The Business Environment: Economics



Pre Reading Comment  - Chapter One

Pay particular attention to the discussion of the laws of supply and demand



Lecture Notes


Lecture Summary

The key components of this lecture are:

  • Understanding the basics of what is a business and what makes a business different from other organizations
  • Understanding the basics of the U.S. economic system including
    • Supply and demand forces



What is Business?


Business is book definition “any organization that provides goods or services for profit” 


What does this mean?

Taking inputs “factors of production”(land, human  capital, physical capital, technology) and combining them in such a way as to make something others will pay for – hopefully paying more than what it cost you to develop, produce, promote and distribute the good or service.



Activity 1: What are the inputs that McDonalds uses to produce their products?  What about the way they combine resources has resulted in their being so profitable?



Individuals who accepts both the risks and the opportunities involved in creating and operating a new business venture are know as entrepreneurs



Activity 2: What are the purposes of profit?  Can there be too much profit?  Too little profit?



·        Incentive for  investors to take risk of investing

·        Investment in new plant and equipment



While this course will focus on for-profit organizations – much of the discussion is relevant to not-for-profit and governmental organizations.



Activity 3: How are profits distributed – or used by an organization?



  • To the owners or investors – dividends
  • Shared with employees – profit sharing plans
  • Retained to reinvest in the organization
  • Philanthropic uses – charity
  • Cost advantages – lower costs of goods for consumers



History of Business


There have been very small, family-operated business entities for a very long time – dating to earliest recorded history


However business structure took a critical turn about  300 years ago.  The first business organizations that separated ownership (stockholders) from managers were formed.  These entities limited the liability of the owners to their investment in the organization.  (Dutch companies that invested in trading ships)


The separation of ownership from management and the limitation on owner liability allowed these organizations to grow much larger and to have an ongoing life than would be possible with a company owned by a single individual.


This evolution also gave rise to the professional manager – a very good thing for many of you as that is what you are likely to become.


Question:  How many of you or your families own stock?  Do you or your family members have a 401K retirement program at work?  Do you plan on owning stock some day?


Economic Systems


Two economic systems have been utilized in the last 100 years



Capitalism Or Socialism


Socialism (book refers to this as a “planned economy”) – A system where the means of production (the capital) is owned by the state and the state dictates the nature of the economic activity.  Karl Marx is often identified as the developer of this approach.  As he stated, this approach is based on “from each according to his abilities to each according to his needs”


This system makes a positive statement about human nature “we will all work hard for the common good.” Unfortunately, there is no personal incentive in this system to work hard, the incentive is to claim the largest need (least effort, highest reward). Therefore, this system has never been associated with high levels of economic growth or profit.



Capitalism  (book refers to as a “market economy”) – System where the means of production are owned by individuals and the nature of economic activity is  determined by the interaction of supply and demand forces working through the price of goods and services.  This system is based on the assumption that each individual will act in order to increase their income and well being – will maximize their satisfaction in economic terms.


This system makes a somewhat less positive statement that humans are motivated by self interest. However, it gives individuals the strongest possible incentives to work and produce, thereby creating larger economic output and higher standards of living than socialism.



Over the past years the relative success of these two alternative systems has been demonstrated by the economic collapse of the former Soviet Union and the Economic strength of the market driven economies


“Communism is inherently the equal sharing of misery while capitalism results in the unequal sharing of blessings  - Winston Churchill



Our economy is in reality a mixture of pure market driven capitalism and some central planning (government support for the aero space industry) and some government ownership of the means of production (post offices and roads).


Activity 4:  Consider a restaurant.  What would it take to open a restaurant in a market economy?  What would it take to open the restaurant in a planned economy?




Supply and Demand

The book (pages 12-15) does a good job of reviewing the forces of supply and demand. Crucial to this analysis is the realization that prices call out economic activity: Higher prices will curtail the amount demanded while at the same time generating incentive for suppliers to increase the amount produced (and vice versa). Therefore, it is only when the amount that is demanded is exactly equal to the amount supplied that prices will cease to change and we reach a situation known as economic equilibrium (where there are no forces for change).



Activity 5: Assume that the price and supply/demand for gas in the United States are at equilibrium levels.  What are 10 factors that could cause the price of gas to rise?  What are 10 factors that could cause the price to fall?  Be ready to explain your thinking.




Note our economy uses the supply and demand interaction to allocate scarce resources at the margin.  Do we allocate a  little more or a little less of our organizational resources to making gas, to discovering new ways to increase fuel economy, to use more fuel efficient cars and trucks.  The price mechanism – the Invisible-hand – makes all of theses allocation decisions in a way that maximizes the utility of those involved in our economy.





Opportunity costs – the value of the best alternative that is foregone in order to allocate resources in a particular manner.


As a society there is a tradeoff between the production of physical capital that allows us to produce more in the future and the  production of consumer goods that enhance quality of life today (the opportunity cost)



Economic issues in the Business Plan


Identify the  potential customers for your business (demand) and the competition (supply).  How do you see these forces changing over time?




Summary of Beyond the Book – expectations for the final


You should understand:


  • The separation of ownership from management in businesses and how this occurred
  • The differences between capitalism and socialism, as well as the concept of a mixed economy
  • The relationship between price and supply and demand
  • The concept of price equilibrium
  • The concept of opportunity costs