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BUSINESS MANAGEMENT 061

TOPIC 1: UNDERSTANDING
THE BUSINESS SYSTEM

The Business
Environment

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After reading this chapter, you should be able to:
1. Define the nature of business and identify its main goals and
functions.
2. Describe the external environments of business and discuss how
these environments affect the success or failure of any
organisation.
3.

4.

Describe the different types of global economic systems

according to the means by which they control the factors of
production.
Show how markets, demand, and supply affect resource
distribution.

LL EE AARR NN II NN GG OO BB JJ EE CC TT II VV EE SS (contd)
(contd)
After reading this chapter, you should be able to:

5. Identify the elements of private enterprise and

explain the various degrees of competition in the
economic system.
6. Explain the importance of the economic
environment to business and identify the factors
used to evaluate the performance of an economic
system.

The Concept of Business and Profit

Business
An organisation that provides goods or services that are then sold
to earn profits.

Profits
The difference between a businesss revenues and its expenses.
The rewards owners get for risking their money and time.

Consumer Choice and Demand

The freedom of consumers to choose how to satisfy their wants
and needs.
The freedom of business owners to decide how to meet those
wants and needs.

Opportunity and Enterprise

Success in business requires spotting a promising opportunity and
then developing a good plan for capitalising on it.

The Concept of Business and Profit (cont.)

The Benefits of Business
Provision of goods and services
Employment of workers
Innovation and opportunities
Increased quality of life and standard of living
Enhanced personal incomes of owners and
stockholders
Tax payments support government
Support for charities and community leadership

The External Environments of Business

External Environment
Everything outside an organisations
boundaries that might affect it
The domestic business environment
The global business environment
The technological environment
The political-legal environment
The sociocultural environment
The economic environment

The External Environments of Business (cont.)

Domestic Business Environment
The environment in which a firm conducts its
operations and derives its revenues by:
Seeking to be close to its customers
Establishing strong relationships with its suppliers
Distinguishing itself from its competitors

The External Environments of Business (cont.)

Global Business Environment
The international forces that affect a business:
International trade agreements
International economic conditions
Political unrest
International market opportunities
Suppliers
Cultures
Competitors
Currency values

The External Environments of Business (cont.)

Technological Environment
All the ways by which firms create value for
their constituents:
Human knowledge
Work methods
Physical equipment
Electronics and telecommunications
Various business activity processing systems

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The External Environments of Business (cont.)

Political-Legal Environment
The regulatory relationship between business and the government
(legal system) and its agencies that define what organisations can
and cant do:
Product identification laws
Local zoning requirements
Advertising practices
Safety and health considerations
Acceptable standards of business conduct
Pro- or anti-business sentiment in government and political stability
are also important considerations, especially for international firms.

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The External Environments of Business (cont.)

Sociocultural Environment
The customs, mores, values, and demographic
characteristics of the society in which an
organisation functions
Sociocultural processes determine the goods,
services, and standards of business conduct a
society is likely to accept

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The External Environments of Business (cont.)

Economic Environment
The relevant conditions that exist in the economic
system in which a company operates
Examples:
If an economy is doing well enough that most people have
jobs, a growing company may find it necessary to pay higher
wages and offer more benefits in order to attract workers from
other companies.
If many people in an economy are looking for jobs, a firm may
be able to pay less and offer fewer benefits.

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Economic Systems
Economic System
A nations system for allocating its resources among
its citizens, both individuals and organisations

Factors of Production

Labour: Human resources

Capital: Financial resources
Entrepreneurs: Persons who risk starting a business
Physical resources: Tangible things used to conduct
business
Information resources: Data and other information
used by businesses

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Types of Economic Systems

Planned Economy (Command economy)
A centralised government controls all or most factors
of production and makes all or most production and
allocation decisions for the economy.

Market Economy
Individual producers and consumers control
production and allocation by creating combinations
of supply and demand.

Market
A mechanism of exchange between buyers and sellers
of a good or service.

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Planned Economies
Communism
A system Karl Marx & Friedrich Engels
envisioned in which individuals would
contribute according to their abilities and
receive benefits according to their needs.
The government owns and operates all factors of
production.
The government assigns people to jobs and owns
all businesses and controls business decisions.

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Market Economics
Capitalism
The government supports private ownership and encourages
entrepreneurship.
Individuals choose where to work, what to buy, and how much to
pay.
Producers choose who to hire, what to produce, and how much to
charge.

Mixed Market Economy

Features characteristics of both planned and market economies.
Privatisation: The process of converting government
enterprises into privately owned companies.
Socialism: The government owns and operates select major
industries such as banking and transportation. Smaller businesses
are privately owned.

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The Economics of Market Systems

Demand
The willingness and ability of buyers to purchase a product (a
good or a service).

Supply
The willingness and ability of producers to offer a good or service
for sale.

The Laws of Demand and Supply in a Market Economy

Demand: Buyers will purchase (demand) more of a product as
its price drops and less of a product as its price increases.
Supply: Producers will offer (supply) more of a product for sale
as its price rises and less of a product as its price drops.

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Surpluses and Shortages

Surplus
A situation in which the quantity supplied
exceeds the quantity demanded
Causes losses

Shortage
A situation in which the quantity demanded
will be greater than the quantity supplied
Causes lost profits
Invites increased competition

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Private Enterprise in a Market Economy

Private Enterprise System
Allows individuals to pursue their own interests
with minimal government restriction.

Elements of a Private Enterprise System

Private property rights
Freedom of choice
Profits
Competition

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Degrees of Competition
Perfect Competition
Prices are determined by supply and demand
because no single firm is powerful enough to
influence the price of its product.
All firms in an industry are small.
The number of firms in the industry is large.

Principles of perfect competition:

Buyers view all products as identical.
Buyers and sellers know the prices that others are paying and
receiving in the marketplace.
It is easy for firms to enter or leave the market.
Prices are set exclusively by supply and demand and accepted
by both sellers and buyers.

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Degrees of Competition (Cont.)

Monopolistic Competition
There are numerous sellers trying to differentiate
their products from those of competitors so as to
have some control over price.
There are many sellers, though fewer than in pure
competition.
Sellers can enter or leave the market easily.
The large number of buyers relative to sellers
applies potential limits to prices.

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Degrees of Competition (Cont.)

Oligopoly
An industry with only a few large sellers.
Entry by new competitors is hard because large capital
investment is needed.
The actions of one firm can significantly affect the
sales of every other firm in the industry.
The prices of comparable products are usually similar.
As the trend toward globalization continues, most
experts believe that oligopolies will become
increasingly prevalent.

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Degrees of Competition (Cont.)

Monopoly
An industry or market that has only one producer (or
else is so dominated by one producer that other firms
cannot compete with it).
The sole supplier enjoys complete control over the prices of its
products; its only constraint is a decrease in consumer demand
due to increased prices.

Natural monopolies: Industries in which one firm

can most efficiently supply all needed goods or
services; typically allowed and regulated by legislated
acts and governmental agencies.
Example: Electric company

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Economic Indicators
Economic Indicators
Statistics that show whether an economic system is
strengthening, weakening, or remaining stable
Measure key goals of the economic system:
economic growth and economic stability
Economic growth indicators
Aggregate output, standard of living, gross domestic product,
and productivity

Economic stability indicators

Inflation and unemployment

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Economic Growth, Aggregate Output,

and Standard of Living
Business Cycle
The pattern of short-term ups and downs (or, better,
expansions and contractions) in an economy.

Aggregate Output
Growth during the business cycle is measured by the total
quantity of goods and services produced by an economic
system during a given period.

Standard of Living
The total quantity and quality of goods and services that
consumers can purchase with the currency used in their
economic system.

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Economic Indicators (cont.)

Gross Domestic Product (GDP)
An aggregate output measure of the total value of all
goods and services produced within a given period
by a national economy through domestic factors of
production.
If GDP is going up, aggregate output is going up; if aggregate
output is going up, the nation is experiencing economic growth.

Gross National Product (GNP)

The total value of all goods and services produced by
a national economy within a given period, regardless
of where the factors of production are located.

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Economic Indicators (cont.)

Real Growth Rate
The growth rate of GDP adjusted for inflation
and changes in the value of the countrys
currency
Growth depends on output increasing at a faster rate
than population.

Real GDP
GDP that has been adjusted to account for
changes in currency values and price changes.

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Economic Indicators (cont.)

Nominal GDP
GDP measured in current dollars or with all
components valued at current prices.

GDP per Capita

A reflection of the standard of living: GDP per

capita means GDP per person.
It is a better measure of the economic well-being
of the average person than GDP itself.

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Economic Indicators (cont.)

Purchasing Power Parity
The principle that exchange rates are set so that the
prices of similar products in different countries are
about the same.
Indicates what people can buy with the financial
resources allocated to them by their respective
economic systemsa better sense of standards of
living across the globe.

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FIGURE 1.3 Purchasing Power Parity Big Mac Index

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Economic Growth
Productivity
A measure of economic growth that compares
how much product a system produces with the
resources needed to produce that product.
If more product is produced with fewer factors of
production, the price of the product decreases.
The standard of living in an economy improves
through increases in productivity.

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Economic Growth (cont.)

Balance of Trade
The economic value of all the products a country
exports minus the economic value of its imported
products.
Positive balance of trade: When a country exports (sells to
other countries) more than it imports (buys from other
countries).
Negative balance of trade: When a country imports more
than it exports. Commonly called a trade deficit.

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Balance of Trade
How does a trade deficit affect economic
growth?

The deficit exists because the amount of money

spent on foreign products has not been paid in full.
In effect, therefore, it is borrowed money, and
borrowed money costs more money in the form of
interest.
The money that flows out of the country to pay off
the deficit cannot be used to invest in productive
enterprises, either at home or overseas.

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FIGURE 1.4 US Balance of Trade

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Economic Growth (cont.)

National Debt
The amount of money that the government owes its
creditors.
Financed by borrowing in the form of bonds: Securities through
which the government promises to pay buyers certain amounts
of money by specified future dates.
Government competition with potential borrowers for available
loan money reduces private borrowing for investments that
would increase productivity.

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Economic Growth (cont.)

Stability
A condition in which the amount of money available in
an economic system and the quantity of goods and
services produced in it are growing at about the same
rate.

Inflation
Inflation occurs when the amount of money injected into
an economy exceeds the increase in actual output,
resulting in price increases exceeding purchasing power
increases.
Inflation rate: The percentage change in a price index such as the
CPI.

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Economic Indicators
Consumer Price Index (CPI)
A measure of the prices of typical products
purchased by consumers living in urban areas
Compared against base periodan arbitrarily selected
time period against which other time periods are
compared.

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Economic Growth (cont.)

Unemployment
The level of joblessness among people actively
seeking work in an economic system
Low unemploymenta shortage of labor available for businesses
to hire; results in higher wages.
Higher wages reduce hiring, which increases unemployment;
results in lower wages.

Cyclical Unemployment
Businesses continuing to eliminate jobs during a
business cycle downturn cause more reduced
revenues and further job losses.

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Economic Growth (cont.)

Recession
A period during which aggregate output, as
measured by real GDP, declines

Depression
A prolonged and deep recession

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Managing the Economy

Fiscal Policy
The ways in which a government collects and spends revenues.
Tax rates can play an important role in fiscal policy.

Monetary Policy
The manner in which a government controls its money supply.
Working mainly through the Federal Reserve System, the
government can influence banks willingness to lend money and
prompt interest rates to go up or down.

Stabilisation Policy
Coordinating fiscal and monetary policies to smooth fluctuations in
output and unemployment and to stabilise prices.