Chapter 2: Economics - The Creation and Distribution of Wealth

 I. THE IMPORTANCE OF THE STUDY OF ECONOMICS.

 LEARNING GOAL 1. Explain how wealth is created in an economy.

 A. Any change in the economic or political system has a major influence on the success of the business system.

 1. The world economic situation and world politics have a major influence on U.S. business.

 2. The three basic objectives of this chapter are to teach students:

 a. HOW FREE MARKETS WORK.

 b. HOW FREE MARKETS DIFFER FROM GOVERNMENT-CONTROLLED MARKETS.

 c. SOME BASIC ECONOMIC TERMS AND CONCEPTS THAT STUDENTS WILL READ IN BUSINESS PERIODICALS.

 B. WHAT IS ECONOMICS?

 1. ECONOMICS is the study of how society chooses to employ resources to produce various goods and services and to distribute them for consumption among various competing groups and individuals.

 2. There aren't enough known resources merely to divide resources among all nations.

 3. RESOURCE DEVELOPMENT is the study of how to use technology to increase the known resources of the world and to create the conditions that will make better use of those resources.

 C. THE ECONOMIC THEORY OF WEALTH CREATION: ADAM SMITH.

 1. ADAM SMITH advocated creating wealth through entrepreneurship.

 a. Rather than divide fixed resources, Smith envisioned creating more resources so that everyone could be wealthier.

 b. In 1776, Smith wrote a book called THE WEALTH OF NATIONS in which he out lined steps for creating prosperity.

 2. Smith is called the FATHER OF CAPITALISM.

 3. CAPITALISM is an economic system in which all or most of the means of production and distribution are privately owned and operated for profit.

 a. In capitalist countries, businesspeople decide how to use their resources and how much to charge.

 b. No country is purely capitalist, but the FOUNDATION OF THE U.S. IS CAPITAL ISM.

 4. What are the driving forces behind wealth creation, according to Adam Smith?

 a. FREEDOM (to keep the profits from what you produce and sell and freedom to own land).

 b. INCENTIVES. One has much more incentive to work long hours and to work hard when one gets to keep the profit from one's labor. The more one works, or course, the more that gets produced for others (the invisible hand).

 D. THE 'INVISIBLE HAND.'

 1. Adam Smith called the mechanism for creating wealth and jobs an INVISIBLE HAND, which turns self-directed gain into social and economic benefits for all.

 2. Basically, what this meant was that a person working hard to make money for his or her own personal interest would (like an invisible hand) also benefit others.

 a. For example, a farmer trying to make money would grow as many crops as possible.

 b. This provides needed food for others.

 c. If everyone worked hard in his or her own self interest, Smith said, society as a whole would prosper.

 3. Many U.S. businesspeople are becoming concerned about social issues and their obligation to return to society some of what they've earned.

 II. THE HISTORY OF BUSINESS AND ECONOMICS.

 LEARNING GOAL 2. Discuss the major differences between capital ism, socialism, communism, and a mixed economy.

 A. Following the ideas of Adam Smith, business people created more wealth than every before.

 1. Great disparities in wealth began to appear.

 2. Although it is not easy, opportunities to start one's own business have always been there, especially in a free market.

 B. THE SEARCH FOR EQUALITY.

 1. FREE-MARKET CAPITALISM (capitalism without any government regulation) naturally leads to INEQUALITY OF WEALTH.

 2. Free-market capitalism may also lead to environmental damage.

 3. Some government rules and regulations are necessary to protect people and the environment.

 C. THE BIRTH OF COMMUNISM.

 1. KARL MARX decided that workers should take over ownership of businesses and share in the wealth.

 a. He wrote THE COMMUNIST MANIFESTO in 1848, becoming the FATHER OF COMMUNISM.

 b. COMMUNISM is a system where all economic decisions are made by the state and the state owns all the major forms of production.

 2. Communist countries include China, North Korea, and Cuba.

 3. Communism doesn't inspire businesspeople to work hard, and is slowly disappearing as an alternative economic form.

 III. THE ATTRACTION OF SOCIALISM.

 A. SOCIALISM is an economic system based on the premise that some businesses should be owned by the government.

 1. Socialists believe that the GOVERNMENT SHOULD DECIDE:

 a. What gets produced.

 b. How much workers should be paid.

 c. How much trade should take place between and among nations.

 2. Advocates of socialism acknowledge the major benefits of capitalism, but believe that wealth should be more evenly distributed.

 3. Socialism became the economic platform from countries such as Holland, Sweden, and France.

 4. Socialist nations rely heavily on government to provide education, health care, retirement, and care for those not able to work.

 B. THE NEGATIVE CONSEQUENCES OF SOCIALISM.

 1. Socialism creates more equality, but it takes away some work incentives.

 2. The motto of socialism is, 'From each according to his or her ability; to each according to his or her need.'

 3. Marginal tax rates (the rate you pay on the additional money earned after a certain income level) in Sweden once reached 85%.

 4. Socialism did not create the jobs or the wealth that capitalism did.

 C. THE TREND TOWARD MIXED ECONOMIES.

 1. There are two economic systems vying for dominance in the world:

 a. FREE MARKET ECONOMIES.

 (i) The marketplace largely determines what goods and services get produced, who gets them, and how the economy grows.

 (ii) Commonly known as CAPITALISM, these economies are based on the principles of Adam Smith.

 b. COMMAND ECONOMIES.

 (i) The government largely decides what goods and services will be produced, who'll get them, and how the economy will grow.

 (ii) These economies, known as SOCIALISM and COMMUNISM, are based on the principles of Karl Marx.

 2. NO ONE ECONOMIC SYSTEM IS PERFECT BY ITSELF.

 a. Free-market mechanisms weren't responsive enough to a nation's social and economic needs.

 b. Socialism and communism didn't create enough jobs or wealth to keep economies growing fast enough.

 c. No country is purely capitalist or purely capitalist, rather some mix of the two systems.

 d. However, the long-term global trend is toward a BLEND OF CAPITALISM AND SOCIALISM.

 3. MIXED ECONOMIES exist where some allocation of resources is made by the market and some by government.

 4. THE U.S. HAS A MIXED ECONOMY.

 a. There is much debate about the role of government in many parts of the economy.

 b. The basic principles of freedom and opportunity remain so that economic growth is sustainable.

 5. In the U.S., the government serves as a means to supplement the basic capitalist system.

 IV. THE FOUNDATIONS OF CAPITALISM.

 LEARNING GOAL 3. Describe how the free-market system works.

 A. Individuals living in a capitalist system have FOUR BASIC RIGHTS:

 1. THE RIGHT TO PRIVATE PROPERTY.

 2. THE RIGHT TO KEEP ALL OF A BUSINESS'S PROFITS AFTER TAXES.

 3. THE RIGHT TO FREEDOM OF COMPETITION.

 4. THE RIGHT TO FREEDOM OF CHOICE.

 B. HOW FREE MARKETS WORK.

 1. In a free-market system, decisions about what to produce and in what quantities are made by the market.

 2. Consumers send signals to producers what to make, how many, and so on through the mechanism of PRICE.

 3. In the U.S. the price tells producers how much to produce, reducing the changes of a long-term shortage of goods.

 C. HOW PRICES ARE DETERMINED.

 1. SUPPLY refers to the quantity of products that manufacturers or owners are willing to sell at different prices at a specific time.

 a. The amount supplied will increase as the price increases.

 b. The quantity producers are willing to supply a certain prices are illustrated on a SUPPLY CURVE.

 2. DEMAND refers to the quantity of products that people are willing to buy at different prices at a specific time.

 a. The quantity demanded will decrease as the price increases.

 b. The quantity consumers are willing to buy at certain prices are illustrated on a DEMAND CURVE.

 3. THE EQUILIBRIUM PRICE or MARKET PRICE is the price at which the quantity demanded and the quantity supplied are equal.

 4. It is the interaction between supply and demand that determines the market price in the long-run.

 a. If surpluses develop, a signal is sent to sellers to lower the price.

b. If shortages develop, a signal is sent to sellers to increase the price.

 D. COMPETITION WITHIN FREE MARKETS.

 1. Competition exists in different degrees, ranging from perfect to nonexistent.

 2. PERFECT COMPETITION exists when there are many sellers in the market and no seller is large enough to dictate the price of a product.

 a. Sellers produce products that appear to be identical.

 b. There are no true examples of perfect competition, but agricultural products are often used as an example.

 3. MONOPOLISTIC COMPETITION exists when a large number of sellers produce products that are very similar but are perceived by buyers as different.

 a. Product differentiation, making buyers think similar products are different, is a key to success.

 b. Under monopolistic competition, individual sellers set prices.

 c. The fast food industry is an example.

 4. An OLIGOPOLY is a form of competition in which just a few sellers dominate a market.

 a. The initial investment is usually high.

 b. Prices tend to be close to the same.

 c. Examples include breakfast cereal, beer, automobiles, and soft drinks.

 5. A MONOPOLY occurs when there is only one seller for a product or service.

 a. In the U.S. laws prohibit the creation of monopolies, but do permit approved monopolies such as public utilities.

 b. New legislation is likely to result in fewer, larger utilities and lower prices.

 6. Competition works best when ORGANIZATIONS KNOW WHAT CONSUMERS WANT.

 V. WORLD MARKETS: SUPPLY AND DEMAND.

 A. Consumers send signals to producers telling them what they (the consumers) want.

 1. There are interferences to the free exchange of goods and services among countries.

 2. This results in surpluses in some countries and shortages in others.

 B. LIMITATIONS OF THE FREE-MARKET SYSTEM.

 1. Capitalism brought prosperity to the U.S. and much of the world, but it brought inequality as well.

 2. When countries introduced capitalist principles, inequality increased dramatically, causing national and world tension.

 3. Government entities also take a large share of total national output and reallocate it to create more equality.

 4. A major question is, WHAT'S THE PROPER BLEND OF GOVERNMENT AND FREE MARKETS?

 VI. UNDERSTANDING THE ECONOMIC SYSTEM OF THE UNITED STATES.

 A. While most of the world was moving toward freer markets, in recent years the U.S. was moving toward more social programs.

 1. There was much conflict between business leaders and government leaders on issues such as taxes, regulations, and social programs.

 2. Currently the U.S. economic system is in a state of flux.

 B. KEY ECONOMIC INDICATORS.

 LEARNING GOAL 4. Use key terms (e.g., GDP and productivity) to explain the U.S. economic condition.

 1. GROSS DOMESTIC PRODUCT (GDP).

 a. GDP is the total value of a country's out put of goods and services in a given year.

 b. A major influence on the growth of GDP is how productive the work force is.

 c. The major figure used until recently was the GROSS NATIONAL PRODUCT (GNP)-the U.S. adopted GDP to be compatible with the rest of the world.

 2. THE UNEMPLOYMENT RATE.

 a. The UNEMPLOYMENT RATE refers to the number of civilians, 16 years old or older, who are unemployed and tried to find a job within the prior four weeks.

 b. FOUR TYPES OF UNEMPLOYMENT

 (i) FRICTIONAL UNEMPLOYMENT- refers to those people who have quit work because they did not like the job, the boss, or working conditions.

 (ii) STRUCTURAL UNEMPLOYMENT- refers to unemployment caused by restructuring of businesses or by a mismatch between the skills (or location) of job seekers and the requirements (or location) of available jobs(i.e. coal miners in areas where mines have been closed.)

 (iii) CYCLICAL UNEMPLOYMENT-unemployment caused by a recession or similar downturn in the business cycle.

 (iv) SEASONAL UNEMPLOYMENT- unemployment which occurs when the demand for labor varies over the year (i.e. harvesting of crops.)

 3. THE PRICE INDEXES.

 a. The CONSUMER PRICE INDEX (CPI) consists of monthly statistics that measure the pace of inflation or deflation.

 (i) Some government benefits, wages, and interest rates are based on the CPI.

 (ii) However, experts argue that CPI overstates inflation and there is a call for an adjustment of the figure.

 b. The PRODUCER PRICE INDEX (PPI) measures prices at the wholesale level.

 C. DISTRIBUTION OF GDP.

 1. The percentage of GDP taken by all levels of government in the U.S. is around 33%.

 2. When you add in all the fees and sales taxes, the government's share can exceed 50%.

 3. One of the sources of prosperity is in creased productivity.

 D. PRODUCTIVITY IN THE UNITED STATES.

 1. PRODUCTIVITY is the total volume of goods and services one worker can produce in a given period of time.

 2. The same amount of labor producing more goods and services is known as an INCREASE IN PRODUCTIVITY.

 a. An increase in farm productivity used to be the basis of American economic growth.

 b. The use of machines led to the increase in productivity in the manufacturing industry.

 3. We are now focusing on ways to increase productivity in the service sector.

 E. PRODUCTIVITY IN THE SERVICE SECTOR.

 1. The service sector uses machines such as word processors and computers to increase productivity. Actually these machines may add to the quality of the services but not to the output per worker which is the definition of productivity.

 2. New measures of productivity for the service economy need to be developed that include quality as well as quantity of output.

 VII. INFLATION AND THE CONSUMER PRICE INDEX.

 A. INFLATION refers to a general rise in the price level of goods and services over time.

 1. The CPI measures the price of an average market basket of goods for an average family over time.

 2. DISINFLATION describes a condition where the increase in prices is slowing (the inflation rate is declining.)

 3. DEFLATION means that prices are actually declining, occurring when countries produce so many goods that people cannot afford to buy them all.

 B. THE ISSUE OF RECESSION VERSUS INFLATION.

 1. A RECESSION is two consecutive quarters of decline in the GNP.

 2. For years the government has tried to pre vent another recession or depression.

 3. A DEPRESSION is a severe recession.

 VIII. THE ISSUE OF MONETARY POLICY.

 LEARNING GOAL 5. Describe monetary policy and its importance to the economy.

 A. MONETARY POLICY is the management of the money placed into the economy and the management of interest rates.

 1. The Federal Reserve System is responsible for managing the money supply.

 2. The Fed is one of the sources of money in the economy; it can add or subtract money from the economy as it sees fit.

 3. The Federal Reserve System operates independently of the president and Congress and has the goal of keeping the economy growing without causing inflation.

 B. TIGHT VERSUS LOOSE MONETARY POLICY.

 1. The Fed can curb inflation by decreasing the money available and discouraging borrowing.

 a. It does this by cutting the money supply and raising interest rates.

 b. Production is cut back slowing the economy and lowering inflation.

 2. When the Fed 'LOOSENS UP THE MONEY SUPPLY,' it tries to stimulate the economy.

 3. A 'TIGHT MONETARY POLICY' is one in which the Fed is restricting the supply of money.

 IX. THE ISSUE OF FISCAL POLICY.

 LEARNING GOAL 6. Discuss fiscal policy and its importance to the economy.

 A. FISCAL POLICY refers to the Federal government's efforts to keep the economy stable by increasing or decreasing taxes and/or government spending.

 1. For many years, federal expenses have been exceeding federal revenues-the result is an increasing federal debt.

 2. The money paid for interest on the debt is so high that it drains money from the economy.

 B. HOW TAXES AND SPENDING AFFECT BUSINESSPEOPLE.

 1. Higher taxes lower the amount available for investment.

 2. The government is spending more each year, even though the rate of growth in spending is slowing.

 3. Fiscal policy has a major influence of businesses.

 C. THE FEDERAL DEFICIT.

 1. The FEDERAL DEFICIT is the difference between federal revenue and federal spending in any given year.

 2. The NATIONAL DEBT is the sum of all the federal deficits over time.

 D. THE NATIONAL DEBT.

 1. The national debt is now about $6 trillion.

 2. A stack of $1000 bills a mere 4 inches high would make you a millionaire, but the stack would have to be 67 miles high to make you a trillionaire!

 3. The national debt is so high because the government grew faster than the economy's ability to pay for it.

 4. The question is: 'What are our national priorities?' We can't afford everything. Which programs to we keep and which must we cut?

 E. JUST TAX THE RICH.

 1. For years, economic was defined as the allocation of scarce resources among competing groups and individuals.

 a. Feeling among many people is that the rich got rich by exploiting the poor.

 b. Some people suggest increasing taxes on the rich and giving the additional money to the poor.

 c. Such was the thinking behind most socialist governments.

 2. However, there aren't enough wealthy people making enough money to pay for all government programs.

 3. Wealthy people make most of their money from investing in business.

 a. If taxes were increased, that investment money would no longer be there.

 b. Taxing the rich isn't a solution.

 c. The tax burden always falls on the middle class, who are already struggling.

 d. Recent tax bills have cut the taxes on the middle class or offered them more benefits.

 4. The only long-term solution is for the economy to grow.

 a. That increases the size of the economic pie and everyone benefits.

 b. Growth strategies, however, are in conflict with goals of more equality.

 5. The economic goal in the future is to keep the economy growing so:

 a. More and more people can rise up the economic ladder.

 b. Pay their share of taxes.

 c. Cut the federal deficit and debt.