, http://www.uspto.gov/web/offices/pac/doc/general/index.html#laws (accessed January 21, 2012). 
[13] 
Mary Bellis, ?Inventors-Edwin Land-Polaroid Photography-Instant Photography/Patents,? April 15,
2006, http://inventors.about.com/library/inventors/blpolaroid.htm (accessed January 21, 2012). 

 
1.6 Measuring the Health of the Economy
 
LEARNING OBJECTIVE 
1. Understand the criteria used to assess the status of the economy. 

Every day, we are bombarded with economic news. We’re told that the economy is
struggling, unemployment is high, home prices are low, and consumer confidence is 
27
 
 
down. As a student learning about business, and later as a business manager, you
need to understand the nature of the U.S. economy and the terminology that we use to
describe it. You need to have some idea of where the economy is heading, and you
need to know something about the government’s role in influencing its direction.
 
Economic Goals 
All the world’s economies share three main goals:
1. Growth
2. High employment
3. Price stability
Let’s take a closer look at each of these goals, both to find out what they mean and to
show how we determine whether they’re being met.
 
Economic Growth 
One purpose of an economy is to provide people with goods and services—cars,
computers, video games, houses, rock concerts, fast food, amusement parks. One way
in which economists measure the performance of an economy is by looking at a widely
used measure of total output called gross domestic product (GDP). GDP is defined as
the market value of all goods and services produced by the economy in a given year. In
the United States, it’s calculated by the Department of Commerce. GDP includes only
those goods and services produced domestically; goods produced outside the country
are excluded. GDP also includes only those goods and services that are produced for
the final user; intermediate products are excluded. For example, the silicon chip that
goes into a computer (an intermediate product) would not count, even though the
finished computer would.

By itself, GDP doesn’t necessarily tell us much about the state of the economy.
But change in GDP does. If GDP (after adjusting for inflation) goes up, the economy is
growing. If it goes down, the economy is contracting. 
28
 
 
 
The Business Cycle 
The economic ups and downs resulting from expansion and contraction constitute
the business cycle. A typical cycle runs from three to five years but could last much
longer. Though typically irregular, a cycle can be divided into four general phases
of prosperity, recession, depression (which the cycle generally skips), and recovery: 
? During prosperity, the economy expands, unemployment is low, incomes rise, and
consumers buy more products. Businesses respond by increasing production and
offering new and better products. 
? Eventually, however, things slow down. GDP decreases, unemployment rises, and
because people have less money to spend, business revenues decline. This
slowdown in economic activity is called a recession. Economists often say that we’re
entering a recession when GDP goes down for two consecutive quarters. 
? Generally, a recession is followed by a recovery in which the economy starts
growing again. 
? If, however, a recession lasts a long time (perhaps a decade or so), while
unemployment remains very high and production is severely curtailed, the economy
could sink into a depression. Though not impossible, it’s unlikely that the United
States will experience another severe depression like that of the 1930s. The federal
government has a number of economic tools (some of which we’ll discuss shortly)
with which to fight any threat of a depression. 
 
Full Employment 
To keep the economy going strong, people must spend money on goods and services.
A reduction in personal expenditures for things like food, clothing, appliances,
automobiles, housing, and medical care could severely reduce GDP and weaken the
economy. Because most people earn their spending money by working, an important
goal of all economies is making jobs available to everyone who wants one. In
principle, full employment occurs when everyone who wants to work has a job. In 
29
 
 
practice, we say that we have ?full employment? when about 95 percent of those
wanting to work are employed.
 
The Unemployment Rate 
The U.S. Department of Labor tracks unemployment and reports the
unemployment rate: the percentage of the labor force that’s unemployed and actively
seeking work. The unemployment rate is an important measure of economic health. It
goes up during recessionary periods because companies are reluctant to hire workers
when demand for goods and services is low. Conversely, it goes down when the
economy is expanding and there is high demand for products and workers to supply
them.
Figure 1.10 "The U.S. Unemployment Rate, 1970–2010" traces the U.S. unemployment
rate between 1970 and 2010. If you want to know the current unemployment rate, go to
the CNNMoney Web site (CNNMoney.com) and click on ?Economy? and then on ?Job
Growth.?

Figure 1.10 The U.S. Unemployment Rate, 1970–2010 
 
30
 
 
 
Price Stability 
A third major goal of all economies is maintaining price stability. Price stability occurs
when the average of the prices for goods and services either doesn’t change or
changes very little. Rising prices are troublesome for both individuals and businesses.
For individuals, rising prices mean you have to pay more for the things you need. For
businesses, rising prices mean higher costs, and, at least in the short run, businesses
might have trouble passing on higher costs to consumers. When the overall price level
goes up, we have inflation. Figure 1.11 "The U.S. Inflation Rate, 1960–2010" shows
inflationary trends in the U.S. economy since 1960. When the price level goes down
(which rarely happens), we have deflation.

Figure 1.11 The U.S. Inflation Rate, 1960–2010 
 
The Consumer Price Index 
The most widely publicized measure of inflation is the consumer price index (CPI),
which is reported monthly by the Bureau of Labor Statistics. The CPI measures the rate
of inflation by determining price changes of a hypothetical basket of goods, such as
food, housing, clothing, medical care, appliances, automobiles, and so forth, bought by
a typical household.
 
31
 
 
 
The CPI base period is 1982 to 1984, which has been given an average value of
100. Table 1.1 "Selected CPI Values, 1950–2010" gives CPI values computed for
selected years. The CPI value for 1950, for instance, is 24. This means that $1 of typical
purchases in 1982 through 1984 would have cost $0.24 in 1950. Conversely, you would
have needed $2.18 to purchase the same $1 worth of typical goods in 2010. The
difference registers the effect of inflation. In fact, that’s what an inflation rate is—the
percentage change in a price index.

You can find out the current CPI by going to the CNNMoney Web site (CNNMoney.com)
and click on ?Economy? and then on ?Inflation (CPI).?

Table 1.1 Selected CPI Values, 1950–2010 
Year 1950 1960 1970 1980 1990 2000 2001 2002 
CPI 24.1 29.1 38.8 82.4 130.7 172.2 177.1 179.9 
Year 2003 2004 2005 2006 2007 2008 2009 2010

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