Chapter 2
How Economic
Issues Affect
Business
Learning Objectives
1.
2.
3.
4.
5.
Capitalism and free markets
Supply, demand and equilibrium
Socialism versus communism
Canada’s mixed economy
Canada’s economic system

Economic indicators, productivity &
business cycle
Economic Links to Business
o
o
o
Economic concepts are the basis for
most major business decisions
Both the global economy and the
Canadian economy have an effect on
Canadian business
Economics is the study of how a
country produces and distributes its
goods and services
Four “What’s” of
an Economic System
o
o
o
o
What is produced?
What amount is produced?
What is the method of output
distribution?
What determines rate of economic
growth?
Adapted from: Edwin Mansfield Economics (New York: W.W. Norton, 1976), p.8
Economic Theory of Wealth
Creation: Adam Smith

The Wealth of Nations in 1776
defined Capitalism as a system of
rights and freedoms:





Right to Make a Profit
Right to Private Property
Right to Buy or Sell
Freedom to Compete
Freedom from Government
Interference
Keynesian Economics



Oxford economist John Maynard
Keynes advocated government
spending to stimulate the economy
He proposed that governments should
borrow in bad times and spend to
help the economy
He stated that governments should
pay off debt in good times to reduce
inflation and get ready for “bad
times”
Three Economic Systems
Mixed
Socialism
(Highly Controlled)
(Little Control)
Communism
Capitalism
Different Economic Systems

Capitalism - individuals seeking
profits produce goods and services




Goods and services are sold in a free
market to those who can pay for them
Communism - the government
decides what will be produced and
who will consume that production
Socialism - some free market and
some government allocation
Most countries have Mixed Economy
The Foundations of Capitalism


How a free market works - many
buyers and sellers trading freely
determine prices at which they will
exchange goods and services
How prices are determined - the
constant interplay between supply
and demand determines an
equilibrium price at which a
transaction will occur
Free-Market Competition
Monopolistic
Oligopoly
Competition
One
Many
Perfect
Competition
Monopoly
Sellers
Supply Curve
High
Price(P)
S
Low
Quantity(S)
High
Demand Curve
High
Price(P)
D
Low
Quantity(D)
High
Equilibrium Point
Surplus
High
Market Equilibrium
Price
S
Low
Shortage
Quantity
D
High
Limits of Free-Markets




Inequality of Wealth- Causes
National & World Tension
Greed Compromises Ethics
Potential Environmental
Damage
Limitations Push Country
towards Socialism =
Government Regulation
Recent Economic Trends



Canada - we have a mixed economy,
as the government has always played
a major role in the economy
Communist countries - they have
moved to capitalist forms of
economies to improve their
standards of living
Socialist countries - they have
reduced government’s role in their
economies
Economics and Business



Strong Economy - Business
prospers
Weak Economy - Business
declines
Gross Domestic Product
(GDP) - this is the total of
goods and services produced
by the economy. This is how
we measure how well the
economy is doing!
Canadian Economy



Key Economic Indicators
Productivity
Business Cycles




Recession
Depression
Recovery
Stabilization



Fiscal Policy
Monetary Policy
National Debt
Key Economic Indicators






Gross Domestic Product (GDP)
Unemployment rate
Price Indexes
 Consumer Price Index(CPI)
 Producer Price Index(PPI)
Housing starts
Commodity prices
Stock markets
U.S. Unemployment (%)
16
14
12
10
8
6
4
2
0
1940
Source: U.S. Bureau of Labor Statistics
1950
1960
1970
1980
1990
2000
2002
Industrialized
Nations’ Tax Rate
U.S.
Austria/Japan
Italy
Canada
Germany
Spain/Sweden
France
Finland
Denmark
0%
Source: Parade Magazine, Apr. 12, 1998.
10%
20%
30%
40%
50%
60%
70%
Number of Workers per Social
Security Recipient
6
5
4
3
2
1
0
1960
Source: Investors.com
2000
2075(Est.)
Change in Labor Productivity- U.S.
9
8
7
6
5
4
3
2
1
0
-1
1950
1960
Source: U.S. Dept. of Commerce, Bureau of Labor Statistics
1970
1980
1990
2000
2002
Distribution of GDP




Employees get their share of GDP via
wages
Employers get their share of GDP via
profits
Governments get their share of GDP
via taxes
What is a fair “share of the pie” is a
source for constant debate - it
depends on one’s perspective
The Issue of Unemployment



Unemployment in Canada remained
stubbornly high during the 1990s
Recession, globalization and
technological change have contributed
to the unemployment problem
There are different types of
unemployment



Cyclical
Seasonal
Structural
Inflation and the CPI


Consumer Price Index (CPI) is the index
economists use to measure the effects
of inflation. Inflation was high prior to
the 1990s, but it has been about 2%
per year in recent years
The Rule of 72 means that dividing 72
by the rate of inflation equals the
number of years that prices will double
due to inflation. Currently, it would
take 36 years for prices to double due
to inflation
What Makes Up The
Consumer Price Index?
Recreation Apparel
5%
6%
Medical Care/
Insurance
7%
Medical Care
6%
Other
5%
Housing & Util.
39%
Food &
Beverage
16%
SOURCE: U.S. Bureau of Labor Statistics
Transportation
18%
Consumer Price Index
200
180
160
140
120
100
80
60 1982-84
40
20
0
1940
Source: U.S. Dept. of Labor, Bureau of Labor Statistics
= 100
1950
1960
1970
1980
1990
2000
2002
The National Debt



Governments adopted Keynesian
economics and deficit spending. They
forgot the second part of Keynesian
economics -- they did not pay down
the debt in good times
By the 1990s many governments had
accumulated large national debts
Canada has finally balanced its budget
after 25 years of deficits and recently
we have had budget surpluses. Tax
cuts are possible?
Government Intervention




In 1929 the stock market crashed
The crash led to a severe, prolonged
Depression
The hardship forced governments to
abandon Adam Smith’s “laissez faire”
approach to economics
Governments looked for ways to
intervene in the economy to alleviate
the suffering
The Outlook for our Economy




We are all painfully aware that
unemployment has remained
stubbornly high in the 1990s
The late 1990s saw improved economic
activity and job prospects
Canada is in the early stages of longterm economic growth with excellent
job prospects for those entering the
workforce
Those with education and the ability to
learn new skills will be successful