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will study such topics as sports marketing and racing management. “The program will be NASCAR-focused but will have a broad application to all portions of the motor sports industry,” says Philip Bayster, head of the school’s business department. Charlotte, the NASCAR epicenter, is home to about 250 racing teams and 25 specialized media and marketing firms. Pay is anything but the pits. Annual salaries for the region’s 14,000 motor sports jobs, not including drivers, average $72,000. ■ What will you do after graduating from high school? Get a job? Go to college? If you choose to work, you will benefit by receiving a paycheck right away. If you decide to earn a college degree—like the NASCAR-focused degree at Belmont Abbey College—you may give up four years of earning potential. The benefit, however, is that your income after college will be greater than the income you will earn with just a high school diploma. Because resources are scarce, everyone has to make choices. To become a good decision maker, you need to know how to identify the problem and then analyze your alternatives. Finally, you have to make your choice in a way that carefully considers the costs and benefits of each possibility. Icon SMI/Corbis CHAPTER 1 What Is Economics? 19 trade-off alternative that is available whenever a choice is to be made opportunity cost cost of the next-best alternative use of money, time, or resources when making a choice Trade-Offs and Opportunity Cost MAIN Idea Economic choices involve trade-offs and the careful evaluation of opportunity costs. Economics & You When you go shopping, you usually have to make choices, because you cannot afford to buy everything you want. Read on to learn about the terms economists apply to these decisions. There are alternatives and costs to everything we do. In a world where “there is no such thing as a free lunch,” it pays to examine these concepts closely. Trade-Offs Every decision we make has its trade-offs, or alternative choices. One way to help us make decisions is to construct models such as the grid in Figure 1.5. This grid shows how Jesse decides to spend a $100 gift. Jesse likes several alternatives: a video game, concert tickets, an MP3 player, and a replica NFL jersey. At the same time, he realizes that each item has advantages and disadvantages. Some of the items can be used more than once, and some might require his parents’ consent
. Some even have additional costs such as batteries. To help with his decision, Jesse can draw a grid that lists his alternatives and several criteria by which to judge them. Then he evaluates each alternative with a “yes” or “no.” In the end, Jesse chooses the jersey because it satisfies more of his criteria than any other alternative. Using a decision-making grid is one way to analyze an economic problem. It forces you to consider a number of alternatives and the criteria you’ll use to evaluate the alternatives. Finally, it makes you evaluate each alternative based on the criteria you selected. Opportunity Cost People often think of cost in terms of dollars and cents. To an economist, however, cost means more than the price tag on a good or service. Instead, economists think broadly in terms of opportunity cost, the cost of the next-best alternative. When Jesse decided to purchase the jersey, his opportunity cost was the MP3 player—the nextbest choice he gave up. In contrast, trade-offs are all of the other alternatives that he could have chosen. Even time has an opportunity cost, although you cannot always put a monetary value on it. The opportunity cost of reading this economics book, for example, the history paper or math homework that you could not do at the same time. Reading Check Summarizing How are trade-offs and opportunity cost related? Figure 1.5 Jesse’s Decision-Making Grid Alternatives Video game Concert tickets MP3 player NFL jersey Costs $100 or less? Durable? Will parents approve? Future expense unnecessary? Can use anytime? Criteria yes yes yes yes yes no yes yes no yes yes yes yes no no yes no no yes yes A decision-making grid lists alternatives and criteria to help evaluate choices. Economic Analysis What do economists mean when they talk about costs? Production Possibilities MAIN Idea Economies face trade-offs when deciding what goods and services to produce. Economics & You You just learned that you face trade-offs and opportunity costs when making choices. Read on to learn how opportunity cost applies to countries as well as individuals. To illustrate opportunity cost, economists use the production possibilities frontier, a diagram representing various combinations of goods and services an economy can produce when all its resources are in use. In the example in Figure 1.6, a mythical country called Alpha produces two goods—cars and clothing. Identifying Possible Alternatives Even though Alpha produces only two goods, the country has a number of alternatives available to it. For example,
it could choose to use all of its resources to produce 70 units of cars and 300 units of clothing, which is shown as point a in Figure 1.6. Or it could shift some of its resources out of car production and into clothing, thereby moving to point b. Alpha could even choose to produce at point c, which represents all clothing and no cars, or at point e, which is inside the frontier. Alpha has many alternatives available to it, which is why the figure is called a production “possibilities” frontier. Eventually, though, Alpha will have to settle on a single combination such as point a, b, or any other point on or inside the curve, because its resources are limited. Fully Employed Resources All points on the curve such as a, b, and c represent maximum combinations of output that are possible if all resources are fully employed. To illustrate, suppose that Alpha is producing at point a, and the people would like to move to point d, which represents the same amount of cars, but more clothing. As long as all resources are fully employed at point a, there are no extra production possibilities frontier diagram representing the maximum combinations of goods and/or services an economy can produce when all productive resources are fully employed resources available to produce the extra clothing. Therefore, point d cannot be reached, nor can any other point outside the curve. This is why the figure is called a production possibilities “frontier”—to indicate the maximum combinations of goods and services that can be produced. The Cost of Idle Resources If some resources were not fully employed, then it would be impossible for Alpha to reach its maximum potential production. Suppose that Alpha was producing at point b when workers in the clothing industry went on strike. Clothing production would fall, causing total output to change to point e. The opportunity cost of the unemployed resources would be the 100 units of lost clothing production. Production at point e could also be the result of other idle resources, such as factories or land that are available but not being used. As long as some resources are idle, the country cannot produce on its frontier—which is another way of saying that it cannot reach its full production potential. Figure 1.6 Production Possibilities Frontier T HE P RODUCTION P OSSIBILITIES F RONTIER 70 s r a C 40 0 a e d b c 300 Clothing 400 The production possibilities frontier shows the different combinations of two products that can be produced if all resources are fully employed. Economic Analysis Why can production take
place on or inside the frontier? CHAPTER 1 What Is Economics? 21 Figure 1.7 Opportunity Cost O PPORTUNITY C OST 70 s r a C 40 0 a b c 300 400 Clothing When the production for one item increases, the production of other items decreases. In the example shown, the opportunity cost for producing and additional 10 units of clothing is the 30 cars given up. Economic Analysis If Alpha decided to produce units of clothing at point c, what would be the opportunity cost in cars? Figure 1.8 Economic Growth E CONOMIC G ROWTH s r a C d b c a Clothing The only way to expand the production possibilities frontier is to attain economic growth. Economic Analysis What factors make it possible for the economy to grow? Opportunity Cost Suppose that Alpha was producing at point a and that it wanted to move to point b. This is clearly possible as long as point b is not outside the production possibilities frontier. However, Alpha will have to give something up in return. As shown in Figure 1.7, the opportunity cost of producing the 100 additional units of clothing is the 30 units of cars given up. As you can see, opportunity cost applies to almost all activities, and it is not always measured in terms of dollars and cents. For example, you need to balance the time you spend doing homework and the time you spend with your friends. If you decide to spend extra hours on your homework, the opportunity cost of this action is the time that you cannot spend with your friends. You normally have a number of trade-offs available whenever you make a decision, and the opportunity cost of the choice you make is the value of the next best alternative that you give up. Economic Growth The production possibilities frontier represents potential output at a given point in time. Eventually, however, changes may cause the production possibilities frontier to expand. The population may grow, the stock of capital may expand, technology may improve, or productivity may increase. If any of these changes occur, then Alpha will be able to produce more in the future. The effect of economic growth is shown in Figure 1.8. Economic growth, made possible by having more resources or increased productivity, causes the production possibilities frontier to move outward. Economic growth will eventually allow Alpha to produce at point d, which it could not do earlier. Reading Check Synthesizing How can the production possibilities frontier be used to illustrate economic growth? Thinking Like an Economist MAIN Idea Economists use a strategy called cost-benefit analysis to evaluate choices. Economics & You
When you work a complicated math problem, do you ever look at a simplified example to better understand the process? Read on to learn how economists use models to understand complex economic activities. Because economists study how people satisfy seemingly unlimited and competing wants through the careful use of scarce resources, they are concerned with strategies that will help people make the best choices. Two strategies are building models and preparing a cost-benefit analysis. Build Simple Models One of the most important strategies is to build economic models. An economic model is a simplified equation, graph, or figure showing how something works. Simple models can often reduce complex situations to their most basic elements. To illustrate, the production possibility frontiers in this section and the circular flow diagram in Figure 1.3 on page 15 are examples of how complex economic activity can be explained by a simple model. Another basic model is the production possibilities frontier that is illustrated in Figure 1.6 on page 21. Realistically, of course, economies are able to produce more than two goods or services, but the concepts of trade-offs and opportunity costs are easier to illustrate if only two products are examined. As a result, simple models such as these are sometimes all that economists need to analyze or describe an actual situation. It is important to realize that models are based on assumptions, or things we think are true. In general, the quality of a model is no better than the assumptions on which it is based, but a model with simple assumptions is usually easier to understand. In the case of the production possibilities frontier, Image Source/Getty Images economic model simplified version of a complex concept or behavior expressed in the form of an equation, graph, or illustration for example, we assumed that only two goods could be produced. This made the model easier to illustrate and still allowed us to discuss the concepts of trade-offs and opportunity costs. It is also important to keep in mind that models can be revised to make them better. If an economic model helps us to make a prediction that turns out to be right, the model can be used again. If the prediction is wrong, the model might be changed to make better predictions the next time. CAREERS Economist The Work * Collect and analyze data, observe economic trends * Advise businesses and other organizations on such topics as energy costs, inflation, imports, and employment levels * Study economic conditions in the United States or in other countries to estimate the economic effects of new legislation or public policies Qualifications * Strong computer and quantitative skills * Ability to conduct complex research, write reports, and prepare statistical
data * Bachelor’s degree, with a focus on economics and statistics, accounting, or calculus * Master’s degree required for most economists in the private sector Earnings * Median annual earnings: $72,780 Job Growth Outlook * Slower than average Source: Occupational Outlook Handbook, 2006–2007 Edition CHAPTER 1 What Is Economics? 23 Cost-Benefit Analysis Before making any major financial decisions, it is a good idea to weigh the benefits against the costs. How might a business use costbenefit analysis? cost-benefit analysis way of thinking about a choice that compares the cost of an action to its benefits free enterprise economy market economy in which privately owned businesses have the freedom to operate for a profit with limited government intervention standard of living quality of life based on ownership of necessities and luxuries that make life easier Apply Cost-Benefit Analysis Most economic decisions can be evaluated with cost-benefit analysis, a way of comparing the costs of an action to the benefits received. This is what Jesse did when he devised a decision-making grid. This decision can be made subjectively, as when Jesse selected the jersey, or it can be made more objectively, especially if the costs of the various alternatives are different. To illustrate, suppose that you have to make a decision, and you like choices A and B equally. If B costs less, it would be the better choice because you would get more satisfaction per dollar spent. Businesses make investment decisions in exactly this manner, choosing to invest in projects that give the highest return per dollar spent or, in other words, the best cost-benefit ratio. Take Small, Incremental Steps Finally, it also helps to take small, incremental steps toward the final goal. This is especially valuable when we are unsure of the exact cost involved. If the cost turns out to be larger than we anticipated, then the resulting decision can be reversed without too much being lost. Reading Check Explaining How does cost-benefit analysis help make economic decisions? The Road Ahead MAIN Idea The study of economics helps people become better citizens. Economics & You As you become old enough to vote, are you also becoming more aware of current events? Read on to learn how economic issues affect politics. The study of economics does more than explain how people deal with scarcity. Economics also includes the study of how things are made, bought, sold, and used. It provides insight as to how incomes are earned and spent, how jobs are created, and how the economy works on a daily basis. The study of economics
also gives us a better understanding of the workings of a free enterprise economy—one in which consumers and privately owned businesses, rather than the government, make the majority of the WHAT, HOW, and FOR WHOM decisions. Topics and Issues The study of economics will provide you with a working knowledge of the economic incentives, laws of supply and demand, price system, economic institutions, and property rights that make the U.S. economy function. Along the way, you will learn about topics such as unemployment, the business cycle, inflation, and economic growth. You will also examine the role of business, labor, and government in the U.S. economy, as well as the relationship of the United States economy with the international community. All of these topics have a bearing on our standard of living—the quality of life based on the ownership of the necessities and luxuries that make life easier. As you study economics, you will learn how to measure the value of our production and how productivity helps determine our standard of living. You will find, however, that the way the American people make economic decisions is not the only way to make these decisions. 24 UNIT 1 Fundamental Economic Concepts REAL LIFE ADVENTURES © 2004 GarLanco. Reprinted with permission of UNIVERSAL PRESS SYNDICATE. All rights reserved. Student Web Activity Visit the Economics: Principles and Practices Web site at glencoe.com and click on Chapter 1— Student Web Activities to learn more about how economics affects our lives. Economists have identified three basic kinds of economic systems. We will analyze these systems and how their organization affects decision making in the next chapter. Economics for Citizenship The study of economics helps us become better decision makers—in our personal lives as well as in the voting booths. Economic issues are often debated during political campaigns, so we need to understand the issues before deciding which candidate to support. Most of today’s political problems have important economic aspects. For example, is it important to balance the federal budget? How can we best keep inflation in check? What methods can we use to strengthen our economy? The study of economics will not provide you with clear-cut answers to all of these questions, but it will give you a better understanding of the issues involved. Understanding the World Around Us The study of economics helps us understand the complex world around us. This is particularly useful because the world is not as orderly as your economics textbook, for example. Your book is neatly divided into sections for study. In contrast, society is dynamic, and
technology and other innovations always lead to changes. Economics provides a framework for analysis—a structure that helps explain how things are organized. Because this framework describes the incentives that influence behavior, it helps us understand why and how the world changes. In practice, the world of economics is complex and the road ahead is bumpy. As we study economics, however, we will gain a much better appreciation of how we affect the world and how it affects us. Reading Check Determining Cause and Effect How do you think our society would be different if citizens did not study economics? SECTION 3 Review Vocabulary 1. Explain the significance of trade-off, opportunity cost, production possibilities frontier, economic model, cost-benefit analysis, free enterprise economy, and standard of living. Main Ideas 2. Illustrating Imagine you have $50 to spend. What one item would you buy? Complete the graphic organizer below to illustrate your final choice, the opportunity cost of your choice, and the trade-offs. Critical Thinking 4. The BIG Idea Why is it important for governments to understand trade-offs and opportunity costs? Explain in a brief paragraph. 5. Synthesizing How does economics play a part in politics? 6. Analyzing Visuals Study the production possibilities frontier in Figure 1.6 on page 21. What does it mean when the frontier shifts outward? What possible causes exist for such a shift? Trade-offs (choices) Top 2 choices Final choice Applying Economics Opportunity cost 3. Explaining What decision-making strategies do economists recommend using? 7. Economic Way of Thinking Search the newspaper and identify a major economic issue facing your community or state. Identify possible solutions and prepare a decision-making grid to evaluate the alternatives. What decision would you make? Write a short essay in which you explain your choice. CHAPTER 1 What Is Economics? 25 CASE STUDY Gap, Inc. Search for the Perfect Jeans G AP R EVENUES We all have them. And if you don’t, you are probably looking for them—the perfect pair of jeans. Preferably, they are faded, soft, and perfect. In 1969, Don and Doris Fisher opened the first Gap store in San Francisco “to make it easier to find” that perfect pair. This store was only the beginning. Gap, Inc., expanded its consumer market through Banana Republic, Old Navy, and, most recently, Forth and Towne00 ’01 ’02 ’03 ’04 ’05 Year Gap U.S
HOW to produce FOR WHOM to produce Factors of Production Four factors of production are required to produce the things we would like to have. Factors of Production Land: natural resources Capital: tools, equipment, machinery, and factories Labor: people with all their eﬀorts, abilities, and skills Entrepreneurs: risk-taking individuals in search of proﬁts Trade-offs and Opportunity Costs All economic decisions require us to make choices among alternatives. Trade-offs are all the available alternatives. The opportunity cost is the next-best alternative we give up. Trade-offs (choices) Top 2 choices Final choice Opportunity cost CHAPTER 1 What Is Economics? 27 CHAPTER 1 Assessment & Activities Review Content Vocabulary Review the Main Ideas Use the key terms from the list below to complete the sentences that follow. a. capital goods b. consumer goods c. economics d. factors of production e. human capital f. opportunity cost g. scarcity h. services i. utility j. value 1. Economic products designed for final use by people are called _____. 2. The _____ of a CD player can be expressed in dollars and cents. 3. Haircuts and appliance repairs are examples of _____. Section 1 (pages 5–10) 18. Identify the cause and effects of scarcity. 19. Explain how the factors of production relate to one another. 20. Describe the key elements of studying economics. Section 2 (pages 12–17) 21. Define goods, services, and consumers and describe the relationship among the three, using a graphic organizer similar to the one below. Consumers: 4. _____ arises because society does not have enough Goods: Services: resources to produce all the things people would like to have. 5. The _____ of going to a football game instead of working would include the money not earned at your job. 22. Describe the paradox of value. 23. Explain how the circular flow of economic activity 6. _____ is the sum of the skills, abilities, health, and generates wealth in an economy. motivation of people. 7. _____ is another name for the capacity of a product to be useful. 8. The only factors of production that are themselves the result of earlier production are _____. 9. Land, capital, labor, and entrepreneurs are _____. 10. ______ is the study of how people use limited resources to satisfy unlimited wants. 24. Identify two ways to increase productivity. Section 3 (pages 19–25) 25.
Describe how economists view the term cost. 26. Identify the economic concept illustrated by the production possibilities frontier. 27. Describe how economic models help economists develop strategies that help people make economic choices. Review Academic Vocabulary 28. Explain why economic education is important. On a separate sheet of paper, use each of these terms in a sentence that reflects the term’s meaning in the chapter. 11. resource 12. comprehensive 13. transferable 14. accumulation 15. mechanism 16. alternative 17. assumption 28 UNIT 1 Fundamental Economic Concepts Critical Thinking 29. The BIG Idea You have learned that scarcity is the fundamental economic problem for societies. Write a short paragraph explaining how scarcity affects you and your family on a daily basis. 30. Determining Cause and Effect Copy the two diagrams of the production possibilities frontiers shown below. Then write captions that explain what each diagram is showing. E FFECT E FFECT s r a C s r a C Economics: Principles and Practices Web site at glencoe.com and click on Chapter 1—Self-Check Quizzes to prepare for the chapter test. Self-Check Quiz Visit the Math Practice 34. A city administrator with a $100,000 annual budget is trying to decide between fixing potholes or directing traffic after school at several busy intersections. Studies have shown that 15 cars hit potholes every week, causing an average of $200 in damages. Collisions at the intersections are less frequent, averaging one per month at an average cost of $6,000, although none have caused injuries or deaths. Use this information to answer the following questions. a. What are the annual costs from the pothole damage? b. What are the annual costs due to damage from Clothing Clothing collisions? 31. Understanding Cost-Benefit Analysis How would you apply the concept of cost-benefit analysis to the decision whether to finish high school? To further your education beyond high school? To purchase a computer? Explain your results in a few sentences. 32. Evaluating Alternatives Refer to the chapter opener activity on page 4 and evaluate the alternatives in one of the three categories (location, music, refreshments). What criteria will you use? What are the trade-offs? On a separate sheet of paper, illustrate your decision in a decision-making grid similar to the one below. c. Given the size of the annual budget, make your recommendation as to which project should be undertaken. Explain your answer in terms of dollar benefits per dollar spent. Thinking Like an
Economist 35. Use a problem-solving process to gather information about the alternatives, trade-offs, and opportunity costs facing the city administrator in the previous question. Consider the advantages and disadvantages of implementing the possible solutions. Prepare a written summary. Alternatives Criterion 1 Criterion 2 Criterion 3 Criterion 4 Interpreting Cartoons 36. Critical Thinking Look at the cartoon below. How does the message of this cartoon relate to the concepts presented in this chapter? Writing About Economics 33. Persuasive Writing Research a recent school funding levy for your school district that was not approved. Find out what changes the school district had to implement to adjust to the reduced funding levels and reduced resources available to schools. Write a two-page paper in which you evaluate the choices. www.CartoonStock.com CHAPTER 1 What Is Economics? 29 DEBATES IN ECONOMICS Should the Minimum Wage Be Increased? $ The minimum wage was created in 1938 by the Fair Labor Standards Act (FLSA), debuting at 25 cents per hour. Even though it has been raised many times since then, it remains the subject of debate. Unions and antipoverty organizations typically spearhead campaigns to increase the minimum wage, saying it will help the nation’s working poor without affecting employment. Business organizations typically oppose a hike in the minimum wage, arguing that it will increase unemployment. Who is right? As you read the selections, ask yourself: Should the minimum wage be increased? PRO A MORAL MINIMUM WAGE... 1968 [was] the last year that the minimum wage was above the nation’s poverty line.... If the minimum wage were pegged at $9.50, millions... would be lifted out of poverty. The largest group of beneficiaries would be children, whose parents would have more money for rent, food, clothing and other basic necessities. Business leaders still trot out economists to claim that raising the minimum wage will destroy jobs and hurt small businesses. But the evidence, based on studies of the effects of past increases in both the federal and state minimum-wage levels,... shows otherwise. Because the working poor spend everything they earn, every penny of a minimum-wage increase goes back into the economy, increasing consumer demand and adding at least as many jobs as are lost. Most employers actually gain, absorbing the increase through decreased absenteeism, lower recruiting and training costs, higher productivity and increased worker morale. —Peter Dreier, director of the Urban & Environmental Policy program
at Occidental College; and Kelly Candaele, founding member of the Peace Institute at California State University, Chico M INIMUM W AGE P URCHASING P OWER L OW BY H ISTORICAL S TANDARDS The Inflation-Adjusted Value of the Minimum Wage ) $8.00 7.00 6.00 5.00 4.00 3.00 2.00 1.00 0.00 1950 1955 1960 1965 1970 1975 1980 Year 1985 1990 1995 2000 2005 2010 Source: Author’s calculations based on the U.S. Department of Labor. 30 UNIT 1 Fundamental Economic Concepts Peter Hvizdak/The Image Works CON WAGE HIKE WOULD COST JOBS Raising the federal minimum wage by $1.50 an hour will reduce job opportunities for those who need it most, new entrants to the job market with the least skills or experience. Raising the minimum wage hurts all American consumers and workers, by artificially inflating the cost of entry-level jobs, which is passed on through higher prices and lower real wages. The convenience store industry offers a compelling employment opportunity, with competitive wages, flexible schedules, and career development. Most convenience stores offer wages far above the minimum—in 2001, the average was $9.28 an hour. However, our industry strongly opposes an increase in the federal minimum wage because it will discourage the creation of entry-level jobs and hurt small businesses. With higher costs of health care and other benefits, and lower profit margins, convenience store owners and petroleum marketers cannot sustain an increase in the minimum wage. NACS members want to do what’s best for their own employees without government interference. And NACS members are very concerned about the inevitable result of a higher minimum wage—a ‘ripple effect’ of higher prices throughout the economy. If Congress really wants to help low-income workers, there are much more constructive things that can be done, such as reducing payroll taxes, cutting the capital gains tax, and eliminating unnecessary and burdensome regulations. —Allison Shulman, director, National Association of Convenience Stores, government affairs Raising the federal minimum wage from $5.15 to $6.65 an hour would: Cost private-sector employers $30.2 billion over four years Impose $2.1 billion in unfunded mandates on state and local governments Source: Congressional Budget Office Analyzing the Issue 1. Identifying What arguments do Dreier and Candae
le make in 1. Identifying support of increasing the minimum wage? 2. Explaining Why does Shulman believe that raising the minimum 2. Explaining wage will hurt convenience stores and other small businesses? 3. Deciding 3. Deciding With which opinion do you agree? Explain your reasoning. CHAPTER 1 What Is Economics? 31 Peter Hvizdak/The Image Works CHAPTER 2 Economic Systems and Decision Making Why It Matters Take a closer look at the way your high school is organized. Who makes the decisions on lesson plans? Who plans out events that take place during the year? Who makes financial decisions, and how? Are parents and voters involved in the educational system? Obtain information from your school district office or the library to create a chart that lists the rights and responsibilities of people in your school district to meet the needs of education. Read Chapter 2 to learn about the different economic systems that societies set up to meet their specific economic needs. The BIG Idea Every society has an economic system to allocate goods and services. In a market economy, individuals can freely make all economic choices, including opening a store. 32 UNIT 1 Peter Beck/Corbis Economics: Principles and Practices Web site at glencoe.com and click on Chapter 2—Chapter Overviews to preview chapter information. Chapter Overview Visit the SECTION 1 Economic Systems GUIDE TO READING Section Preview Reading Strategy In this section, you will learn about the different types of economic systems that govern WHAT goods and services to produce, HOW to produce them, and FOR WHOM to produce them. Comparing and Contrasting As you read the section, complete a graphic organizer like the one below to identify ways in which a market economy differs from, and is similar to, a command economy. Content Vocabulary • economic system (p. 33) • traditional economy (p. 34) • command economy (p. 35) • market economy (p. 37) • market (p. 37) • capitalism (p. 38) • mixed economy (p. 39) • socialism (p. 39) • communism (p. 39) Academic Vocabulary • stagnation (p. 35) • allocate (p. 36) • emphasizing (p. 36) Market Economy Similarities Command Economy COMPANIES IN THE NEWS McDonald’s and Hindu Culture —Global Business Today For thousands of years, India’s Hindu culture has revered the cow. Hindu scriptures state that the cow is a gift of the gods to the human race....
[The cows] are everywhere, ambling down roads, grazing in rubbish dumps and resting in temples—everywhere, that is, except on your plate, for Hindus do not eat the meat of the sacred cow.... McDonald’s responded to this cultural food dilemma by creating an Indian version of its Big Mac—the “Maharaja Mac”—which is made from mutton.... According to the head of McDonald’s Indian operations, “We had to reinvent ourselves for the Indian palate.” ■ When companies want to do business in other countries, they need to adjust their business plans to meet local customs. This is what McDonald’s corporation had to do when it expanded to India. While India’s economy shares many characteristics with the United States, many of its business practices are based on a more traditional economic system. All societies use an economic system—an organized way of providing for the wants and needs of their people. The way societies organize themselves determines the type of economic system they have. Three major kinds of economic systems exist—traditional, command, and market economies. In practice, however, almost all economies, like that of India, combine elements of all three. economic system organized way in which a society provides for the wants and needs of its people David H. Wells/Corbis CHAPTER 2 Economic Systems and Decision Making 33 Student Web Activity Visit the Economics: Principles and Practices Web site at glencoe.com and click on Chapter 2—Student Web Activities for an activity on the economies of traditional societies. traditional economy economic system in which the allocation of scarce resources and other economic activities are based on ritual, habit, or custom Traditional Economies MAIN Idea Traditional societies use ritual, habit, or customs to answer the basic questions of WHAT, HOW, and FOR WHOM to produce. Economics & You Does your family have a tradition that has been passed down from generation to generation? Read on to learn how traditions govern the economies of some societies. Many of our actions spring from habit and custom. Why, for example, does the bride toss the bouquet at a wedding? Such practices have become part of our traditional culture. Characteristics In a society with a traditional economy, the use of scarce resources—and nearly all other economic activity—stems from ritual, habit, or custom. Habit and custom also dictate most social behavior. Individuals are generally not free to make decisions based on what they want or would like to have. Instead, their roles
are defined by the customs of their elders and ancestors. Examples Many societies—such as the central African Mbuti, the Australian Aborigines, and other indigenous peoples around the world—have traditional economies. The Inuit of northern Canada in the 1800s provide an especially interesting case of a traditional economy. For generations, Inuit parents taught their children how to survive in a harsh climate, make tools, fish, and hunt. Their children, in turn, taught these skills to the next generation. When the Inuit hunted, it was traditional to share the spoils of the hunt with other families. If a walrus or bear was taken, hunters divided the kill evenly into as many portions as there were heads of families in the hunting party. The hunter most responsible for the kill had first choice, the second hunter to help with the kill chose next, and so on. Because the Inuit shared freely and generously with one another, members of the hunting party later shared their portions with other families who had not participated. The result was that the hunter had the honor of the kill and the respect of the village, rather than a physical claim to the entire animal. Because of this tradition of sharing, a village could survive the long, harsh winters as long as skilled hunters lived in the community. This custom was partially responsible for the Inuit’s survival for thousands of years. Advantages The main advantage of a traditional economy is that everyone knows which role to play. Little uncertainty exists over Traditions This woman in Botswana weaves a basket based on methods handed down by her ancestors. What are the main characteristics of a traditional economy? Gallo Images/Corbis &The Global Economy YOU The Great Wal [Mart] of China What do you and 1 billion Chinese consumers have in common? Access to a Wal-Mart store. China’s membership in the World Trade Organization has opened the door for capitalist companies to do business in this communist country. Now a growing number of WalMarts—48 and counting—cater to China’s upper-middle class. Chinese consumers are pleased with the cleanliness and convenience Wal-Mart has to offer. Joe Hatfield, president and CEO of Wal-Mart Asia, explains that while Chinese grocers use fans to scatter flies, “They hold us to a higher standard than others and to set the expectations for others to follow.” While each new store creates roughly 500 new jobs, the retailer’s presence in China does not come without controversy. Opp
onents deride the company’s low wages—between $84 and $96 per month—and argue that Wal-Mart encourages exploitation of Chinese workers. Headlines detailing the power struggle between the AllChina Federation of Trade Unions (ACFTUS) and Wal-Mart have drawn attention to the retailer’s anti-union stance in a Communist country. Meanwhile, the world watches as China seeks to balance modern and traditional ways, as well as capitalist and communist ideologies. WHAT to produce. If you are born into a family of hunters, you hunt. If you are born into a family of farmers, you farm. Likewise, little uncertainty exists over HOW to produce, because you do things much the same way your parents did. Finally, the FOR WHOM question is determined by the customs and traditions of the society. In some societies, you would provide for your immediate family. In others, such as the Inuit, you would share what you have hunted with all families of the village. In other words, tradition dictates how people live their lives. Disadvantages The main drawback of a traditional economy is that it tends to discourage new ideas and new ways of doing things. The strict roles in a traditional society have the effect of punishing people who act differently or break the rules. The lack of progress leads to economic stagnation and a lower standard of living than in other economic systems. Reading Check Describing What are the advantages and disadvantages of a traditional economy? Command Economies MAIN Idea Command economies rely on a central authority to make most of the economic decisions. Economics & You As you make career decisions, does the government or other authority tell you what to do? Read on to find out how decisions are made in a command economy. In a command economy, a central authority makes the major decisions about WHAT, HOW, and FOR WHOM to produce. A command economy can be headed by a king, a dictator, a president, or anyone else who makes the major economic decisions. Characteristics In a pure command economy, the government makes the major economic decisions. This means that the government decides if houses or apartments will be built. It also decides on the best way to build them, as well as who will receive them. Most command economies severely limit private property rights. People are not allowed to own their homes, businesses, and command economy economic system with a central authority that makes the major economic decisions Claro Cortes IV/Reuters/Corbis CHAPTER 2 Economic Systems and Decision Making 35 Consumer Goods Command economies often limit the
production of consumer goods. The result is sparsely stocked shelves, such as in this store in Pyongyang, North Korea. Why might command economies lack consumer goods? other productive resources, although they may have some personal items and tools. communist bloc countries of the former Soviet Union had command economies. Individual freedom also is limited. For example, if the government wants engineers rather than social workers, then its universities will train more engineers. This limits individual choices because people have to live within the government’s restrictions. Finally, government officials tend to favor themselves when making economic decisions. The result is that some of the country’s money often goes to luxury goods like houses, cars, and extravagant vacations for these officials. Examples Because they tend to be unproductive, few pure command economies exist today. North Korea and Cuba are modern examples, but in the 1970s and 1980s, the In the former Soviet Union, for example, the State Planning Commission determined needs, set goals, and established production quotas for major industries. If it wanted growth in heavy manufacturing, it would allocate resources to that sector. If it wanted to strengthen national defense, it directed resources to military production. Advantages The main strength of a command system is that it can change direction drastically. The former Soviet Union went from a rural agricultural society to an industrial nation in a few decades by emphasizing the growth of heavy industry. During this period, the central planning agency shifted resources on a massive scale. 36 UNIT 1 Fundamental Economic Concepts Adrian Bradshaw/EPA/Landov Another advantage of command economies, especially those represented by the former Soviet Union, is that many health and public services are available to everyone at little or no cost. Disadvantages Pure command economies have their disadvantages. One is that they ignore the basic wants and needs of consumers. In the Soviet Union, for example, generations of people were forced to do without consumer goods and adequate housing. Similarly, the current North Korean government has put a strong emphasis on defense. In the meantime, the North Korean people have been suffering years of hunger. At times, the government even had to accept aid from international sources. A second disadvantage is that the system gives people the incentive to fill their quotas instead of producing a good product. At one time in the former Soviet Union, quotas for electrical motors were measured in tons of output. Soviet workers then filled their quotas by producing the world’s heaviest electrical motors. A third weakness is that a command economy requires a large decision-making bureaucracy. In the former Soviet Union
, an army of clerks, planners, and other administrators was needed to operate the system. This structure slowed decision making and raised the cost of production. Yet a fourth weakness is that the planning bureaucracy lacks the flexibility to deal with minor day-to-day problems. As a result, command economies tend to lurch from one crisis to the next—or collapse completely, as did the former Soviet Union. Finally, rewards for individual initiative are rare in a command economy. Each person is expected to perform a job in a factory or on a farm according to the decisions made by central planners. Reading Check Analyzing What are the major problems with a command economy? Mike Baldwin/Cornered/Cartoon Stock Market Economies MAIN Idea In a market economy, consumers and businesses jointly answer the questions of WHAT, HOW, and FOR WHOM to produce. Economics & You Name one or two things you like about the economic system in the United States. Read on to learn about the advantages of a market economy. In a market economy, people make decisions in their own best interest. In economic terms, a market is an arrangement that allows buyers and sellers to come together to exchange goods and services. A market might be in a physical location, such as a farmers’ market, or on an Internet site, such as eBay. Regardless of its form, a market can exist as long as a mechanism is in place for buyers and sellers to meet. Characteristics A market economy is characterized by a great deal of freedom. People can spend their money on the products they want most, which is like casting dollar “votes” for those products. This tells producers which products people want, thus helping them answer the question of WHAT to market economy economic system in which supply, demand, and the price system help people make economic decisions and allocate resources market meeting place or mechanism that allows buyers and sellers to come together (also see page 15) Market Economies In a market economy, people have the freedom to start any business they wish. How do the two entrepreneurs in the cartoon reflect this freedom of choiceForget lemonade. The real money’s in bottled water.” CHAPTER 2 Economic Systems and Decision Making 37 capitalism economic system in which private citizens own and use the factors of production in order to generate profits Skills Handbook See page R45 to learn about Comparing and Contrasting. produce. Businesses are free to find the best production methods when deciding HOW to produce. Finally, the income that consumers earn and spend in the market
determines FOR WHOM to produce. Market economies also feature the private ownership of resources. A market economy is often described as being based on capitalism—an economic system where private citizens own the factors of production. The term capitalism draws attention to the private ownership of resources, while the term market economy focuses on where the goods and services are exchanged. As a result, the two terms focus on different features of the same economy. Examples Many of the most prosperous economies in the world, such as the United States, Japan, South Korea, Singapore, Australia, Great Britain, and parts of Western Europe, are based on markets and capitalism. While there are significant differences among them, these economies share the common elements of markets and the private ownership of resources to seek profits. Advantages The first advantage of a market economy is its high degree of individual freedom. People are free to spend their money on almost any good or service they choose. They also are free to decide where and when they want to work, or if they want to invest further in their own education and training. At the same time, producers are free to decide whom they want to hire, which inputs they want to use, as well as the way they want to produce. The second advantage of a market economy is that it adjusts gradually to change over time. Prior to 2005, for example, gasoline prices were low, so people tended to buy large gas-guzzling SUVs. When the price of gas rose sharply in that year, SUV sales fell, and smaller, more fuel-efficient vehicles became popular. A third advantage is the relatively small degree of government interference. Except for certain concerns such as national defense, environmental protection, and some care for the elderly, the government normally tries to stay out of the way of buyers and sellers. Figure 2.1 Comparing Economic Systems Traditional Command Market Advantages • Sets forth certain economic roles for all members of the community • Stable, predictable, and continuous life • Capable of dramatic change in a short time • Many basic education, health, and other public services available at little or no cost Disadvantages • Discourages new ideas and new ways of doing things • Stagnation and lack of progress • Lower standard of living • Does not meet wants and needs of consumers • Lacks eﬀective incentives to get people to work • Requires large bureaucracy, which consumes resources • Has little ﬂexibility to deal with day-to-day changes • Lacks room for individual initiative Every society has an
economic system. The type of system that is best for a society depends on its ability to satisfy people’s wants and needs and to fulfill its economic goals. Economic Analysis Which economic system do you think is best able to provide for the wants and needs of individuals, and why? • Individual freedom for everyone • Able to adjust to change gradually • Lack of government interference • Decentralized decision making • Incredible variety of goods and services • High degree of consumer satisfaction • Rewards only productive resources; does not provide for people too young, too old, or too sick to work • Does not produce enough public goods such as defense, universal education, or health care • Workers and businesses face uncertainty as a result of competition and change mixed economy economic system that has some combination of traditional, command, and market economies socialism political and economic system in which the government owns and controls some factors of production communism economic and political system in which all factors of production are collectively owned and controlled by the state A fourth advantage is that decision making is decentralized. Billions, if not trillions, of individual economic decisions are made daily. Collectively, people make the decisions that direct scarce resources into the uses consumers favor most, so everyone has a voice in the way the economy runs. A fifth advantage of the market economy is the variety of goods and services. You can find ultrasound devices to keep the neighbor’s dog out of your yard, or you can download music and video to your cell phone. In short, if a product can be imagined, it is likely to be produced in hopes that people will buy it. A sixth advantage is the high degree of consumer satisfaction. In a market economy, the choice one group makes does not affect the choices of other groups. If 51 percent of the people want to buy classical music, and 49 percent want to buy rap music, people in both groups can still get what they want. Disadvantages The market economy does not provide for everyone. Some people may be too young, too old, or too sick to earn a living or to care for themselves. These people would have difficulty surviving in a pure market economy without assistance from family, government, or charitable groups. A market economy also may not provide enough of some basic goods and services. For example, private markets do not adequately supply all of the roads, universal education, or comprehensive health care people would like to have. This is because private producers concentrate on providing products they can sell for a profit. Finally, a market economy has a high degree of uncertainty. Workers
might worry that their company will move to another country in search of lower labor costs. Employers may worry that someone else will produce a better or less expensive product, thereby taking their customers. Reading Check Identifying What are the main characteristics of a market economy? Mixed Economies MAIN Idea Most economies in the world today feature some mix of traditional, command, and market economies. Economics & You You just learned about traditional, command, and market economies. Read on to learn how most societies combine elements of each. While textbooks identify neat categories like traditional, command, and market economies, the real world is not so orderly. Most countries have mixed economies— systems that combine elements of all three types. When we consider political systems as well as economic systems, the picture gets even more complicated. For example, socialism is a mixed economic and political system in which the government owns and controls some, but not all, of the basic productive resources. In socialistic countries, the government also provides some of the basic needs of its people, such as education and health care. is An extreme form of socialism communism—a political and economic system where all property is collectively—not privately—owned. In a communist system, labor is organized for the common advantage of the community, and everyone consumes according to their needs. In practice, however, communist governments have become so involved in economic decisions that they are often called command economies. Characteristics If government or tradition, as well as markets, answer some of the questions of WHAT, HOW, and FOR WHOM to produce, then a society has a mixed economy. The type of political system in a mixed economy is less important than the way basic economic decisions are made. For example, some mixed economies have a political system based on democracy, and others do not. The state’s involvement in economic decisions also can vary. Some governments provide only for basic needs such as defense, a justice system, and CHAPTER 2 Economic Systems and Decision Making 39 Figure 2.2 The Spectrum of Mixed Economies In mixed economies, government involvement can range from providing basic public goods to making most economic decisions. Economic Analysis What distinguishes socialism from communism? See StudentWorks™ Plus or glencoe.com. C OMMUNISM S OCIALISM C APITALISM Directed by command Ownership of resources Directed by the free market All productive resources are government owned and operated. Basic productive resources are government owned and operated; the rest are privately owned and operated. Productive resources are privately owned and operated. Centralized
planning directs all resources. Government makes all economic decisions. Allocation of resources Government plans ways to allocate resources in key industries. Role of government Government directs the completion of its economic plans in key industries. Capital for production is obtained through the lure of profits in the market. Government may promote competition and provide public goods. universal education. The more socialistic a country is, the more it will make major economic decisions, often with the claim that this is done for the betterment of the people. Some governments intervene only in certain key sectors or industries and leave the rest to markets. If the government intervenes too much, a mixed economy can turn into a command economy. Examples There is a wide range of mixed economies. China has a mixture of traditional, command, and market economies. While tradition has a strong influence in rural areas, the government makes many of the major economic decisions and owns many of the factors of production. China is changing, however. In recent years the government has allowed some private ownership of resources, and capitalism is beginning to flourish. In Norway, the government owns the basic petroleum industry. It uses the revenue from the sale of oil to other nations to keep its domestic gas prices low, finance education, maintain roads, and provide social welfare for its citizens. Because the government controls just one industry, the mixed economy is based on capitalism and markets with some elements of socialism. Cuba and North Korea today are very similar to the former Soviet Union, where a socialist government controlled resources to provide for all the people. However, the ownership and control of resources were so extensive that many economists thought of the country as a command economy. Advantages One advantage of a mixed economy is that it provides assistance for some people who might otherwise be left out. All societies 40 UNIT 1 Fundamental Economic Concepts include some people who are too young, too old, or too sick to provide for themselves, for example, and most societies have traditions that address some of these concerns. If the society has a democracy, voters can use their electoral power to affect the WHAT, HOW, and FOR WHOM decisions even if the government owns no productive resources. For example, the government can pass laws to provide aid for those most in need or to fund road construction. Under socialism, the FOR WHOM question is addressed more directly. Ideally, those who are not fortunate or productive enough to take care of themselves still share certain benefits, such as free or low-cost public housing, transportation, medical care, and education. Disadvantages While mixed economies tend to
provide more services, the costs for these benefits can mean higher costs for citizens overall. Germany, for example, offers a wide range of benefits, but it also has a high tax rate. During economic downturns, when the government collects fewer taxes, less money is available for these programs. The German government has discussed placing limits on benefits, such as unemployment and welfare, because of lower revenues. In some socialist countries, the availability of services may be limited or the quality may deteriorate over time. Today, for example, Cuba claims that it has free health care for everyone, but the care is substandard for everyone except high-ranking members of the Communist Party and those willing to pay for services in dollars. Historically, both socialism and communism have proved to be less efficient than capitalism. For example, if workers receive government guarantees of jobs, more workers may be hired in a plant than are necessary, driving up production costs. Because socialism has proved to be so inefficient, many socialistic countries today allow more capitalist development. This is especially true in China, where the emergence of capitalism has helped the country to become one of the major economic powers in the world today. Reading Check Explaining How can you explain the range of mixed economies in the world? SECTION 1 Review Vocabulary 1. Explain the significance of economic system, traditional economy, command economy, market economy, market, capitalism, mixed economy, socialism, and communism. Main Ideas 2. Describing Use a graphic organizer like the one below to describe how economic systems answer the basic economic questions. WHAT, HOW, and FOR WHOM? Traditional economy Command economy Market economy Mixed economy 3. Explain how a command economy differs from the other economic systems. Critical Thinking 4. The BIG Idea Why do market economies tend to be more efficient than traditional or command economies? 5. Analyzing Visuals Look at the chart on page 40. Why does the top row show arrows on the left and right? 6. Inferring Why are market economies more innovative than either traditional or command economies? 7. Analyzing How does a traditional economy differ from a mixed economy like that of the United States today? Applying Economics 8. Mixed Economy List specific examples to illustrate why the U.S. economy is categorized as a mixed economy. CHAPTER 2 Economic Systems and Decision Making 41 CASE STUDY CASE STUDY The Home Depot® Fast Rise to Riches In 1978, co-founders Bernie Marcus and Arthur Blank tapped into America’s love of “big” and bargains when they
started a chain of retail warehouses stacked floor to ceiling with everything a builder or homeowner could want or need. Thus The Home Depot® was born. NEWS FLASH Rethinking Pink Other predominantly “male” markets are also reaching out to women, and not just by changing a product’s color to pink. Harley-Davidson has created a section on its Web site for its growing female base. When Apple introduced its multicolored iPod Mini, it experienced a 74 percent jump in sales. Lagging Sales In the early 2000s, however, Home Depot’s largest competitor, Lowe’s, gained sales faster. Its secret? Focusing on women customers. The home-improvement market is huge, estimated at a quarter of a trillion dollars. Roughly one-fourth of that (over $50 billion) consists of purchases made by women. Hardware retailers big and small began courting women— with features such as brighter lighting, wider aisles, and easy-to-reach shelves. N ET S ALES FOR T HE H OME D EPOT AND L OWE’S, 1996–2005 Home Depot Lowe’s 100 80 60 40 20 1996 1997 1998 1999 2000 2002 2003 2004 2005 2006 2001 Years Source: www.homedepot.com and www.morningstar.com. “Do It Herself” The Home Depot decided to jump on the bandwagon, but it took this courtship one step further. It set up nationwide Do-It-Herself Workshops, taught by experienced Home Depot associates who offer hands-on demonstrations and step-by-step instructions for completing a project. The first workshop took place in May 2003. A little over a year later, more than 200,000 women had attended one of the Do-It-Herself remodeling workshops. Today The Home Depot is the world’s secondlargest retailer, after Wal-Mart. As of spring 2006, the company operated 2,054 stores in 50 states, the District of Columbia, Puerto Rico, U.S. Virgin Islands, 10 Canadian provinces, and Mexico. Analyzing the Impact 1. Summarizing How did The Home Depot market its stores toward women? 2. Making Inferences Think about recent television and magazine advertisements. Which gender do you feel marketers were targeting? Describe five products and the “hook” used to capture the consumer’s attention. 42 UNIT 1 Fundamental Economic Concepts The Home Depot SECTION 2 Eval
uating Economic Performance GUIDE TO READING Section Preview Reading Strategy In this section, you will learn how economic freedom, economic security, and economic equity are related to the level of satisfaction people have with their economic systems. Differentiating As you read the section, identify seven major economic and social goals by completing a graphic organizer like the one below. Content Vocabulary • minimum wage (p. 44) • Social Security (p. 45) • inflation (p. 45) • fixed income (p. 45) Academic Vocabulary • adverse (p. 45) • accommodate (p. 46) Economic and Social Goals —Newsweek COMPANIES IN THE NEWS Fruits That Go Fizz Schoolkids in Oregon are trying something new at lunch: carbonated fruit that the Fizzy Fruit Co. hopes will lead to effervescent profits. Founder Galen Kaufman discovered his product when he ate a pear that had been stored in dry ice, which is made of carbon dioxide. The pear was fizzy and sweet, and ever since, Kaufman’s been trying to commercialize the idea. Not a few exploded kitchen experiments later, Kaufman has found his market. School-lunch supplier Sodexho has been serving the fruit in a pilot project at 14 Oregon schools, and it is expected to be in about 500 schools nationally by next month. Fizzy Fruit will also soon be sold in vending machines and at convenience stores. The trick is in the packaging. Because the fruit loses its fizz within about 20 minutes of being exposed to air (think of a soda bottle left uncapped), it’s got to be wrapped tight. ■ When Galen Kaufman discovered that fruit could fizz, he made it his goal to market the idea. Economic systems also have goals. These goals provide a way to guide economic decisions. They can also help people measure how well the system is working to meet its goals. If our economic system fails to achieve our goals, we may decide to seek changes. We could demand laws to modify the system until our needs are met. In the United States, efforts to meet our economic and social goals have caused the economy to evolve slowly over time. Getty Images CHAPTER 2 Economic Systems and Decision Making 43 minimum wage lowest legal wage that can be paid to most workers Economic and Social Goals produce. The belief in economic freedom, like the belief in political freedom, is one of the cornerstones of American society. MAIN Idea Americans share several major economic and social goals. Economics & You As you approach graduation, what
kinds of goals have you set for your future? Read on to learn about the economic goals of the nation. In the United States, people share many broad economic and social goals. While it might be difficult to find all of our goals listed in any one place, they are repeated many times in statements made by friends, relatives, community leaders, and elected officials. We can categorize those statements into seven major economic and social goals. Economic Freedom Americans traditionally place a high value on the freedom to make their own economic decisions. They like to choose their own occupations, employers, and uses for their money. Business owners like the freedom to choose where and how they Economic Efficiency Most people recognize that resources are scarce and that factors of production must be used wisely. If resources are wasted, fewer goods and services can be produced and fewer wants and needs can be satisfied. Because economic decision making must be efficient, economic efficiency is also one of our major goals. Economic Equity Americans have a strong tradition of justice, impartiality, and fairness. Many people, for example, believe in equal pay for equal work. As a result, it is illegal to discriminate on the basis of age, sex, race, religion, or disability in employment. At the national level, we have established the minimum wage—the lowest legal wage that can be paid to most workers. While not everyone supports it, the minimum wage does put a floor on the amount of income that some workers earn. Economic Freedom Americans are free to open any business they choose, such as this music store. How might the goal of economic freedom conflict with other goals? Chuck Savage/Corbis Most people believe that advertisers should not be allowed to make false claims about their products. Many states even have “lemon laws” that allow new car buyers to return cars with too many defects. Economic Security Americans desire protection from such adverse economic events as layoffs and illnesses. As a result, many states have set up programs to help workers who lose their jobs through no fault of their own, and many employers have insurance plans to cover the injuries and illnesses of their workers. At the national level, Congress has set up Social Security—a federal program of disability and retirement benefits that covers most working people. More than 90 percent of all American workers participate in the Social Security system. Retirees, survivors, disabled persons, and Medicare recipients are eligible for benefits. Survivors are spouses and children of deceased persons covered by Social Security. Medicare also provides health insurance for persons 65 or older. Full Employment When people work
, they earn income by producing goods and services for others. Without jobs, people cannot support themselves or their families, nor can they produce output for others. As a result, most people want their economic system to provide as many jobs as possible. The goal of full employment even became law when Congress passed the Employment Act of 1946 in an effort to avoid the widespread joblessness before World War II. Price Stability Another goal is to have stable prices. If inflation—a rise in the general level of prices—occurs, workers need more money to pay for food, clothing, and shelter. People who live on a fixed income—an income that does not increase even though prices go up—find that bills are harder to pay and planning for the future is more difficult. On Easy Street? The earliest reported recipient of Social Security was Ernest Ackerman, a retired Cleveland motorman. Ackerman retired one day after the Social Security program began. In return for the nickel withheld from his pay for this one day, he received a lump-sum payment of 17 cents, barely higher than the smallest payment ever of 5 cents. Such lump sum payments were made until 1942, with an average payment of $58.06. Ida May Fuller from Ludlow, Vermont, became the first recipient of monthly Social Security benefits. Social Security federal program of disability and retirement benefits that covers most working people inflation rise in the general level of prices fixed income income that does not increase even though prices go up High rates of inflation can even discourage business activity. During times of inflation, interest rates on loans tend to increase along with the prices of goods and services. If interest rates get too high, they can discourage both borrowing and spending by businesses. Price stability adds a degree of certainty to the future for businesses and consumers alike. Economic Growth The last major goal of most Americans is economic growth. Most people hope to have a better job, a newer car, their own home, and a number of other things in the future. Overall growth enables more people to have more goods and services. Because the nation’s population is likely to increase, economic growth is necessary to meet everyone’s needs. Future Goals The seven goals we have discussed so far are the ones on which most people seem to agree. As our society evolves, however, it is possible for new goals to develop. Do people feel that a cleaner environment is important enough to be added to the list of goals? Should we add the preservation of endangered species such as the California Channel Islands fox? In the
end, we are the ones who decide on the goals that are most important to us, and it is entirely possible that our goals could change in the future. Reading Check Interpreting What major themes can you identify in the list of seven economic goals? CHAPTER 2 Economic Systems and Decision Making 45 Skills Handbook See page R48 to learn about Problems and Solutions. Resolving Trade-Offs Among Goals MAIN Idea Conflicts among goals can be solved by comparing the cost of a goal to its benefit. Economics & You You learned earlier about trade-offs when deciding how to spend a monetary gift of $100. Read on to find out how trade-offs also apply to economics goals. People often have different ideas about how to reach a goal, or the goals themselves might conflict. Even our economic policies have opportunity costs. For example, a policy that keeps foreignmade shoes out of the United States could help achieve the goal of full employment in the domestic shoe industry, but it could work against individual freedom if people have fewer choices of shoes to buy. Even an increase in the minimum wage involves a conflict of goals. On one hand, supporters of the increase argue that an increase is the equitable, or “right,” thing to do. Opponents argue that an increase may cause fewer workers to be hired. In addition, it restricts the freedom of employers to pay wages that they think are fair. How are trade-offs among goals resolved? In most cases, people compare their estimate of the costs to their estimate of the benefits, and then vote for political candidates who back their position. If the majority of voters feel that the minimum wage is too low, then it will be raised. The minimum wage then tends to stay at this new level until the majority of people feel that it needs to be changed again. People, businesses, and government are usually able to resolve conflicts among goals. Fortunately, the economic system of the United States is flexible enough to allow choices, accommodate compromises, and still satisfy the majority of Americans. In a democratic society, government reflects the will of a majority of its people. As a result, many government functions reflect people’s desire to modify the economic system to achieve their economic goals. A program such as Social Security, as well as laws dealing with child labor and the minimum wage, reveal how Americans have modified their free enterprise economy. This system most likely will undergo further change as the goals and objectives of the American people change. Reading Check Explaining Why do trade-offs among goals exist
? SECTION 2 Review Vocabulary 1. Explain the significance of minimum wage, Social Critical Thinking 4. The BIG Idea How does an increase in the minimum Security, inflation, and fixed income. wage involve a conflict of goals? Main Ideas 2. Explain why it is important for a nation to set economic and social goals. 3. Determining Cause and Effect Use a graphic organizer like the one below to illustrate how economic and social goals may conflict with one another. Action: prohibit imports of foreign cars helps achieve works against Goal: Goal: 5. Inferring What can Americans do to influence the economic goals of the nation? 6. Applying How do laws against false or misleading advertising promote the goal of economic equity? Applying Economics 7. Economic Security Interview a friend or relative who is retired or approaching retirement to find out if he or she believes the government has achieved the goal of economic security for its senior citizens, and why. Write a paragraph to describe these views and explain why you agree or disagree with them. 46 UNIT 1 Fundamental Economic Concepts NEWSCLIP We do not usually associate economic efficiency with fun. In the past few years, though, some companies have found a new and unusual tool to make job training more efficient—and more fun. On-the-Job Video Gaming Laura Holshouser’s favorite video games include Halo, Tetris, and an online training game developed by her employer. A training game? That’s right. The 24-year-old graduate student, who manages a Cold Stone Creamery ice-cream store in Riverside, Calif., stumbled across the game on the corporate Web site in October. It teaches portion control and customer service in a cartoon-like simulation of a Cold Stone store. Players scoop cones against the clock and try to avoid serving too much ice cream. The company says more than 8,000 employees, or about 30% of the total, voluntarily downloaded the game in the first week.... The military has used video games as a training tool since the 1980s. Now the practice is catching on with companies, too.... Corporate trainers are betting that games’ interactivity and fun will hook young, media-savvy employees like Holshouser and help them grasp and retain sales, technical, and management skills.... $736 Cost of traditional training per employee 8,000 Number of employees who download the game in the first week $5,888,000 Cost of traditional training for 8,000 employees $500,
000 Average cost of corporate training game Companies like video games because they are costeffective. Why pay for someone to fly to a central training campus when you can just plunk them down in front of a computer? Even better, employees often play the games at home on their own time.... Games are especially well-suited to training technicians.... Last year, Cisco rolled out six new training games—some of them designed to teach technicians how to build a computer network. It’s hard to imagine a drier subject. Not so in the virtual world. In one Cisco game, players must put the network together on Mars. In a sandstorm.... Sounds suspiciously like fun. —Reprinted from BusinessWeek Examining the Newsclip 1. Summarizing How has on-the-job video gaming made workers and companies more efficient? 2. Analyzing How do companies make video training games appealing for their employees? Persuasive Games CHAPTER 2 Economic Systems and Decision Making 47 SECTION 3 American Free Enterprise GUIDE TO READING Section Preview Academic Vocabulary In this section, you will learn how under capitalism the basic economic decisions of WHAT, HOW, and FOR WHOM to produce are made through the free interaction of individuals looking out for their own best interests. Content Vocabulary • free enterprise (p. 48) • voluntary exchange (p. 49) • private property rights (p. 50) • profit (p. 50) • profit motive (p. 50) • competition (p. 50) • consumer sovereignty (p. 51) • mixed or modified free enterprise economy (p. 53) • incentive (p. 50) • catalyst (p. 51) • regulator (p. 52) Reading Strategy Listing As you read the section, complete a graphic organizer like the one below to identify the five characteristics of a free enterprise economy. Then provide an example of each. Characteristic Example —adapted from BusinessWeek COMPANIES IN THE NEWS Hot Growth at Claire’s When Bonnie and Marla Schaefer became vice-CEOs of Claire’s Stores Inc., they had much to prove to the company’s board. Within a few years they did just that: profits nearly doubled, earning Claire’s a slot on BusinessWeek’s 2005 list of Hot Growth companies. How did the sisters do it? One way was to focus on a troubled recent acquisition they renamed Icings. The new store appeals to the 17-to-
27 crowd. Unlike their father, Rowland Schaefer, founder and former CEO of Claire’s, the sisters use market research to identify teen trends. They also licensed popular celebrities such as Mariah Carey to provide cosmetics and jewelry lines. The sisters won’t stop there. The company already has stores in Europe and Japan, and franchises are now expanding into other continents. ■ free enterprise capitalistic economy in which competition is allowed to flourish with a minimum of government interference C apitalism has become the economic system of choice in many parts of the world because of its ability to generate wealth, just as it has for Claire’s. Capitalism, as you have learned, is an economic system in which private citizens own and use the factors of production to generate profits. The U.S. economy is based on free enterprise. Under free enterprise, resources are privately owned, and competition is allowed to flourish with a minimum of government interference. We often use the terms capitalism and free enterprise interchangeably, but they have different meanings. While capitalism stands for the private ownership of resources, free enterprise is the unhindered use of privately owned resources to earn profits. 48 UNIT 1 Fundamental Economic Concepts Silvia Otte/Getty Images voluntary exchange act of buyers and sellers freely and willingly engaging in market transactions Characteristics of Free Enterprise Capitalism MAIN Idea The American economy incorporates the main characteristics of a free enterprise economy. Economics & You How much freedom do you have to make your own economic choices? Read on to learn how this freedom characterizes our own market economy. A capitalistic free enterprise economy has five important characteristics: economic freedom, voluntary exchange, private property rights, the profit motive, and competition. Economic Freedom Economic freedom means more than being able to buy the things you want. It means that you have the freedom to choose your occupation, your employer, and your job location. You can even leave your current job and move on to another job that offers greater opportunity. Businesses also enjoy considerable economic freedom. They are free to hire the best workers, and they are free to produce the products they feel will be the most profitable. Businesses can make as many items as they want, sell them wherever they please, and normally charge whatever price they choose. In short, they are free to risk success or failure. Voluntary Exchange A second characteristic of capitalism is voluntary exchange—the act of buyers and sellers freely and willingly engaging in market transactions. Voluntary transactions benefit both the buyer and the seller, or the exchange would never occur.
For example, when buyers spend their money on a product, they act on a belief that the item they purchase is of greater Figure 2.3 Characteristics of Free Enterprise Capitalism Economic freedom: People may choose their jobs, employers, and how to spend their money. Businesses may choose what products to sell and how much to charge for them. Private property rights: People may control their possessions as they wish. Competition: Producers and sellers compete with one another to attract consumers, while lowering costs. Consumers compete with one another to obtain the best products at the lowest prices. Voluntary exchange: Buyers and sellers may engage freely and willingly in market transactions. Profit motive: People and organizations may improve their material well-being by making money. “Free enterprise capitalism” describes a market economy in which private citizens own the factors of production and businesses compete with minimal government interference. Economic Analysis What items are included in the category of private property? CHAPTER 2 Economic Systems and Decision Making 49 The Role of the Entrepreneur MAIN Idea Entrepreneurs are the driving force of the free enterprise system. Economics & You Can you think of a successful entrepreneur and the business he or she runs? Read on to learn why entrepreneurs are important in a free enterprise economy. The entrepreneur plays one of the most important roles in the free enterprise economy. The entrepreneur organizes and manages land, capital, and labor in order to seek the reward called profit. Entrepreneurs are the people who start up new businesses such as restaurants, automobile repair shops, Internet stores, and video arcades. They include people who may have worked for others at one time, but who decided to quit and start their own businesses. Entrepreneurs want to “be their own boss” and are willing to take risks to make their dreams come true. Many entrepreneurs fail. Others survive and manage to stay in business with varying degrees of success. A few, and only a very few, manage to become fantastically wealthy. Well-known entrepreneurs include Robert Johnson, founder of BET, Robert Johnson private property rights fundamental feature of capitalism that allows individuals to own and control their possessions as they wish profit extent to which persons or organizations are better off financially at the end of a period than they were at the beginning profit motive incentive that encourages people and organizations to improve their financial and material well-being competition the struggle among sellers to attract consumers Personal Finance Handbook See pages R6–R9 for more information on saving and investing. value than the money they give up—or they would not make the
purchase. When sellers exchange their products for cash, they believe that the money they receive is more valuable than the product they sell— otherwise they would not make the sale. Private Property Rights Another major feature of capitalism is private property rights, which allow people to own and control their possessions as they wish. People have the right to use or even abuse their property as long as they do not interfere with the rights of others. Private property gives people the incentive to work, save, and invest. When people are free to do as they wish with their property, they are not afraid to accumulate, improve, use, or lend it. They also know they can keep any rewards they might earn. Profit Motive Under free enterprise capitalism, people are free to risk any part of their wealth in a business venture. If it goes well, they will earn rewards for their efforts. If it goes poorly, however, they could lose part or all of their investment. Profit is the extent to which persons or organizations are better off financially at the end of a specific period than they were at the beginning. The profit motive—the incentive that encourages people and organizations to improve their material wellbeing—is largely responsible for the growth of a free enterprise system. Competition Capitalism thrives on competition—the struggle among sellers to attract consumers. Competition is possible because individual entrepreneurs have the freedom to produce the products they think will be the most profitable. Free enterprise capitalism allows competition to flourish, benefiting both producers and consumers alike. Reading Check Summarizing How does voluntary exchange work in the free enterprise economy? 50 UNIT 1 Fundamental Economic Concepts Kathy Willens/AP/Wide World Photo Bill Gates, who founded Microsoft, and Mary Kay Ash, who founded Mary Kay Cosmetics. Despite the high rate of failure among entrepreneurs, the dream of success is often too great to resist. The entrepreneur is both the spark plug and the catalyst of the free enterprise economy. When an entrepreneur is successful, everybody benefits. The entrepreneur is rewarded with profits, a growing business, and the satisfaction of a job well done. Workers are rewarded with more and better-paying jobs. Consumers are rewarded with new and better products. The government is rewarded with a higher level of economic activity and larger tax receipts that can be used to build roads, schools, and libraries for people not even connected with the original entrepreneur. It does not stop there. Successful entrepreneurs attract other firms to the industry who rush in to “grab a share” of the profits. To remain competitive and stay in business, the original
entrepreneur may have to improve the quality of the product or cut prices, which means that customers can buy more for less. In the end, the entrepreneur’s search for profits can lead to a chain of events that brings new products, greater competition, more production, higher quality, and lower prices for consumers. Reading Check Analyzing Why are entrepreneurs considered both spark plugs and catalysts of the free enterprise economy The Role of the Consumer MAIN Idea The economy in the United States adapts to consumers’ wants. Economics & You When you go shopping and cast your dollar “votes,” do you realize that you are helping to answer the question of WHAT to produce? Read on to learn how consumers help decide what products are offered in a free market economy. Consumers have power in the economy because ultimately they determine which products are produced. If consumers like a new product, the producer will be rewarded with profits. If consumers do not buy it, the firm may lose money or even go out of business. The term consumer sovereignty recognizes the role of the consumer as sovereign, or ruler, of the market. The phrase “the customer is always right” reflects this power. In recent years, producers have had outstanding successes with products ranging from video games to Internet search engines such as Google. Other products—including “Crystal” Pepsi, celery-flavored Jell-O, and Dr. Care’s aerosol toothpaste (which kids discovered they could spray around the bathroom)—were rejected. In addition, consumers’ wants change constantly as people are exposed to new ideas and products. Today, Americans purchase more home computers every year than TV sets, even though computers were consumer sovereignty role of consumer as ruler of the market when determining the types of goods and services produced Skills Handbook See page R40 to learn about Analyzing Information. Entrepreneurs and Consumers Some entrepreneurs, like Robert Johnson, develop corporations for consumers nationwide, while others serve local customers. How do consumers influence the economy? photo: Hot dog stand in Los Angeles barely known just 25 years ago. They buy products all over the world and frequently use the Internet to research products and make purchases. The dollars consumers spend in the marketplace are the “votes” that give them a say in what is, and what is not, produced. Because of this, consumers play an important role in the American free enterprise economy. Reading Check Summarizing What role do consumers play in a free enterprise system? CAREERS Construction and Building Inspector (Zoning
Officer) The Work * Examine the construction or repair of buildings, sewer and water systems, dams, bridges, highways, and streets to ensure compliance with building codes, zoning regulations, and contract specifications * Review blueprints, write reports and detailed logs, and schedule inspections Qualifications * Profound knowledge of construction materials and practices * Experience with survey instruments, metering devices, and test equipment * Degree or certificate in building inspection with an emphasis on blueprint reading, construction technology, drafting, mathematics, and English and Spanish * Background in engineering or architecture or a degree from a community college Earnings * Median annual earnings: $43,670 Job Growth Outlook * Faster than average Source: Occupational Outlook Handbook, 2006–2007 52 UNIT 1 Fundamental Economic Concepts David Young-Wolff/PhotoEdit The Role of Government MAIN Idea The economic role of the U.S. government is decided by its citizens. Economics & You What economic roles do you think federal, state, and local governments play in your life? Read on to learn how the government has modified our country’s economic system. The role of government—whether national, state, or local—stems from the desires, goals, and aspirations of its citizens. Government has become involved in the economy because the citizens want it that way. Consequently, government has become a protector, provider, regulator, and consumer. In general, the role of government in the economy is justified whenever the benefits outweigh the costs. Protector As protector, the United States government enforces laws such as those against false and misleading advertising, unsafe food and drugs, environmental hazards, and unsafe automobiles. It also enforces laws against abuses of individual freedoms. Employers, for example, cannot discriminate against workers because of their age, gender, race, or religion. Provider All levels of government provide goods and services for citizens. The national government supplies a system of justice and national defense. It provides subsidies to parts of the economy, such as agriculture. In addition, it gives funding to state and local governments for some programs such as road construction. State governments provide education, highways, and public welfare. Local governments provide parks, libraries, sanitation, and bus services. Regulator In its role as a regulator, the national government is charged with preserving competition in the marketplace. It also oversees communications, interstate commerce, and mixed or modified free enterprise economy economy where people carry on their economic affairs freely but are subject to some government intervention and regulation even entire industries, such as banking and nuclear power. Many state governments oversee
insurance rates, while local governments regulate economic activity with building and zoning permits. The regulatory role of government is controversial. Most businesses do not like to be told how to run their affairs. Consumers, however, do not always know when they are at risk from hazards, such as potential poisoning from unsafe food preparation or false and misleading advertising from some companies. As a result, they want the government to monitor and regulate such activities. Consumer The tasks of protecting, providing, and regulating are expensive. All levels of government, like any business, consume scarce resources to fulfill their role. Government has grown so much in recent years that it is now the second-largest consuming unit in the economy, after the consumer sector, eclipsing spending by all private businesses combined. You will learn later in this textbook how the government collects and spends the money required to accomplish these tasks. Modified Free Enterprise Perhaps an unintended consequence of government’s role as protector, provider, regulator, and consumer is the emergence of the mixed, or modified free enterprise economy. In this economy, people and businesses carry on their economic affairs freely, but they are subject to some government intervention and regulation. Some people prefer to have no government involvement in the economy, but this is not possible. After all, some services, such as national defense and a system of laws and justice, cannot be supplied by the private sector alone. Unfortunately there is no clear answer to the question of how much government involvement is necessary, but if it changes, it will be because the voting public wants it that way. Reading Check Explaining Why do Americans want government to play a role in the economy? Use specific examples. SECTION 3 Review Vocabulary 1. Explain the significance of free enterprise, voluntary exchange, private property rights, profit, profit motive, competition, consumer sovereignty, and mixed or modified free enterprise economy. Main Ideas 2. Describe the five major characteristics of a free enterprise system by completing a graphic organizer like the one below. Free Enterprise System 3. Explain the differences in the roles of entrepreneurs, consumers, and the government. Critical Thinking 4. The BIG Idea When consumers cast their “votes” in a free enterprise economy, how do they influence what is and is not produced? 5. Analyzing Visuals Look at the photo on page 51. How are the consumers demonstrating their sovereignty? 6. Drawing Conclusions How is the protection of private property rights necessary to the other characteristics of free enterprise? 7. Analyzing Explain why entrepreneurs are the driving force of the free enterprise system
. Applying Economics 8. Voluntary Exchange Cite at least three examples of voluntary exchanges you made this week. How are you better off by having made the exchanges? Did the person with whom you exchanged gain too? How? CHAPTER 2 Economic Systems and Decision Making 53 ENTREPRENEUR Profiles in Economics Tony Hawk (1968– ) • professional athlete at age 14 and best skateboarder in the world by age 16 • owner of a successful business empire based on resurgence of skateboarding and name recognition Making a Name Tony Hawk did not set out to become a businessman. When his brother gave him his first skateboard at age nine, all he wanted to do was have some fun. But he was determined that he would learn how to ride it. This determination—and 6 hours of skateboarding a day—led to success. By age 16, Hawk was the best skateboarder in the world. He also opened a skateboarding company, Birdhouse Projects, that brought him his first big financial success. The Hawk Takes Off While Hawk had made a name for himself, skateboarding itself faded in popularity, and with it Hawk’s company. Then ESPN decided to broadcast the X Games in 1995. The show’s immense success revitalized the skateboarding phenomenon and brought Hawk’s name into the mainstream. At the end of his competitive career in 1999, Hawk had won 73 first-place competition titles, created some 80 new tricks, and pioneered a new form of vertical skateboarding. Hawk’s skills piqued the interest of software developer Activision. In 1998 the company approached him with an idea for his own skateboarding video game. Hawk wanted to “make sure that the skating aspect is authentic.” He met weekly with the game developers, nixing unrealistic moves and refining aerial stunts. The next year, “Tony Hawk’s Pro Skater” flew off the shelves. The Pro Skater games eventually sold 20 million copies and gave Hawk over $6 million a year in royalties. In 2002 Hawk launched the Boom Boom HuckJam tour, an extreme sports event that brings the world’s best skateboarders, BMX bikers, and motocross racers to arenas around the country. On top of that, his combined brands, which today include skateboards, clothes, shoes, video games, and action figures, generate about $300 million a year in retail sales. Examining the Profile 1. Drawing Conclusions How has Tony Hawk used his sport
to develop into an entrepreneur? 2. Making Inferences How do you know that Hawk is careful about which products he brands? Explain. When Tony Hawk first started skateboarding, he saw it as a fun way to spend some time. Just three years later, he signed with his first sponsor, and today he has turned it into a multimillion-dollar business. 54 UNIT 1 Fundamental Economic Concepts CBS Photo Archive/Getty Images CHAPTER 2 Visual Summary Study anywhere, anytime! Download quizzes and flash cards to your PDA from glencoe.com. Economic Systems Most countries have a mix of three different types of economic systems. Traditional Command Market Mixed • Most economic activities based on ritual, habit, or customs • Everyone knows which role to play • Little innovation • Government makes all major economic decisions • Private property severely limited • Can be adjusted quickly to meet a country’s demands • Does not meet all of consumers’ wants and needs • Is inefficient and discourages innovation • People make economic decisions based on supply, demand, and the price system • High degree of individual freedom and innovation • Does not provide for the basic needs of everyone • Provides a mix of all three economic systems • Government involvement varies • Government provides help to some people who might otherwise be left out • Systems like socialism and communism are less efficient than capitalism Economic and Social Goals In the United States, we share several economic and social goals. Economic freedom Economic growth Economic efficiency Economic and Social Goals Economic equity Economic security Price stability Full employment Free Enterprise The U.S. economic system is based on the free enterprise system and is characterized by competition and private ownership of resources. Characteristics Role of Entrepreneurs Role of Consumers Role of Government • Economic freedom • Voluntary exchange • Private property rights • Profit motive • Competition • Organize land, capital, and labor in order to seek profit • Accept the risk of loss • Decide HOW to produce • Are innovators and catalysts • Decide WHAT is produced by how they spend their money • Spur development of new products by changing their wants • As protector, provider, and regulator, ensures and enforces that economic and social goals are carried out • Is a large consumer in the economy CHAPTER 2 Economic Systems and Decision Making 55 CHAPTER 2 Assessment & Activities Review Content Vocabulary Review the Main Ideas On a separate sheet of paper, write the letter of the key term that best matches each statement below. a. capitalism b. command economy c. consumer sovereignty d. economic system e. private property rights f. profit motive g
. traditional economy h. voluntary exchange Section 1 (pages 33–41) 17. Describe the main characteristics of a traditional economy. 18. Identify the five major weaknesses of a command economy. 19. Explain who makes economic decisions in a market economy. 1. the idea that buyers and sellers rule the market 20. Describe the advantages and disadvantages of a mixed 2. a society’s organized way of providing for its people’s economy. wants and needs 3. the incentive that encourages people and organizations Section 2 (pages 43–46) to try to improve their material well-being 21. Describe how individuals and businesspeople benefit 4. an economic system in which the factors of production from economic freedom. are owned by private citizens 5. the right and privilege to control one’s own possessions 22. Discuss who benefits from economic security. 23. Explain how a society resolves conflicts between 6. an economic system in which ritual, habit, and custom economic and social goals. dictate most economic and social behavior 7. an economic system in which a central authority makes economic decisions 8. the act of buyers and sellers freely conducting business in a market Review Academic Vocabulary On a separate sheet of paper, define and illustrate each of the following terms. See the sample below. Term Definition Illustration • Incentive • Something that encourages or motivates 9. allocate 10. emphasize 11. stagnation 12. adverse 13. catalyst 14. regulator 15. accommodate 16. incentive 56 UNIT 1 Fundamental Economic Concepts Section 3 (pages 48–53) 24. Describe the five major characteristics of free enterprise. Free Enterprise 25. Explain why entrepreneurs are thought to have important roles in the economy. 26. Describe how consumers have influenced the success of products in recent years. 27. List the five major roles that the government plays in the economy. Economics: Principles and Practices Web site at glencoe.com and click on Chapter 2—Self-Check Quizzes to prepare for the chapter test. Self-Check Quiz Visit the Critical Thinking Thinking Like an Economist 28. The BIG Idea Some people believe that the profit motive conflicts with the goals of economic security and equity. Do you agree? Why or why not? 29. Understanding Cause and Effect How has the development of modern transportation and communication systems affected the type of economy that exists in the United States? 30. Making Inferences What incentive does owning private property give people? 31. Making Comparisons Reproduce the following diagram on a separate sheet of paper. Then,
in the spaces indicated, identify several elements of command and tradition in the U.S. economy that make it a mixed, or modified private enterprise, economy. Market economy Command economy Traditional economy Analyzing Visuals 32. Critical Thinking Look at the chart on page 40. Explain how government involvement differs under communism, socialism, and capitalism. Where on the spectrum does the economy of the United States fit, and why? Math Practice 33. If the typical minimum-wage employee works 40 hours a week and has two weeks’ unpaid vacation, how much will that person earn in a year if the minimum wage is $5.15/hour? How much extra will that person earn for every $0.25 increase per hour in the wage? 34. Critical Thinking Not all societies have market economies. Some have command or traditional economies. Use the discussion of opportunity cost and cost-benefit analysis in Chapter 1 on pages 20 and 24 to explain why you would or would not like to live in a society with a different economic system. Prepare a decision grid similar to the one on page 20 to help you with your analysis. Write a paragraph that summarizes your conclusion. Applying Economic Concepts 35. Tradition Most people tip for service in restaurants, but not for service at clothing stores or gas stations. Explain how this illustrates economic behavior by tradition rather than by market or command. 36. Economic and Social Goals Compare the figures below and then answer the questions that follow. a. If the diagram in Figure 1 represents “needs” and “wants,” how would you label the two diagrams in the figure? Explain your choice. b. If the two circles in Figure 2 represent the goals of economic security and economic equity, where would you place a federal policy such as the minimum wage law—in area A, B, or C? Explain your choice. c. If you were to change “Economic security” to “Economic efficiency” in Figure 2, would this change your placement of the minimum wage policy? How? Figure 1 Figure 2 Economic security Economic equity A B C CHAPTER 2 Economic Systems and Decision Making 57 &The Global Economy YOU Pirating Intellectual Property A major feature of capitalism is the concept of private property rights—the freedom to own and control your possessions as you wish. Another major feature is the profit motive—taking a risk with your labor, property, or money in order to reap financial gains. Unfortunately, in our global economy the risks you take don’t always result in rewards—at
least for you. Stolen Profits Pirates of intellectual property reduce profits in some industries by as much as 50 percent. The term intellectual property (IP) refers to creations of the mind: inventions, literary and artistic works, symbols, names, images, and designs. Piracy of CDs, software, and clothing designs has expanded in recent years, along with counterfeit money and prescription medications. The illegal trade in pirated and counterfeit goods costs the legal world economy an estimated $630 billion per year. Case Study: China In Silk Alley, a street in Beijing, bargain hunters can find just about anything on the cheap, including inexpensive knockoffs of Gucci, Chanel, Prada, and PC SOFTWARE MARKET $60 * 50 40 30 20 10 0 retail value $52 $22 Developed countries 2004 Paid for 2004 Pirated $7 $12 Developing countries Source: Second Annual BSA and IDC Global Software Piracy Study, 2005 58 UNIT 1 Fundamental Economic Concepts S OFTWARE P IRAC Y Highest piracy rates Lowest piracy rates Vietnam Ukraine China Zimbabwe Indonesia Russia Nigeria Tunisia Algeria Kenya 92% 91% 90% 90% 87% 87% 84% 84% 83% 83% Germany Finland Japan Switzerland Denmark United Kingdom Sweden Austria New Zealand United States 29% 29% 28% 28% 27% 27% 26% 25% 23% 21% *Percentage of software pirated versus paid for Source: Second Annual BSA and IDC Global Software Piracy Study, 2005 North Face products. Chinese piracy has made a significant dent in American music, movie, and software profits. In 2004 alone, U.S. companies lost an estimated $40 billion to IP piracy, the majority of which allegedly took place in China. In the past, China blamed its flourishing culture of piracy on a myriad of issues. Yet the Chinese government also fostered a culture of piracy by maintaining that intellectual property was not an individual right, but a benefit to the state. Now that the country is a member of the World Trade Organization, China must follow marketeconomy rules. It did a remarkable job of cracking down on its own domestic pirates, who have attempted to profit from the 2008 Beijing Olympics. U.S. officials now want to see similar efforts to protect U.S. intellectual property. Worldwide Problem P IRATED S OFTWARE D OLLAR L OSSES BY R EGION (IN MILLIONS) European Union ($12,151) North America ($7,549) Latin America ($1,
546) Asia Pacific ($7,897) Rest of Europe ($2,313) Middle East/Africa ($1,239) Piracy has become a worldwide problem and affects the bottom line of companies everywhere. IP theft also raises unemployment rates and lowers tax revenues, especially in developing countries. Losses in tax revenue are more costly than one might think. Experts estimate that in four years, a 10 percent drop in the global piracy rate would add roughly 2.4 million new jobs, $400 billion in profits, and $67 billion in tax revenues world-wide. Source: Second Annual BSA and IDC Global Software Piracy Study, 2005 photo: A bulldozer destroying pirated CDs, DVDs, and videos in Moscow, Russia What Does It Mean For You? While you might think that software piracy does not affect you directly, this is far from the truth. Companies that lose profits from IP theft often pass the cost of piracy on to you—the honest consumer. For every song or movie downloaded or sold illegally, businesses must charge paying customers more to cover their production costs. In addition, government revenue that could go to your education, parks, or better roads instead is funneled into law enforcement to prevent IP piracy. But perhaps the biggest loser in IP piracy is creativity. After all, if you were an artist or designer, would you be willing to spend your money as well as months or years of your life to develop a new product, only to have it copied and your profits taken away by someone else? Analyzing the Issue 1. Identifying What economic policy allowed IP piracy to grow in China? 2. Describing What is the relationship between piracy rates and developing countries? 3. Applying Check your local newspaper, news magazines, or Internet news sources for recent articles about intellectual property theft. How does IP piracy affect your state? DMITRY LEBEDEV/AP Images CHAPTER 3 Business Organizations Why It Matters You have an idea for a new product and you want to set up a company to market it. You need $5,000 to get started with production and advertising. Use what you have already learned about the factors of production to create a list of resources you will need and where to find them. Read Chapter 3 to learn about the different ways to organize a business. The BIG Ideas 1. The profit motive acts as an incentive for people to produce and sell goods and services. 2. Governments and institutions help participants in a market economy accomplish their financial goals. Businesses can be owned by individuals
such as this flower shop owner, by two or more partners, or by many stockholders of a large company. 60 UNIT 1 Tony Anderson/Getty Images Economics: Principles and Practices Web site at glencoe.com and click on Chapter 3—Chapter Overviews to preview chapter information. Chapter Overview Visit the SECTION 1 Forms of Business Organization GUIDE TO READING Section Preview In this section, you will learn about the advantages and disadvantages of various forms of business organization. Academic Vocabulary • comprise (p. 62) • entity (p. 63) Reading Strategy Content Vocabulary • stockholder (p. 67) • shareholder (p. 67) • dividend (p. 67) • common stock (p. 67) • preferred stock (p. 68) • sole proprietorship (p. 62) • stock (p. 67) • proprietorship (p. 62) • unlimited liability (p. 63) • inventory (p. 64) • limited life (p. 64) • partnership (p. 64) • general partnership (p. 64) • bond (p. 69) • limited partnership (p. 64) • principal (p. 69) • interest (p. 69) • corporation (p. 67) • double taxation (p. 69) • charter (p. 67) Contrasting As you read about business organizations, complete a graphic organizer similar to the one below to show how the three types of business organizations differ from one another. Business Organizations Proprietorship Partnership Corporation COMPANIES IN THE NEWS Selling to a Different Beat —adapted from BusinessWeek Marc Weinstein’s Amoeba Music store stocks 2.5 million titles, half of which are rare and used vinyl records. With genres ranging from jazz and hip-hop to Hungarian folk music and Pakistani qawwali, Amoeba is Weinstein’s alternative to music megastores. Amoeba’s 1990 launch in Berkeley, California, was risky. Still, Weinstein and his two partners staked $325,000 in loans and savings on their vision. The risk yielded sales of $10,000 on opening day. Today the business has stores in Los Angeles and San Francisco. And while most of the industry faces declining sales, Amoeba’s sales continue to rise. For Weinstein and company, the vision is evolving. Soon Amoeba will have its own record label and launch a Web site for music downloads. ■ There are three main forms of
business organization in the economy today—the sole proprietorship, the partnership, and the corporation. Each offers its owners significant advantages and disadvantages. The type of business an entrepreneur decides on can have real consequences. If Marc Weinstein and his co-founders had organized as a corporation instead of a partnership, then the corporation would have to please its stockholders. Instead, the business was organized as a partnership, which allows the partners to set their own criteria for success. Marianna Day Massey/ZUMA Press CHAPTER 3 Business Organizations 61 sole proprietorship or proprietorship business owned and run by a single person who has the rights to all profits and unlimited liability for all debts of the firm Skills Handbook See page R50 for more information on Using Bar and Circle Graphs. Sole Proprietorships MAIN Idea Sole proprietorships are easy to start, but owners have unlimited liability. Economics & You Have you ever dreamed of starting your own business? Read on to learn what it takes to own a business. as they set up operations. You could start a proprietorship simply by putting up a lemonade stand in your front yard. Someone else could decide to mow lawns or open a restaurant. A proprietorship can be run on the Internet, out of a garage, or from an office in a professional building. The most common form of business organization in the United States is the sole proprietorship or proprietorship—a business owned and run by a single individual. Because proprietorships are basically one-person operations, they comprise the smallest form of business and have the smallest fraction of total sales. As Figure 3.1 shows, they are also relatively profitable, as they bring in about one-fifth of the total profits earned by all businesses. Forming a Proprietorship The sole proprietorship is the easiest form of business to start because it involves almost no requirements except for occasional business licenses and fees. Most proprietorships are ready for business as soon Advantages As you have learned, a sole proprietorship is easy to start up. If someone has an idea or an opportunity to make a profit, he or she only has to decide to go into business and then do it. Management also is relatively simple. Decisions do not require the approval of a co-owner, boss, or other “higher-up.” This flexibility means that the proprietor can make an immediate decision if a problem comes up. A third advantage is that the owner can keep the profits of successful management without having
to share them with other owners. The owner also has to accept the possibility of a loss, but the lure of profits makes people willing to take risks. Figure 3.1 Business Organizations Number of organizations 8.5% 19.9% Sales 4.6% 11.8% Net income (profit) 20.9% 25.7% 71.6% 83.6% 53.4% Corporations Partnerships Sole proprietorships Source: 2006 Statistical Abstract of the United States. Businesses in the United States can be organized as sole proprietorships, partnerships, or corporations. Their numbers, sales, and profits vary widely. Corporations make up only 20 percent of businesses, yet they account for over half of the total net income. Economic Analysis Which business organization accounts for the largest amount of sales? Sole Proprietorship Anyone can start a business as a sole proprietor, as this pharmacist has done. What are the advantages of sole proprietorships? Fourth, the proprietorship does not have to pay separate business income taxes because the business is not recognized as a separate legal entity. The owner still must pay individual income taxes on profits taken from the sole proprietorship, but the business itself is exempt from any tax on income. Suppose, for example, Mr. Winters owns and operates a small hardware store in a local shopping center and a small auto repair business in his garage next to his home. Because neither business depends on the other, and because the only thing they have in common is Mr. Winters’s ownership, the two businesses appear as separate and distinct economic activities. For tax purposes, however, everything is lumped together at the end of the year. When Mr. Winters files his personal income taxes, the profits from both businesses are combined with any wages and salaries from other sources. He does not pay taxes on either of the businesses separately. Another advantage of the proprietorship is the psychological satisfaction many people get from being their own boss. These people often have a strong desire to see Getty Images their name in print, have dreams of great wealth or community status, or simply want to make their mark in history. A sixth advantage is that it is easy to get out of business. All the proprietor has to do is pay any outstanding bills and then stop offering goods or services for sale. unlimited liability requirement that an owner is personally and fully responsible for all losses and debts of the business Disadvantages The main disadvantage of a proprietorship is that the owner of the business has unlimited
liability. This means that the owner is personally and fully responsible for all losses and debts of the business. If the business fails, the owner’s personal possessions may be taken away to satisfy business debts. As an example, let us revisit the earlier case of Mr. Winters, who owns and operates two businesses. If the hardware business should fail, his personal wealth, which includes the automobile repair shop, may be legally taken away to pay off debts arising from the hardware store. A second disadvantage of a proprietorship is the difficulty of raising financial capital. Generally, a large amount of CHAPTER 3 Business Organizations 63 Partnerships MAIN Idea In a partnership, each partner fully shares responsibility for the operation of the business and all profits or losses. Economics & You Have you ever had a partner for a school project? How did you handle individual tasks, and how were grades assigned? Read on to find out about issues associated with partnerships. A partnership is a business that is jointly owned by two or more persons. It shares many of the same strengths and weaknesses of a sole proprietorship. As shown in Figure 3.1, partnerships are the least numerous form of business organization in the United States, accounting for the second smallest proportion of sales and net income. Types of Partnerships The most common form of partnership is a general partnership, in which all partners are responsible for the management and financial obligations of the business. In a limited partnership, at least one partner is not active in the daily running of the inventory stock of finished goods and parts held in reserve limited life situation in which a firm ceases to exist when an owner dies, quits, or sells the business partnership unincorporated business owned and operated by two or more people who share the profits and responsibility for debts general partnership form of partnership where all partners are equally responsible for management and debts limited partnership form of partnership where one or more partners are not active in the daily running of the business and have limited responsibility for debts money is needed to set up a business, and even more may be required for its expansion. However, banks and other lenders are often reluctant to lend money to new or very small businesses. As a result, the proprietor often has to raise financial capital by tapping savings, using credit cards, or borrowing from friends and family. The size and efficiency of a proprietorship also are disadvantages. A retail store, for example, may need to hire several employees just to stay open during normal business hours. It may also have to carry a minimum inventory—a stock of finished goods
and parts in reserve—to satisfy customers or to keep production flowing smoothly. Because of limited financial capital, the proprietor may not be able to hire enough personnel or stock enough inventory to operate the business efficiently. A fourth disadvantage is that the proprietor often has limited managerial experience. The owner-manager of a small company may be an inventor who is highly qualified as an engineer but lacks the “business sense” or the time needed to oversee the growth of the company. This owner may have to hire others to do the types of work—manufacturing, sales, and accounting—at which he or she is not an expert. A fifth disadvantage is the difficulty of attracting qualified employees. Because proprietorships tend to be small, employees often have to be skilled in several areas. In addition, many top high school and college graduates are more likely to be attracted to positions with larger, wellestablished firms than small ones. This is especially true when larger firms offer fringe benefits—employee benefits such as paid vacations, sick leave, retirement, and health or medical insurance—in addition to wages and salaries. A sixth disadvantage of the sole proprietorship is limited life. This means that the firm legally ceases to exist when the owner dies, quits, or sells the business. Reading Check Describing What are the major disadvantages of a sole proprietorship? 64 UNIT 1 Fundamental Economic Concepts Annette Coolidge/PhotoEdit business. Likewise, the limited partner only has limited responsibility for the debts and obligations of the business. which normally involve attorney fees and a filing fee for the state, are minimal if they are spread over several partners. Forming a Partnership Like a proprietorship, a partnership is relatively easy to start. Because more than one owner is involved, formal legal papers called articles of partnership are usually drawn up to specify arrangements between partners. Although not always required, these papers state ahead of time how the expected profits (or possible losses) will be divided. The articles of partnership may specify that the profits be divided equally or by any other arrangement suitable to the partners. They also may state the way future partners can be added to the business, and the way the property of the business will be distributed if the partnership ends. Advantages Like the sole proprietorship, one advantage of the partnership is its ease of startup. Even the costs of the articles of partnership, Ease of management is another advantage. Each partner usually brings a different area of expertise to the business: one might have a talent for marketing, another for production, another
for bookkeeping and finance, and yet another for shipping and distribution. While partners normally agree ahead of time to consult with each other before making major decisions, partners generally have a great deal of freedom to make minor ones. A third advantage is the lack of special taxes on a partnership. As in a proprietorship, the partners withdraw profits from the firm and then pay individual income taxes on them at the end of the year. Partners have to submit special schedules to the Internal Revenue Service detailing their profits from the partnership, but this is for informational purposes only and does not give a partnership any special legal status. Fourth, partnerships can usually attract financial capital more easily than proprietorships. They are generally larger and Partnerships Businesses owned by two or more people are called partnerships. Lawyers, doctors, and architects often form partnerships to limit overhead costs. How are partnerships founded? (l) Corbis, (r) Doug Menuez/Getty Images CHAPTER 3 Business Organizations 65 Liability In a partnership, all partners take on responsibility for the debts of the business. How do general partnerships and limited partnerships differCongratulations on becoming a partner - your share of company losses are $200,000.” have a better chance of getting a bank loan. The existing partners could also take in new partners who bring financial capital with them as part of their price for joining. A fifth advantage of partnerships is the more efficient operations that come with their slightly larger size. In some areas, such as medicine and law, a relatively small firm with three or four partners might be just the right size for the market. Other partnerships, such as accounting firms, may have hundreds of partners offering services throughout the United States. A sixth and final advantage is that partnerships often find it easier to attract top talent than proprietorships. Because most partnerships offer specialized services, top graduates seek out stable, well-paying firms to apply their recently acquired skills. Disadvantages The main disadvantage of the general partnership is that each partner is fully responsible for the acts of all other partners. If one partner causes the firm to suffer a huge loss, each partner is fully and personally responsible for the loss. This is similar to the unlimited liability feature of a proprietorship, but it is more complicated because more owners are involved. As a result, most people are extremely careful when they choose a business partner. In the case of the limited partnership, a partner’s responsibility for the debts of the business is limited by the size of his or her investment in the firm. If the business fails
and debts remain, the limited partner loses only the original investment, leaving the general partners to make up the rest. Another disadvantage is that the partnership, like the proprietorship, has limited life. When a partner dies or leaves, the partnership must be dissolved and reorganized. However, the new partnership may try to reach an agreement with the older partnership to keep its old name. A third disadvantage is the potential for conflict between partners. Sometimes partners discover that they do not get along, so they have to either learn to work together or leave the business. If the partnership is large, these types of problems can easily develop, even though initially everyone thought they would get along. Reading Check Contrasting What are the differences between a general partnership and a limited partnership? 66 UNIT 1 Fundamental Economic Concepts John Morris/Cartoon Stock Corporations MAIN Idea Corporations are one of the most important forms of business and can easily raise large amounts of financial capital. Economics & You Do you know someone who works for a corporation? Read on to learn how corporations are organized. Corporations account for only about onefifth of the businesses in the United States, as shown in Figure 3.1, although they are responsible for a majority of all sales. A corporation is a form of business organization recognized by law as a separate legal entity with all the rights of an individual. This status gives the corporation the right to buy and sell property, to enter into legal contracts, and to sue and be sued. Forming a Corporation Unlike a sole proprietorship or partnership, a corporation is a very formal and legal arrangement. People who want to incorporate, or form a corporation, must file for permission from the national government or the state where the business will have its headquarters. If approved, a charter—a government document that gives permission to create a corporation— is granted. The charter states the company’s name, address, purpose, and other features of the business. The charter also specifies the number of shares of stock, or ownership certificates in the firm. These shares are sold to investors, called stockholders or shareholders. As shown in Figure 3.2, stockholders then own a part of the corporation. The money gained from the sale of stock is used to set up the corporation. If the corporation is profitable, it may eventually issue a dividend—a check that transfers a portion of the corporate earnings—to each stockholder. Corporate Structure When investors purchase stock, they become owners with certain ownership rights. The extent of these rights depends on the type of stock
purchased: common or preferred. Common stock represents basic ownership of a corporation. The owner of common stock usually receives one vote for each share of stock. This vote is used to elect a board of directors, which in turn directs the corporation’s business by setting broad policies and goals. The board also hires a professional management team to run the business on a daily basis. corporation form of business organization recognized by law as a separate legal entity charter written government approval to establish a corporation stock certificate of ownership in a corporation stockholders or shareholders people who own a share or shares of stock in a corporation dividend check that transfers a portion of the company profits to stockholders, usually quarterly common stock most frequently used form of corporate ownership, with one vote per share for stockholders Figure 3.2 Stock Ownership 1/200th If a corporation has 200 shares of stock, and if you could divide the firm into 200 equal parts, the owner of a single share of stock would own 1/200th of the corporation. Economic Analysis How does common stock differ from preferred stock? CHAPTER 3 Business Organizations 67 preferred stock form of corporate ownership without vote, in which stockholders get their investments back before common stockholders Preferred stock represents nonvoting ownership shares of the corporation. Because the stock is nonvoting, preferred stockholders do not have the right to elect members to the board of directors. However, preferred stockholders receive their dividends before common stockholders receive theirs. If a corporation goes out of business, preferred stockholders get their investment back before common stockholders get theirs back. In theory, a stockholder who owns a majority of a corporation’s common stock can elect board members and control the company. In some cases, the common stockholder might elect himself or herself, or even other family members, to the board of directors. In practice, this is not done very often because most corporations are so large and the number of shares held by the typical stockholder is so small. Most small stockholders either do not vote or they turn their votes over to someone else. This is done with the use of a proxy, a ballot that gives a stockholder’s representative the right to vote on corporate matters. Although corporations differ in size and industry, they generally organize in similar ways. As Figure 3.3 shows, the day-to-day operations of a corporation are divided into different departments headed by vice presidents, who in turn report to the president of the company. Neither the president nor the other employees of the corporation have direct
contact with the owners, or shareholders, of the company. Advantages The main advantage of a corporation is the ease of raising financial capital. If the corporation needs more capital, it can sell additional stock to investors. The revenue Figure 3.3 Corporate Structure See StudentWorks™ Plus or glencoe.com. Owners, the shareholders, elect the Board of directors, who select the President, who hires the Vice president, sales Vice president, production Vice president, finance Domestic International Quality control Research and development Payroll This organizational chart shows the chain of command of a typical organization. It also outlines the basic components of the business, such as sales, production, and payroll. Economic Analysis Who reports directly to the vice president of production? can then be used to finance or expand operations. A corporation may also borrow money by issuing bonds. A bond is a written promise to repay the amount borrowed at a later date. The amount borrowed is known as the principal. While the money is borrowed, the corporation pays interest, the price paid for the use of another’s money. A second and very important advantage is that the corporation provides limited liability for its owners. This means that the corporation itself, not its owners, is fully responsible for its obligations. To illustrate, suppose a corporation cannot pay all of its debts and goes out of business. Because of limited liability, stockholder losses are limited to the money they invested in stock. Even if other debts remain, stockholders are not responsible for them. Some firms will incorporate just to take advantage of the limited liability. For example, suppose Mr. Winters, who owns the hardware store and the auto repair business, now decides to set up each business as a separate corporation. If the hardware business should fail, his personal wealth, which includes stock in the automobile repair business, is safe. Mr. Winters may lose all the money invested in the hardware business, but that would be the extent of his loss. From a broader economic perspective, limited liability enables firms to undertake potentially profitable ventures which are inherently risky. For example, corporations rather than individuals usually introduce new medicines because of the limited liability feature. A third advantage of a corporation is that the directors of the corporation can hire professional managers to run the firm. This means that the owners, or stockholders, can own a portion of the corporation without having to know much about the business itself. Another advantage is unlimited life, meaning that the corporation continues to exist even when ownership changes. Because the corporation is recognized as a separate legal entity
, the name of the company stays the same, and the corporation continues to do business. Cornered by Mike Baldwin ”. “ Double Taxation Shareholders have to pay corporate taxes and income taxes on their dividends. Why are people interested in owning stock when they have to pay so much in taxes? bond formal contract to repay borrowed money with interest principal amount borrowed when getting a loan or issuing a bond interest payment made for the use of borrowed money double taxation taxation of dividends both as corporate profit and as personal income This leads to a fifth advantage, the ease of transferring ownership of the corporation. If a shareholder no longer wants to be an owner, he or she simply sells the stock to someone else who then becomes the new owner. As a result, it is easier for the owner of a corporation to find a new buyer than it is for the owner of a sole proprietorship or a partnership. Disadvantages Because the law recognizes the corporation as a separate legal entity, the corporation must keep detailed sales and expense records so that it can pay taxes on its profits. This leads to the first disadvantage, the double taxation of corporate profits. Double taxation means that stockholder dividends are taxed twice. They are taxed the first time when the corporation pays taxes on its profits. Then they are taxed a CORNERED © 2004 Mike Baldwin. Reprinted with permission of UNIVERSAL PRESS SYNDICATE. All rights reserved. CHAPTER 3 Business Organizations 69 What’s a public corporation anyway? It’s one that has “gone public,” which means anyone with a little extra cash can buy stock and own a part of the company. A privately held corporation, on the other hand, sells shares only to a select group of people. Sometimes that group may consist of a few family members. The Securities and Exchange Commission (SEC) was set up in 1934 to regulate the sale of stock by public corporations. Skills Handbook See page R41 for more information on Evaluating Information. second time when investors, as the owners of the corporation, report their dividends as personal income. Another disadvantage of the corporate structure is the difficulty and expense of getting a charter. Depending on the state, attorney’s fees and filing expenses can cost several thousand dollars. A third disadvantage of the corporation is that the owners, or shareholders, have little voice in how the business is run. Shareholders vote for the board of directors, and the directors turn day-today operations over to a professional management team. The result is a separation of ownership
and management. This is different from the proprietorship and partnership, where ownership and management are usually one and the same. Finally, the fourth disadvantage is that corporations are subject to more government regulation than other forms of business. Corporations must register with the state in which they are chartered. If a corporation wants to sell its stock to the public, it must register with the federal Securities and Exchange Commission (SEC). It will also have to provide financial information concerning sales and profits to the general public on a regular basis. Even an attempt to take over another business may require federal government approval. Reading Check Evaluating Why do many business owners prefer corporations over other forms of business organization? SECTION 1 Review Vocabulary 1. Explain the significance of sole proprietorship, Critical Thinking 4. The BIG Idea How do partnerships support the profit proprietorship, unlimited liability, inventory, limited life, partnership, general partnership, limited partnership, corporation, charter, stock, stockholder, shareholder, dividend, common stock, preferred stock, bond, principal, interest, and double taxation. Main Ideas 2. Discuss the advantages and disadvantages of the corporation. 3. Describing Use a graphic organizer like the one below to describe the characteristics of proprietorships, partnerships, and corporations. Business Form Characteristics Proprietorship Partnership Corporation motive of entrepreneurs? 5. Analyzing Visuals Look at Figure 3.3 on page 68. What is the relationship between the owners and the employees of the corporation? 6. Drawing Conclusions When a corporation wants to introduce a potentially profitable but risky product, it frequently sets up a separate company that has its own corporate structure. Why do you think the corporation does this? Applying Economics 7. Partnerships Assume that you and a friend want to start a partnership to run your own business, such as a music store. Draw up one-page articles of partnership that outline how you will address financial issues of the partnership. 70 UNIT 1 Fundamental Economic Concepts ENTREPRENEUR Profiles in Economics Andrea Jung (1958− ) • first female chief executive officer (CEO) in Avon Products’ 118-year history • ranked #5 on Fortune magazine’s “50 Most Powerful Women in Business” The Avon Lady When promoted to Avon’s top spot in 1999, Andrea Jung was charged with modernizing and restructuring what many considered to be a hopelessly antiquated company. Women have been selling Avon cosmetics directly to customers since 1886, but in the Internet era, this hands-on business
model became a liability. If women had no Avon representative in their area, they had no way to purchase the products from the catalog—until Andrea Jung took charge. The Mobilization Campaign Jung faced a problem. Putting Avon products in retail stores or offering them online put the company in direct competition with its own army of 5 million independent sales representatives in 140 countries. Working closely with the “reps” was paramount to Jung. So when Jung took the company online, she made sure it directed users to local reps. She also gave the reps the opportunity to purchase kiosks in malls and other retail venues as franchises. Fluent in Mandarin Chinese, she helped strengthen Avon’s presence in China and other countries, such as Russia. She also updated and innovated products and introduced a new line, called Mark™ that was tailored to the increasing number of younger, collegeaged reps and their customers. These changes and others caused a rebound in Avon stock, led to increases in annual revenues from $5.3 billion to more than $8 billion, and made Jung a corporate celebrity. Jung also had an impact within the company. Avon has more women in management—86 percent—than any other Fortune 500 company. Jung serves as a mentor to other women in the company. She encourages questions and rewards success. Although she is a private person, Jung has learned to be more open with Avon reps and motivate them to enact the changes she sees ahead. Examining the Profile 1. Summarizing What changes did Jung make to Avon’s marketing strategy? 2. For Further Research What career steps did Jung take that allowed her to move from a degree in English literature to a top management position? After graduating from Princeton with a degree in English literature, Andrea Jung wanted to spend just two years in retail before pursuing a law degree. Instead, she turned retail into a career—and Avon into a global success. Nancy Kaszerman/Corbis CHAPTER 3 Business Organizations 71 SECTION 2 Business Growth and Expansion GUIDE TO READING Section Preview In this section, you will learn how businesses grow through merging with other companies or by reinvesting profits in themselves. Content Vocabulary • merger (p. 72) • income statement (p. 73) • net income (p. 73) • depreciation (p. 73) • cash flow (p. 73) • horizontal merger (p. 75) • vertical merger (p. 75) • conglomerate (p. 76) • multinational (p.
76) Academic Vocabulary • internally (p. 75) • dominant (p. 75) Reading Strategy Comparing As you read the section, complete a graphic organizer similar to the one below by comparing a vertical merger to a horizontal merger. Vertical merger Similarities Horizontal merger —Newsweek COMPANIES IN THE NEWS Reinvesting for Monster Growth How does a booming company spark new growth the year after its sales nearly double? If you’re Hansen Natural, maker of Monster Energy drinks, you start by signing a two-year endorsement deal with Ricky Carmichael, the Michael Jordan of motocross and supercross racing. It’s good for business when “R.C.” hoists a can of Monster on the victory stand....[A] big endorsement deal is just one way Hansen hopes to build on its growth. CEO Rodney Sacks [and fellow South African-born company president Hilton Schlosberg] wants to roll out new products that reach... the key male market of 18- to 25-year-olds. In addition to regular Green Monster, there’s... Monster Assault in a camouflage can aimed at teens and a Lost Energy brand targeting surfers and skateboarders. ■ merger combination of two or more businesses to form a single firm When Hansen Natural decided to sign up a celebrity to endorse its products, the company hoped to increase profits by expanding its markets and sales. Investing these profits in new plant, equipment, and products is one way a business can grow. Another way a business can expand is by engaging in a merger—a combination of two or more businesses to form a single firm. Yet mergers can be risky because they often combine very different corporate cultures, and there is no guarantee that consumers will like the resulting products. Even so, the payoffs can be huge, so the temptation to merge is always attractive to businesses. 72 UNIT 1 Fundamental Economic Concepts Glencoe Photo Growth Through Reinvestment MAIN Idea Business owners can use their profits to update and expand their firms. Economics & You Do you know a local business that has expanded in recent years? Read on to learn how business owners reinvest cash flow for growth. Most businesses use financial statements to keep track of their business operations. One of the most important of those is the income statement—a report showing a business’s sales, expenses, net income, and cash flows for a period of time, such as three months or a year. We can use the
income statement to show how a business can use some of the revenue it receives from sales to grow through reinvestment. Estimating Cash Flows An income statement such as the one in Figure 3.4 shows a firm’s net income—the funds left over after all of the firm’s expenses, including taxes, are subtracted from its sales. These expenses include the cost of inventory, wages and salaries, interest payments, and all other payments the firm must make as part of its normal business operations. One of the most important of these payments is depreciation—a noncash charge the firm takes for the general wear and tear on its capital goods. Depreciation is called a noncash charge because the money stays in the firm rather than being paid to someone else. For example, interest may be paid to a bank, wages may be paid to employees, or payments may be made to suppliers to provide some of the inputs used in production. However, the money allocated to depreciation never goes anywhere. Since this money stays in the business, the firm treats it as a form of income. Because of this, firms usually prefer to take as much depreciation as possible. As you can see in the figure, an incease in depreciation would lower the earnings before tax but increase the cash flow. The cash flow—the sum of net income and noncash charges, such as depreciation—is the bottom line, a more comprehensive measure of profits. This is because the cash flow represents the total amount of new funds generated from operations. Reinvesting Cash Flows If the business has a positive cash flow, the owners can then decide how to allocate it. The board of directors of a corporation income statement report showing a firm’s sales, expenses, net income, and cash flows for a certain period, usually three months or a year net income common measure of business profits determined by subtracting all expenses, including taxes, from revenues depreciation gradual wear on capital goods cash flow total amount of new funds a business generates from operations Figure 3.4 Growth Through Reinvestment First quarter income statement Generates Investment in new plant, equipment, and technologies Sales of goods and services Less: Cost of goods sold Wages and salaries Interest payments Depreciation Earnings before tax Less: Taxes at (40%) Net income Plus: Depreciation Allows Cash flow $1,000 400 250 50 100 $200 80 $120 100 $220 See StudentWorks™ Plus or glencoe.com. Businesses use income statements to record sales and expenses. Cash flow
includes the net income plus depreciation. Any cash flow not paid out to stockholders as dividends is money that businesses can use for reinvestment. Economic Analysis Which of the items on the income statement represents the real measure of profits for the business? Shareholder dividends CHAPTER 3 Business Organizations 73 may declare a dividend to be paid directly to shareholders as a reward for their investments. The owners of a proprietorship or partnership may keep some cash flow as the reward for risk-taking. The remainder of the funds could then be reinvested in new plant, equipment, or technologies. When cash flows are reinvested in the business, the firm can produce additional products. This generates additional sales and an even larger cash flow during the next sales period. As long as the firm has positive cash flows, and as long as the reinvested funds are larger than the wear and tear on equipment, the firm will grow. Finally, the concept of cash flow is also important to investors. In fact, if investors want to know about the financial health of a firm, a positive cash flow is one of the first things they look for. Reading Check Summarizing What is the benefit of reinvesting cash flow in a business? Growth Through Mergers MAIN Idea Mergers allow firms to quickly grow in size. Economics & You Can you think of any recent mergers and the issues those mergers raised? Read on to learn about the various types of mergers. When two companies merge, one gives up its separate legal identity. For public recognition purposes, however, the name of the new company may reflect the identities of both. When Chase National Bank and Bank of Manhattan merged, the new company was called the Chase Manhattan Bank of New York. Later it changed its name to the Chase Manhattan Corporation to reflect its geographically expanding business. Finally, after merging with JP Morgan, it settled on JPMorgan Chase. Likewise, Procter & Gamble kept the brand name Gillette after it bought the company. &The Global Economy YOU Know Your Manners As American businesses expand into other countries, they face a question that has nothing to do with actual business: how to interact with people from a different culture. You too may someday find yourself working in another country or traveling abroad to meet with businesspeople. How will you know what to do and say? Many books and Web sites offer advice on customs to Americans doing business in other countries. Here are some things to keep in mind as you travel around the globe: • Gift-giving is an important part of Japanese business protocol. Present your
gift with both hands and note that it is of no large value. This tells your business partner that you value the relationship more than the gift itself. • In Argentina, it is not unusual for a business associate to arrive 30 to 40 minutes late to a meeting. • The amount of time you spend in negotiations will often determine the importance of a business arrangement in India. More time implies greater importance. • In Germany, avoid using first names. These are reserved for family and close friends. Even among long-time colleagues, it is common to address one another using titles and last names. • Local politics are open for discussion in South Africa. In fact, not knowing local and regional politics can end any business dealings. 74 UNIT 1 Fundamental Economic Concepts Digital Vision/Getty Images Figure 3.5 Types of Mergers VERTICAL MERGER Horizontal mergers combine two or more firms that produce the same kind of product. Vertical mergers bring together firms involved in different stages of manufacturing or marketing. Economic Analysis How does a company benefit from a vertical merger? H ORIZONTAL M ERGER + = Nickel Savings Bank People's Building & Loan Association Nickel Savings & Loan Association Hickory Tree Farms + Boston Baseball Bat, Inc. + Fast Delivery, Inc. = Boston Baseball Bat, Inc. horizontal merger combinationof two or more firms producing the same kind of product vertical merger combination of firms involved in different stages of manufacturing or marketing Types of Mergers There are two types of mergers, both of which are illustrated in Figure 3.5. The first is a horizontal merger, which takes place when firms that produce the same kind of product join forces. One such example is the bank merger of JP Morgan and Chase Manhattan to form JPMorgan Chase. When companies involved in different stages of manufacturing or marketing join together, it results in a vertical merger. One example of a vertical merger is the formation of the U.S. Steel Corporation. At one time it mined its own ore, shipped it across the Great Lakes, smelted it, and made steel into many different products. Vertical mergers take place when companies seek to protect against the potential loss of suppliers. Reasons for Merging Mergers take place for a variety of reasons. A business may seek a merger to grow faster, to become more efficient, to acquire or deliver a better product, to eliminate a rival, or to change its image. For example, some managers find that they cannot grow as fast as they would like using the funds they generate internally. As a result, one
firm may consider merging with another firm. Sometimes a merger makes sense, and other times it may not, but the desire to become a larger company in the industry—if not the largest—is one reason that mergers take place. Efficiency is another reason for mergers. When two firms merge, they no longer need two presidents, two treasurers, and two personnel directors. The new company can have more retail outlets or manufacturing capabilities without significantly increasing management costs. In addition, the new company may be able to get better discounts by making volume purchases, and it may be able to make more effective use of its advertising. Sometimes the merging firms can achieve two objectives at once—such as dominant size and improved efficiency. CHAPTER 3 Business Organizations 75 Figure 3.6 Conglomerate Structure A conglomerate is a firm with at least four businesses that make unrelated products, none of which is responsible for a majority of its sales. General Electric is a U.S. conglomerate with products ranging from aircraft engines to movies. Economic Analysis How many different industries can you identify in the list of GE products? 8.5% 24.2% 28.1% 10.5% 20.2% 8.5% Source: www.ge.com, 2006 Commercial finance Consumer finance Health care Industrial Infrastructure NBC Universal photo on top: Engineer working on GE aircraft engine photo on bottom: Entrance to NBC Universal Studios conglomerate firm with four or more businesses making unrelated products, with no single business responsible for a majority of its sales multinational corporation producing and selling without regard to national boundaries and whose business activities are located in several different countries Some mergers are driven by the desire to acquire new product lines. When a telecommunications company such as AT&T buys a cable TV company, for example, it can offer faster Internet access and telephone service in a single package. Sometimes firms merge to catch up with, or even eliminate, rivals. Royal Caribbean Cruises acquired Celebrity Cruise Lines and nearly doubled in size to become the second largest cruise line behind Carnival. Finally, a company may use a merger to lose its corporate identity. For example, ValuJet merged with AirWays to form AirTran Holdings Corporation. The new company flew the same planes and routes as the original company, but AirTran hoped the name change would help the public forget ValuJet’s tragic Everglades crash in 1996 that claimed 110 lives. Conglomerates A corporation may become so large through mergers and acquisitions that it turns into a conglomerate. A
conglomerate is a firm that has at least four businesses, each making unrelated products and none responsible for a majority of its sales. Diversification is one of the main reasons for conglomerate mergers. Some firms hope to protect their overall sales and profits by not “putting all their eggs in one basket.” Isolated economic events, such as bad weather or a sudden change of consumer tastes, may affect some product lines but not all of them at the same time. In recent years, the number of conglomerates in the United States has declined. In Asia, however, conglomerates remain strong. Samsung, Gold Star, and Daewoo are still dominant in Korea, as are Mitsubishi, Panasonic, and Sony in Japan. Multinationals Other large corporations have become international in scope. A multinational is a corporation that has manufacturing or service operations in a number of different countries. In effect, it is a citizen of several countries at one time. A multinational is likely to pay taxes in each country where it has operations and is subject to the laws of each. General Motors, 76 UNIT 1 Fundamental Economic Concepts (t) Brownie Harris/Corbis, (b) Robert Landau/Corbis Nabisco, British Petroleum, Royal Dutch Shell, Mitsubishi, and Sony are examples of multinational corporations that have attained worldwide economic importance. Multinational corporations are important because they have the ability to move resources, goods, services, and financial capital across national borders. A multinational with its headquarters in Canada, for example, could sell bonds in France. The proceeds could then be used to expand a plant in Mexico that makes products for sale in the United States. A multinational may also be a conglomerate if it makes unrelated products, but it is more likely to be called a multinational if it conducts operations in several different countries. Multinationals are usually welcome in a nation because they transfer new technology and generate new jobs in areas where jobs are needed. Multinationals also produce tax revenues for the host country, which helps that nation’s economy. At times, multinationals have been known to abuse their power by paying low wages to workers, exporting scarce natural resources, or interfering with the development of local businesses. Some critics point out that multinational corporations are able to demand tax, regulatory, and wage concessions by threatening to move their operations to another country. Other critics are concerned that multinationals may alter traditional ways of life and business customs in the host country. Most economists, however, welcome the lower-cost production and higher
-quality output that global competition brings. They also believe that the transfer of technology that eventually takes place will raise the standard of living for everyone. On balance, the advantages of multinationals far outweigh the disadvantages. Reading Check Contrasting How do conglomerates and multinationals differ? Skills Handbook See page R42 to learn about Making Inferences. SECTION 2 Review Vocabulary 1. Explain the significance of merger, income statement, net income, depreciation, cash flow, horizontal merger, vertical merger, conglomerate, and multinational. Critical Thinking 5. The BIG Idea How could a merger between two large cellular phone companies provide better products in a more efficient manner? Main Ideas 2. Describe how a firm can generate funds internally to grow and expand. 3. Explain the basic difference between a conglomerate and a multinational corporation. 6. Analyzing Visuals Look at Figure 3.6 on page 76. Explain how the diversification of General Electric illustrates the saying: “Don’t put all your eggs in one basket.” 7. Inferring What are the possible benefits and drawbacks of multinationals to their host countries? 4. Identifying Use a graphic organizer like the one below to identify the reasons businesses merge. Applying Economics Reasons for mergers 8. Horizontal Mergers Research the ownership of radio stations in a nearby metropolitan area. Are any owned by the same company? Do the stations have the same types of broadcasts or the same advertising? Write a one- to two-page paper about your findings. In your paper, explain why a company would want to own multiple stations in the same geographical market. CHAPTER 3 Business Organizations 77 Case Study 7-Eleven “Convenience” Is Born In 1927 an employee of the Southland Ice Company in Dallas, Texas, began selling milk, bread, and eggs from the ice dock on Sundays and evenings when grocery stores were closed. This sparked the idea for the convenience store. In 1946 the stores were renamed 7-Eleven to reflect their new hours: 7 a.m. to 11 p.m. Japan Borrows the Idea In the early 1970s, Toshifumi Suzuki, a young Japanese executive, came to the United States to look into franchising Denny’s restaurants in Japan. He was more impressed by the 7-Elevens he saw. With its densely populated cities and small commercial lots, Japan was perfectly suited to the convenience-store format. In 1974 Suzuki opened a chain of stores under the 7-Eleven name. Since
then, the retailer has changed the way the country shops and eats. Many stores offer banking services, dry-cleaning drop-off, parcel post, mobile-phone recharging, photocopying, and even voter registration. They also stock cheap, high-quality foods, such as gourmet rice balls, exotic salads, and other delicacies customized to local tastes. Technology, coordinated deliveries, and inventory control have boosted efficiency. The company uses a satellite-based ordering system that 78 UNIT 1 Fundamental Economic Concepts TWPhoto/Corbis includes detailed weather reports. This way, managers know to order more cold noodles on warm days or more fresh produce on rainy days, when customers want to avoid a trip to the grocery store. Today 7-Eleven is Japan’s most profitable retailer. 7-ELEVENS IN THE UNITED STATES AND JAPAN 300 200 100 ) 10,000 5,000 US* Population Japan 7-Elevens *Number of stores includes 7-Eleven stores in Canada The Student Buys the Teacher While 7-Eleven Japan boomed, its U.S. counterpart declined. In the late 1980s, 7-Eleven Japan and its parent company, Ito-Yokado, helped turn around the U.S. stores. They improved the U.S. distribution network and introduced new sandwiches, bakery items, and coffees. In 1991, ItoYokado bought 70 percent of the American company outright. Today nearly 30,000 7-Eleven stores generate total sales of more than $43 billion in 17 countries and U.S. territories. Analyzing the Impact 1. Drawing Conclusions How do you know that 7-Eleven is a multinational corporation? 2. Comparing and Contrasting In what ways do 7-Elevens in Japan differ from their U.S. counterparts? SECTION 3 Nonprofit Organizations GUIDE TO READING Section Preview In this section, you will learn about the economic benefits that cooperatives and other nonprofit organizations bring to their members. Content Vocabulary • nonprofit organization (p. 79) • cooperative (p. 80) • co-op (p. 80) • credit union (p. 80) • labor union (p. 81) • collective bargaining (p. 81) • professional association (p. 81) • chamber of commerce (p. 81) • Better Business Bureau (p. 82) • public utility (p. 83) Academic Vocabulary • analyze (p. 80) • dev
oting (p. 80) Reading Strategy Describing As you read the section, complete a graphic organizer similar to the one below by describing the benefits of nonprofit organizations. Organization Benefits Community organization Consumer cooperative PEOPLE IN THE NEWS Katrina Volunteer Vacation —adapted from American Red Cross News online Last semester, they studied textbook disasters. Over their winter break, they helped feed and comfort Hurricane Katrina victims. Each day, Nellie Afshar, Jemma Binder, Dawn Birk, Zachary Joyce, and graduate student Jessica Walsh from the State University of New York at New Paltz rose before dawn, helped load supplies, spent all day dispensing hot meals in flood-ravaged areas, and then pitched in to clean their vehicles afterward. Their service fulfilled a field work requirement for a disaster studies practicum, part of SUNY’s new disaster studies minor, but the experience was more than that for these students. “You couldn’t get me up at 6 a.m. for any other reason,” said Joyce, 21. “I wouldn’t get up at 6 a.m. to make money. This is the best work I’ve ever done.” ■ Most businesses use scarce resources to produce goods and services in hopes of earning a profit for their owners. Other organizations operate on a “not-for-profit” basis. A nonprofit organization works in a businesslike way to promote the collective interests of its members rather than to seek financial gain for its owners. The American Red Cross is one example of a nonprofit. Like other nonprofits, it relies on volunteers such as the SUNY students for much of its work. In this way, nonprofits and other community and civic organizations can perform useful services with minimal expense and without regard to earning a profit. nonprofit organization economic organization that operates like a business but does not seek financial gain Nam Y. Huh/AP/Wide World Photos CHAPTER 3 Business Organizations 79 cooperative or co-op nonprofit association performing some kind of economic activity for the benefit of its members credit union nonprofit service cooperative that accepts deposits, makes loans, and provides other financial services Community Organizations and Cooperatives MAIN Idea A variety of nonprofit organizations provide a wide range of goods and services to communities and members. Economics & You Have you volunteered for a community organization? Read on to find out how such organizations help their communities. Community Organizations Community organizations include schools, churches, hospitals, welfare groups, and adoption agencies. Many of these organizations are legally incorporated
to take advantage of unlimited life and limited liability. They are similar to profit-seeking businesses but do not issue stock, pay dividends, or pay income taxes. Figure 3.7 Cooperatives Consumer Cooperatives Housing cooperatives Discount price clubs Bulk foods store Service Cooperatives Credit unions Insurance companies Babysitting services Producer Cooperatives Farmers marketing cooperatives Cooperatives are voluntary associations of people formed to carry on some kind of economic activity that will benefit their members. Economic Analysis How do the three kinds of cooperatives differ? If their activities produce revenues in excess of expenses, they use the surplus to further their work. Like for-profit businesses, nonprofit organizations use scarce factors of production. Their work is difficult to analyze economically because the value of their efforts is not easy to measure. Still, the large number of these organizations shows that they are important to our economic system. Cooperatives A common type of nonprofit organization is the cooperative, or co-op. A cooperative is a voluntary association formed to carry on some kind of economic activity that will benefit its members. As Figure 3.7 shows, cooperatives can have a variety of goals. Cooperatives fall into three major categories: consumer, service, and producer. The consumer cooperative is a voluntary association that buys bulk amounts of goods such as food or clothing on behalf of its members. Members usually help keep the cost of the operation down by devoting several hours a week or month to the operation. If successful, the co-op is able to offer its members products at prices lower than those charged by regular businesses. A service cooperative provides services such as insurance, credit, or child care to its members, rather than goods. One example is a credit union, a financial organization that accepts deposits from, and makes loans to, employees of a particular company or government agency. Like consumers, producers also can have co-ops. A producer cooperative helps members promote or sell their products. In the United States, most cooperatives of this kind are made up of farmers. The co-op helps the farmers sell their crops directly to central markets or to companies that use the members’ products. Some co-ops, such as the Ocean Spray cranberry co-op, market their products directly to consumers. Reading Check Explaining How does a cooperative work? Labor Unions Workers may join a labor union that represents their interests. How do labor unions help their members? labor union organization that works for its members’ interests concerning pay, working conditions, and benefits collective bargaining negotiation between union and company representatives over pay
, benefits, and other job-related matters professional association nonprofit organization of professional or specialized workers seeking to improve working conditions, skill levels, and public perception of its profession chamber of commerce nonprofit organization of local businesses formed to promote their interests Labor, Professional, and Business Organizations Education Association for teachers, are independent and represent workers in specific industries. MAIN Idea Some nonprofit organizations are formed to promote the interests of workers and consumers. Economics & You You just learned about nonprofit organizations that help consumers and communities. Read on to find out about groups that support workers and businesses. Nonprofit organizations are not just limited to co-ops and civic groups. Many other groups also organize this way to promote the interests of their members. Labor Unions One important economic institution is the labor union, an organization of workers formed to represent its members’ interests in various employment matters. The union participates in collective bargaining when it negotiates with management over issues such as pay, working hours, health care coverage, vacations, and other jobrelated matters. Unions also lobby for laws that will benefit and protect their workers. The largest labor organization in the United States is the American Federation of Labor-Congress of Industrial Organizations (AFL-CIO), an association of unions whose members include workers in many different jobs. Other unions, such as the National Andrew Lichtenstein/Corbis Professional Associations Some workers belong to professional societies, trade associations, or academies. Such a professional association consists of people in a specialized occupation interested in improving the working conditions, skill levels, and public perceptions of the profession. The American Medical Association (AMA) and the American Bar Association (ABA) are examples of organizations that include members of specific professions. These groups influence the licensing and training of their members, set standards for conduct, and are actively involved in political issues. Other professional associations represent bankers, teachers, college professors, police officers, and hundreds of other professions. Business Associations Businesses also organize to promote their collective interests. Most communities have a local chamber of commerce, an organization that promotes the welfare of its member businesses. The typical chamber sponsors activities ranging from educational programs to lobbying for favorable business legislation. Industry or trade associations represent specific kinds of businesses. Trade associations are interested in shaping the CHAPTER 3 Business Organizations 81 Better Business Bureau businesssponsored nonprofit organization providing information on local companies to consumers government’s policy on such economic issues as free enterprise, imports and tariffs, the minimum wage, and new construction. Some business associations help protect the consumer. The Better Business Bureau is
a nonprofit organization sponsored by local businesses. It provides general information on companies, maintains records of consumer inquiries and complaints, and offers consumer education programs. Reading Check Summarizing How do professional associations help their members? CAREERS Sociologist The Work * Study the development, interaction, and behavior of social groups, including various social, religious, and business organizations * Gather firsthand information from people and derive conclusions that can lead to formulating policies that impact educators, lawmakers, administrators, and others committed to resolving social problems * Knowledge of society and social behavior may be used by companies in product development, marketing, and advertising Qualifications * Strong mathematical skills, quantitative research and analysis skills, and the ability to communicate ideas clearly * Objectivity, an open mind, and systematic work habits * Master’s degree, with a Ph.D. required of sociologists teaching at the university level Earnings * Median annual earnings: $57,870 Job Growth Outlook * Slower than average Source: Occupational Outlook Handbook, 2006–2007 Edition 82 UNIT 1 Fundamental Economic Concepts Dawn Tardif/Corbis Government MAIN Idea The government provides some goods and services while helping to make sure the economy runs smoothly. Economics & You You read earlier about the role of the government in economic policy. Read on to learn more details about that role. Although you may not think of it that way, your local, state, or national government actually is a nonprofit economic organization. Sometimes government plays a direct role in the economy, while at other times the role is indirect. Direct Role of Government Many government agencies produce and distribute goods and services to consumers, giving government a direct role in the economy. The role is “direct” because the government supplies a good or service that competes with private businesses. One example of direct involvement is the Tennessee Valley Authority (TVA). The TVA supplies electric power for most of Tennessee and parts of Alabama, Georgia, Kentucky, North Carolina, Virginia, and Mississippi. This power supplier competes directly with other, privately owned, power companies. Another example is the Federal Deposit Insurance Corporation (FDIC), which insures deposits in our nation’s banks. Because the insurance the FDIC supplies could be provided by privately owned insurance companies, the FDIC is also an example of the direct role of government. Perhaps the best-known government corporation is the U.S. Postal Service (USPS). Originally an executive department called the Post Office Department, the USPS became a government corporation in 1970. Many of these
federal agencies are organized as government-owned corporations. Like privately owned businesses, these corporations have a board of directors that hires a professional management team to oversee daily operations. These corporations charge fees for their products and services, and the revenue goes back into the “business.” Unlike private corporations, however, Congress supplies funds to cover any losses the public corporation may incur. State and local governments also play a direct role in the economy. State governments provide colleges and universities, retirement plans, and statewide police protection. Local governments provide police and fire protection, rescue services, and schools. At the same time, all levels of government help develop and maintain roads, libraries, and parks. Indirect Role of Government The government plays an indirect role when it acts as an umpire to help the market economy operate smoothly and efficiently. One such case is the regulation of public utilities, municipal or investorowned companies that offer products such as water, sewerage, and electric service to the public. Because many public utilities have few competitors, consumers often want government supervision. For example, the federal government established regulatory control over the cable television industry in 1993 because it felt that some operators were charging too much. Without competition, utilities with exclusive rights in certain areas have little incentive to offer services at reasonable rates. The government also plays an indirect role when it grants money to people in the form of Social Security checks, veterans’ benefits, financial aid to college students, rent subsidies, and unemployment compensation. Such payments give the recipients of these funds a power they otherwise might not have—the power to “vote” by making their demands known in the market. This power influences the production of goods and services, which in turn affects the allocation of scarce resources. Reading Check Evaluating Do you think one government role is more important than another? Why? Student Web Activity Visit the Economics: Principles and Practices Web site at glencoe.com and click on Chapter 3—Student Web Activities for an activity on nonprofit organizations. public utility company providing an essential service such as water or electricity to consumers SECTION 3 Review Vocabulary 1. Explain the significance of nonprofit organization, cooperative, co-op, credit union, labor union, collective bargaining, professional association, chamber of commerce, Better Business Bureau, and public utility. Main Ideas 2. Describe the roles that federal, state, and local governments play in the economy. 3. Identifying Use a graphic organizer like the one below to identify the different types of nonprofit organizations. Critical Thinking 4. The BIG Idea Compare and
contrast the purposes of the following nonprofits: American Red Cross, American Medical Association, and Teachers’ Credit Union. 5. Analyzing Visuals Look at Figure 3.7 on page 80. Select one of the cooperatives and explain the benefits it offers its members. 6. Inferring What motivates individuals to join professional associations and unions? 7. Drawing Conclusions Explain why the government, rather than private firms, operates agencies such as the TVA and the FDIC. Nonprofit organizations Applying Economics 8. Nonprofit Organizations Identify a nonprofit organization in your community. Discuss with an official or volunteer of the organization how the loss of nonprofit status would affect its activities and services. Write a paragraph about your findings. CHAPTER 3 Business Organizations 83 NEWSCLIP Running a cooperative doesn’t make being in business easier. In fact, it may be especially difficult to secure high prices for members while remaining competitive in the market. Ocean Spray Cranberries Inc., one of the largest producer cooperatives in the United States, has made it work. Ocean Spray’s Creative Juices Randy C. Papadellis has a corporate mandate that would make many CEOs blanch.... The chief executive officer of juice giant Ocean Spray Cranberries Inc. leads a cooperative that’s owned by about 800 cranberry and grapefruit farmers. Papadellis has to buy all the fruit his farmers produce—about two-thirds of the world’s cranberry crop—and buy it at the highest possible price.... It’s a dilemma that has sparked frenetic cranberryfueled creativity. After spurring supermarkets to add juice aisles in the 1960s, Ocean Spray followed with hits including the first juice boxes, low-calorie cranberry drinks, and white cranberry juice. Now Craisins, the dried-fruit snack made from husks that used to be thrown away but are now reinfused with juice, have exploded in popularity. Ocean Spray is spinning out variations—chocolate-covered Craisins, anyone?—as fast as it can. The company’s food product segment has doubled during the past two years, and total sales have grown 12%, to $1.1 billion.... Ocean Spray remains No. 1 in juices.... 1976 Membership expands to include grapefruit growers 1930 Cooperative formed by 3 cranberry growers 1981 First company to introduce juice boxes 2006 Ocean Spray cooperative has over 900 members 1963 First juice blend introduced 2004 Members
vote down a joint venture with PepsiCo 1930 1940 1950 1960 1970 1980 1990 2000 2010 84 UNIT 1 Fundamental Economic Concepts Courtesy of Ocean Spray Cranberries, Inc. Of course, past success isn’t any guarantee of future results.... The cooperative is supposed to pay farmers the commodity price for fruit plus a dividend reflecting the profits of the Ocean Spray brand. But in 2000 overproduction sent the price of raw cranberries crashing from over $60 a barrel to under $20.... Papadellis quickly realized that the farmers needed to decide whether or not the cooperative still made sense.... After weeks of arguing the pros and cons, and with a buyout offer on the table from Pepsi, the farmers opted for Papadellis’ vision of a more focused Ocean Spray that would stay independent.... The plan not only improved the bottom line but also won back the trust of the farmers.... —Reprinted from BusinessWeek Examining the Newsclip 1. Summarizing What is the purpose of the Ocean Spray Cranberry Inc. cooperative? 2. Analyzing How does the organizational structure of the cooperative reflect member interests? CHAPTER 3 Visual Summary Study anywhere, anytime! Download quizzes and flash cards to your PDA from glencoe.com. Business Organizations Three main forms of business organizations exist in the United States today. Sole proprietorships Partnerships Corporations • Owned and run by a single owner • Easy to set up and operate with few or no requirements • Owner responsible for all operations but reaps all earnings • Owner has unlimited liability • Two or more owners • Requires legal papers • Can attract different talents as partners • Relatively easy to raise capital • All partners are equally liable • Owners purchase stock but do not run the company • Formal and legal arrangement • Easier to raise capital • Owners taxed twice • Limited liability Growth A company can reinvest its profits or merge with another firm in order to grow. R EINVESTMENT M ERGERS Net income + Depreciation = Cash flow Reinvest in new plant, equipment, or technology More products Increase in cash flow Horizontal Firms produce the same kind of products Vertical Firms involved in different stages of production Nonprofit Organizations Some organizations work in a businesslike way to promote the interests of their members. Unlike businesses, these nonprofit organizations do not seek to earn a profit. Community or civic organizations Cooperatives • Range from schools to churches and hospitals • Most are legally incorporated, with unlimited life
and limited liability • Provide goods and services while trying to improve the quality of life for people • Consumer cooperatives provide goods to their members at lower prices • Service cooperatives offer specific services to members • Producer cooperatives help members sell their products Other organizations Government • Labor unions represent their members in employment matters • Professional associations seek to improve the skills, working conditions, and public perception of their members • Business associations support specific businesses or trade groups • Has a direct role in the economy by providing some goods and services • Has an indirect role in the economy by acting as a regulator and a provider of benefits CHAPTER 3 Business Organizations 85 CHAPTER 3 Assessment & Activities Review Content Vocabulary Review the Main Ideas On a separate sheet of paper, classify each of the numbered terms below into the following categories. Some terms may apply to more than one category. a. sole proprietorships b. partnerships c. corporations d. nonprofit organizations 1. bond 2. stock 3. cooperative 4. dividend 5. unlimited liability 6. charter 7. labor union Section 1 (pages 61–70) 21. Explain why sole proprietorships are attractive for entrepreneurs wanting to start a new business. 22. Identify the strengths and weaknesses of a partnership. 23. Describe the difference between owning stocks and owning bonds. Section 2 (pages 72–77) 24. Describe how a business obtains, and then disposes of, its cash flow. 25. Discuss the difference between a horizontal and a vertical merger. 26. Explain why a corporation might choose to become a conglomerate. Section 3 (pages 79–83) 8. professional association 27. Discuss the difference between a nonprofit and other 9. limited partner 10. credit union 11. limited liability 12. limited life 13. merger 14. cash flow forms of business organizations. 28. Describe the purpose of a labor union. 29. Identifying Use a graphic organizer like the one below to identify examples of the direct and the indirect roles of government. Role of Government Review Academic Vocabulary Direct Indirect Design a crossword puzzle using the terms below. Use a synonym or antonym (specify which) as your clue. For example, clues for “limited” could be “endless (ant.)” or “restricted (syn.).” 15. entity 16. comprise 17. internally 18. dominant 19. analyze 20. devoting 86 UNIT 1 Fundamental Economic Concepts Critical Thinking 30. The BIG Idea If you were planning to open a busi- ness
such as a sportswear store or lawn service, which form of business organization would you prefer—sole proprietorship, partnership, or corporation? Explain. Economics: Principles and Practices Web site at glencoe.com and click on Chapter 3—Self-Check Quizzes to prepare for the chapter test. Self-Check Quiz Visit the 31. Drawing Conclusions Do you think mergers are beneficial for the U.S. economy? Defend your response. 32. Analyzing Cite a case in your community where a cooperative would fulfill a definite economic need. Explain why you think so, and then describe what kind of cooperative you would set up. 33. Comparing and Contrasting What is the difference between the unlimited liability of proprietorships and partnerships, and the limited liability of corporations? 34. Understanding Cause and Effect What advantages might a multinational corporation bring to a host nation? Math Practice 35. Examine the table that follows. Then answer the following questions. Sole proprietorships, 1990–2002 1990 1995 2000 2002 Thinking Like an Economist 37. Identify two ways a firm’s cash flow can be used. Explain why these uses are a trade-off, and explain the opportunity costs of these choices in terms of the firm’s future growth. Analyzing Visuals 38. Look at Figure 3.5 on page 75. Describe in your own words each type of merger. Then discuss the benefits of each. Writing About Economics 39. Expository Writing Use the library or the Internet to research a conglomerate. Then write a paper describing where the company is headquartered, where its manufacturing plants are located, and where it sells its products. Also include reasons why the firm chose those particular locations. Business receipts Business deductions 731 589 807 1,021 1,030 638 806 809 Interpreting Cartoons 40. Look at the cartoon below. What message is the cartoonist trying to deliver? How does the cartoon relate to what you have learned about proprietorships and corporations Net income a. What is the net income for each of the years listed? How did you find the answer? b. In what year did sole proprietorships have the largest net income? c. In what year did sole proprietorships have the largest net income as a percentage of business receipts? How did you find your answer? Applying Economic Concepts 36. Business Organizations Return to your list from the Why It Matters activity on page 60. Now that you have learned about the different business
forms, review the resources on your list and decide how you will organize your new business. Prepare an oral report and present your decision and rationale to the class. John S. Pritchett CHAPTER 3 Business Organizations 87 UNIT 2 Microeconomics: Prices and Markets CHAPTER 4 Demand CHAPTER 5 Supply CHAPTER 6 Prices and Decision Making CHAPTER 7 Market Structures Buyers and sellers in a music store show how supply and demand play out in the market. 88 UNIT 2 Spencer Grant/PhotoEdit Spencer Grant/PhotoEdit CHAPTER 4 Demand Why It Matters Think about the items you bought during the past two months. What influenced your purchases? Did you need the items, or did you buy them because you wanted them? Make a list of the items, and next to each one write why you bought it. Then add for each item whether you would have bought more if the price had been lower, or fewer had the price been higher. Read Chapter 4 to learn how economists interpret your actions. The BIG Idea Markets exist when buyers and sellers interact, and market prices are set by the interaction of demand and supply. When prices go down for products, such as the computers in this computer store, consumers demand more of them. 90 UNIT 2 AP/Wide World Photos Economics: Principles and Practices Web site at glencoe.com and click on Chapter 4—Chapter Overviews to preview chapter information. Chapter Overview Visit the SECTION 1 What Is Demand? GUIDE TO READING Section Preview Academic Vocabulary In this section, you will learn that you express demand for a product when you are willing and able to purchase it. • prevail (p. 92) • inversely (p. 93) Content Vocabulary • demand (p. 91) • microeconomics (p. 91) • market economy (p. 92) • demand schedule (p. 92) • demand curve (p. 93) • Law of Demand (p. 93) • market demand curve (p. 94) • marginal utility (p. 95) • diminishing marginal utility (p. 95) Reading Strategy Identifying As you read this section, use a web diagram similar to the one below to identify the characteristics of demand. Characteristics of Demand PRODUCTS IN THE NEWS Wrist Watch —adapted from The Columbus Dispatch It’s all in the wrist. Actually, this spring, it’s all on the wrist. Skinny bracelets and subtle strands of bling are being replaced by chunky looks with boldness
and color, often worn in multiples. “Last year, everything was thin; now, ‘big’ is being demanded everywhere,” said Toni Miller Dunleavy, owner of Etc. Gifts and Accessories. Big and brash wrist frosting takes its newest form with Wonder Woman-esque cuffs.... Other popular choices include wide, flexible “liquid metal” (a la chain mail) and oversize bangles strung with colored beads or seashells—or even bottle caps or typewriter keys. Meanwhile, those slim bangles from years past shouldn’t be tossed: A piling of 8, 10, or more easily makes the wearer a member of the bigger-is- better bracelet brigade. ■ When we talk about the “demand” for a product, we mean more than the desire to simply have or to own the item. In order for demand to be counted in the marketplace, desire must be coupled with the ability and willingness to pay for it. Only those people with demand—the desire, ability, and willingness to buy a product—can compete with others who have similar demands. Demand, like many of the other topics discussed in Unit 2, is a microeconomic concept. Microeconomics is the part of economic theory that deals with behavior and decision making by individual units, such as people and firms. Collectively, our microeconomic concepts help explain how prices are determined and how individual economic decisions are made. demand combination of desire, ability, and willingness to buy a product microeconomics part of economics that studies small units, such as individuals and firms AINACO/CORBIS CHAPTER 4 Demand 91 market economy economic system in which people and firms make all economic decisions (also see page 37) demand schedule a table that lists how much of a product consumers will buy at all possible prices An Introduction to Demand MAIN Idea Demand is a concept specifying the different quantities of an item that will be bought at different prices. Economics & You Do you buy more of an item when the price goes down, or less of it when the price goes up? Read on to see how this behavior illustrates the concept of demand. In a market economy people and firms act in their own best interests to answer the basic WHAT, HOW, and FOR WHOM questions. Demand is central to this process, so an understanding of the concept of demand is essential if we are to understand how the economy works. Demand Illustrated Fortunately, the concept of demand is easy
to understand because it involves only two variables—the price and quantity of a specific product at a given point in time. For example, we might want to know how many people would want to see a movie on a given afternoon if the price was $5. Or we might want to know how many would want to view it if the price was $10. The answers would depend on a number of things, including the number of people living in the area, the number and types of other movies that were playing at the same time, and of course the popularity of the movie itself. But in the end, everything would be measured in terms of prices and quantities. The Individual Demand Schedule To see how an economist would analyze demand, look at Panel A in Figure 4.1. It shows the amount of a product that a consumer, whom we’ll call Mike, would be willing and able to purchase over a range of possible prices that go from $5 to $30. The information in Panel A is known as a demand schedule. The demand schedule shows the various quantities demanded of a particular product at all prices that might prevail in the market at a given time. Figure 4.1 The Demand for Compact Digital Discs A D EMAND S CHEDULE B D EMAND C URVE Price $30 25 20 15 10 5 Quantity demanded 30 25 20 15 10 5 0 a b 1 2 3 4 Quantity 5 6 7 8 The demand schedule and the demand curve both show the quantity of CDs an individual consumer demands at every possible price. Note how the three CDs demanded at a price of $15 are plotted as point a on the demand curve. Economic Analysis Why is the demand curve downward sloping? Demand and Prices If the prices of CDs drop, consumers will be better able and more willing to buy them. How does this situation reflect the Law of Demand? demand curve a curve that shows the quantities demanded at all possible prices Law of Demand rule stating that consumers will buy more of a product at lower prices and less at higher prices Personal Finance Handbook See pages R4–R5 for more information on budgeting. As you can see, Mike would not buy any CDs at a price of $25 or $30, but he would buy one if the price fell to $20, and he would buy three if the price was $15, and so on. Just like the rest of us, he is generally willing to buy more units of a product as the price gets lower. The Individual Demand Curve The demand schedule in Panel A
of Figure 4.1 can also be shown graphically as the downward-sloping line in Panel B. All we have to do to is to transfer each of the price-quantity observations in the demand schedule to the graph, and then connect the points to form the curve. Economists call this the demand curve, a graph showing the quantity demanded at each and every price that might prevail in the market. For example, point a in Panel B shows that Mike purchased three CDs at a price of $15 each, while point b shows that he will buy five at a price of $10. The demand schedule and the demand curve are similar in that they both show the same information—one in the form of a table and the other in the form of a graph. Reading Check Interpreting How do you react to a change in the price of an item? How does this illustrate the concept of demand? The Law of Demand MAIN Idea There is an inverse relationship between the price of an item and the quantity demanded. Economics & You When you go shopping, do you try to catch sale days? Read on to find out how an economic “law” describes your behavior. The prices and quantities in Figure 4.1 point out a feature of demand: for practically every good or service that we might buy, higher prices are associated with smaller amounts demanded. Conversely, lower prices are associated with larger amounts demanded. This is known as the Law of Demand, which states that the quantity demanded varies inversely with its price. When the price of something goes up, the quantity demanded goes down. Likewise, when the price goes down, quantity demanded goes up. Why We Call It a “Law” Expressing something as a “law” may seem like a strong statement for a social science like economics to make, but there are two reasons why economists prefer to do so. First, the inverse relationship between price and quantity demanded is something Brand X Pictures/PunchStock CHAPTER 4 Demand 93 Figure 4.2 Individual and Market Demand Curves The market demand curve shows the quantities demanded by everyone in the market who is interested in purchasing a product. Point a on the market demand curve represents the three CDs Mike and Julia each would purchase at a price of $15 for a total of six CDs. Economic Analysis How do the three demand curves differ? See StudentWorks™ Plus or glencoe.com. M IKE’S I NDIVIDUAL D EMAND C URVE J
ULIA’S I NDIVIDUAL D EMAND C URVE M ARKET D EMAND C URVE $30 e c i r P 25 20 15 10 5 0 $30 $30 a’ b Quantity 25 20 15 10 5 0 a’’ b’’ Quantity 25 20 15 10 10 11 12 13 14 15 Quantity Skills Handbook See page R49 to learn about Using Line Graphs. market demand curve a curve that shows how much of a product all consumers will buy at all possible prices that we find in study after study, with people almost always stating that they would buy more of an item if its price goes down, and less if the price goes up. Second, common sense and simple observation are consistent with the Law of Demand. This is how people behave in everyday life—they normally buy more of a product at lower prices than they do at higher ones. All we have to do is to note the increased purchases at the mall whenever there is a sale. This is why economics is a social science: because it is the study of the way we behave when things around us change. The Market Demand Curve So far we have discussed a particular individual’s demand for a product. Sometimes, however, we are more concerned with the market demand curve, the demand curve that shows the quantities demanded by everyone who is interested in purchasing the product. Figure 4.2 shows the market demand curve D for Mike and his friend Julia, the only two people whom (for simplicity) we assume to be willing and able to purchase CDs. To get the market demand curve, all we do is add together the number of CDs that Mike and Julia would purchase at every possible price. Then, we simply plot the prices and quantities on a separate graph. To illustrate, point a in Figure 4.2 represents the three CDs that Mike would purchase at $15, plus the three that Julia would buy at the same price. Likewise, point b represents the quantity of CDs that both would purchase at $10. The market demand curve in Figure 4.2 is very similar to the individual demand curve in Figure 4.1. Both show a range of possible prices that might prevail in the market at a given time, and both curves are downward sloping. The main difference between the two is that the market demand curve shows the demand for everyone in the market. Reading Check Explaining How does the market demand curve reflect the Law of Demand? 94 UNIT 2 Microeconomics: Prices and Markets marginal
utility additional satisfaction or usefulness a consumer gets from having one more unit of a product diminishing marginal utility decrease in satisfaction or usefulness from having one more unit of the same product Demand and Marginal Utility MAIN Idea As we buy more of an item, we get less satisfaction from each additional purchase. Economics & You When you buy clothes, why do you prefer a variety of colors and styles to identical items? Read to see how this relates to marginal utility. As you may recall from Chapter 1, economists use the term utility to describe the amount of usefulness or satisfaction that someone gets from the use of a product. Marginal utility—the extra usefulness or additional satisfaction a person gets from acquiring or using one more unit of a product—is an important extension of this concept because it explains so much about demand. The reason we buy something in the first place is because we feel that the product is useful and will give satisfaction. However, as we use more and more of a product, we encounter diminishing marginal utility, the principle which states that the extra satisfaction we get from using additional quantities of the product begins to decline. Because of our diminishing satisfaction, we usually are not willing to pay as much for the second, third, fourth, and so on, as we did the first unit. This is why our demand curve is downward-sloping, and this is why Mike and Julia won’t pay as much for the second CD as they did for the first. Diminishing satisfaction happens to all of us at some time. For example, when you buy a drink because you are thirsty, you get the most satisfaction from the first purchase. Since you are now less thirsty, you get less satisfaction from the second purchase, and even less from the next, so you are not willing to pay as much for the second and third purchases. Reading Check Describing How does the principle of diminishing marginal utility explain the price we pay for another unit of a good or service? SECTION 1 Review Vocabulary 1. Explain the significance of demand, microeconomics, market economy, demand schedule, demand curve, Law of Demand, market demand curve, marginal utility, and diminishing marginal utility. Main Ideas 2. Describing What is the relationship between the demand schedule and the demand curve? 3. Determining Cause and Effect Using a graphic organizer like the one below, explain how a change in price changes the quantity demanded of an item. Price floor price decreases Quantity demanded Quantity demanded Critical Thinking 4. The BIG Idea How does the principle of diminishing marginal utility explain the
slope of the demand curve? 5. Inferring Although people buy more of a product when the seller lowers the price, some items such as luxury goods are not offered at a lower price. Why? 6. Analyzing Visuals Look at the demand schedules on page 94. Assume that Julia is willing to purchase different quantities at the same prices, and write down the new demand. Then plot a new market demand curve that incorporates the changed demand. 7. Using Graphs Create your own demand schedule for an item you currently purchase. Next, plot your demand schedule on a demand curve. Be sure to include labels. Applying Economics 8. Diminishing Marginal Utility Using what you have learned about diminishing marginal utility, find examples from your own experience and explain how they support this concept. CHAPTER 4 Demand 95 NEWSCLIP Oscar Mayer, one of the brands of Kraft Foods Inc., first launched its Lunchables product line in 1988. The prepackaged lunches quickly became popular, and today these snacks are available in many different flavor combinations. They also have come under attack by critics. Kraft is finding ways to satisfy these critics and keep consumer demand high. Slimmer Kids, Fatter Profits? Charles Davis, a Kraft food maven, is on a health kick. But then, he has no choice. Making cheese healthier is complicated. Add too much calcium, and it starts to taste chalky. Take out too much fat, and the cheese emerges from mechanical graters like Play-Doh. “It becomes a big glob instead of having good shredding integrity,” says Charles W. Davis, vice-president of global technology and quality for convenient meals at Kraft Foods Inc. Nutrition Facts Serving per package 1 Amount per serving Calories 410 Calories from Fat 90 % Daily Value 15% 23% 13% 37% 21% 8% Total Fat 10g Saturated Fat 4.5g Cholesterol 40mg Sodium 890mg Total Carbohydrate 64g Dietary Fiber 2g Sugars 27g Protein 16g Nutrition Facts Serving per package 1 Amount per serving Calories 780 Calories from Fat 290 % Daily Value 49% 35% 5% 57% 38% 24% Total Fat 32g Saturated Fat 7g Cholesterol 15mg Sodium 1380mg Total Carbohydrate 113g Dietary Fiber 6g Sugars 61g Protein 9g Davis can tell you all about finding that delicate balance between what tastes good and what’s good for you. Since 2004, the 48-year-old chemist has been leading a team
of scientists, technicians, and engineers working to improve the nutritional content of Kraft’s popular Lunchables Lunch Combinations line, a process known industrywide as reformulation. That means he has spent an inordinate amount of time experimenting not only with cheese but also with the juice drinks, crackers, deli meats, and fruit snacks that make up these all-in-one meals. If you count all 41 varieties of Lunchables, Davis has cut calories by an average of 10%, fat by 24%, and sodium by 20%. Why do Davis and hundreds of other people throughout the company do nothing else but experiment in their kitchen labs all day? Because their employer has no choice. Kraft, the nation’s largest food manufacturer, and its competitors risk becoming this decade’s cigarette companies: vilified for pushing junk to children, restricted by oftenconflicted regulators, challenged in court. —Reprinted from BusinessWeek Examining the Newsclip 1. Understanding Cause and Effect Why did Kraft decide to reformulate a product that was already popular? 2. Making Inferences What might happen to demand for the Lunchables products if Kraft did not respond to consumer demands? 96 UNIT 2 Microeconomics: Prices and Markets SECTION 2 Factors Affecting Demand GUIDE TO READING Section Preview Reading Strategy Listing As you read about the determinants of demand, list each on a table similar to the one below and provide an example of each. Determinants of Demand Determinant Example Effect on demand In this section, you will learn about the factors that cause changes in demand. Content Vocabulary • change in quantity demanded (p. 98) • income effect (p. 98) • substitution effect (p. 98) • change in demand (p. 99) • substitutes (p. 100) • complements (p. 101) Academic Vocabulary • principle (p. 98) • illustrated (p. 98) —TIME COMPANIES IN THE NEWS McMakeover Deluxe McDonald’s is getting a makeover. The fast-food force has launched its first restaurant redesign in 30 years. More than 6,000 locations will feature the new look by year’s end. Customers will have three zones to choose from, based on their dining needs. Counter seating will serve eat-and-run customers. Those looking to linger will find soft lighting and plush chairs. Mingling teens can cram tables together in a flexible seating area. “It’s something McDonald’s should have done
years ago,” says restaurant analyst Howard Penney. The design suggests a certain coffee chain, but Penney says it could give McDonald’s an edge over fast-food rivals. ■ Why would McDonald’s go to the trou- ble and expense of redesigning its restaurants? The company realizes that consumer demand is changing. This means the company has to change too, or it risks losing business to competitors that better meet customer demand. Such changes in demand have an effect on both the demand schedule and the demand curve. When it comes to demand, there are two types of changes. When the price of a product changes while all other factors remain the same, we have a change in the quantity demanded. Sometimes other factors change while the price remains the same—similar to the change in consumer taste in our news story. When this happens, we see a change in demand. James Leynse/CORBIS CHAPTER 4 Demand 97 Change in the Quantity Demanded demanded. As we will see, the income and substitution effects also help us understand this principle. change in quantity demanded movement along the demand curve showing that the amount someone is willing to purchase changes when the price changes income effect that part of a change in quantity demanded due to a change in the buyer’s real income when a price changes substitution effect that part of a change in quantity demanded due to a price change that makes other products more or less costly MAIN Idea Only a change in price can cause a change in quantity demanded. Economics & You When you shop for an item, do you also consider prices of related items? Read on to learn how demand accounts for this behavior. Look at Figure 4.3 to see what happens when only the price changes and everything else remains constant. Point a on the demand curve shows that six CDs are demanded at a price of $15. When the price falls to $10, 10 CDs are demanded. This movement from point a to point b is a change in quantity demanded—a change that is graphically represented as a movement along the demand curve. When the price goes up, fewer CDs are demanded. When the price goes down, more are Figure 4.3 Change in the Quantity Demanded D EMAND C URVE e c i r P $30 25 20 15 10 5 0 Decrease in quantity demanded a b Increase in quantity demanded 10 11 12 13 14 15 Quantity Only a change in price can cause a change in quantity demanded. When the price goes down, the quantity demanded increases. When the price
goes up, the quantity demanded decreases. Both changes appear as a movement along the demand curve. Economic Analysis Why do price and quantity demanded move in opposite directions? The Income Effect When the price of a product drops, consumers pay less and, as a result, have some extra income to spend. For example, we can see from Figure 4.3 that consumers spent $90 to buy six CDs when the price was $15 per CD. If the price drops to $10, they would spend only $60 on the same quantity, leaving them $30 “richer” because of the drop in price. They may even spend some of this extra income on more CDs. As a result, part of the increase from 6 to 10 units purchased, shown as the movement from point a to point b on the demand curve, is due to consumers feeling richer. If the price had gone up, consumers would have felt a bit poorer and would have bought fewer CDs. This illustrates the income effect, the change in quantity demanded because of a change in price that alters consumers’ real income. The Substitution Effect A lower price also means that CDs will be relatively less expensive than other goods and services such as concerts and movies. As a result, consumers will have a tendency to replace a more costly item— say, going to a concert—with a less costly one—more CDs. The substitution effect is the change in quantity demanded because of the change in the relative price of the product. Together, the income and substitution effects explain why consumers increase their consumption of CDs from 6 to 10 when the price drops from $15 to $10. Whenever a price change causes a change in quantity demanded, the change appears graphically as a movement along the demand curve. The change in quantity demanded, as illustrated in Figure 4.3, can be either an increase or a decrease, but in either case the demand curve itself does not shift. Reading Check Describing How is a change in the quantity demanded illustrated on the demand curve? Figure 4.4 Change in Demand A change in demand occurs when people decide to purchase different amounts of a product at the same price. When we plot the numbers from the demand schedule, we get two separate demand curves. An increase in demand appears as a shift of the demand curve to the right. A decrease in demand appears as a shift to the left. Economic Analysis What might cause a change in demand for CDs? A D EMAND S CHEDULE B D EMAND C URVE See StudentWorks™ Plus
or glencoe.com. Price $30 25 20 15 10 5 D 0 1 3 6 10 15 D1 1 3 6 10 15 20 e c i r P $30 25 20 15 10 5 0 a a’ Decrease in demand Increase in demand b b’ D D1 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 Quantity change in demand shift of the demand curve when people buy different amounts at every price Change in Demand MAIN Idea Several factors can cause the demand curve to shift. Economics & You Can you remember something fashionable that quickly went out of style? Read on to learn how changing consumer tastes affect demand. Sometimes other factors change while the price remains the same. When this happens, people may decide to buy different amounts of the product at the same prices. This is known as a change in demand. As a result, the entire demand curve shifts—to the right to show an increase in demand, or to the left to show a decrease in demand. Therefore, a change in demand results in an entirely new demand curve, while a change in quantity demanded is a movement along the original demand curve. A change in demand is illustrated in the schedule and graph in Figure 4.4. Note that Panel A has a third column showing that people are willing to buy different amounts at each and every price. At a price of $15, for example, consumers are now willing to buy 10 CDs instead of 6, moving from point a to point a´. When this information is transferred to the graph, the demand curve appears to have shifted to the right. When demand changes, a new schedule or curve must be constructed to reflect the new quantities demanded at all possible prices. Demand can change because of changes in the determinants of demand: consumer income, consumer tastes, the price of related goods, expec tations, and the number of consumers. Consumer Income Changes in consumer income can cause a change in demand. An increase in income means people can afford to buy more at all possible prices. Suppose, for example, that CHAPTER 4 Demand 99 &The Global Economy YOU Digital Demand in South Korea The increasing demand for new technology is When a financial crisis hit Asia over a decade ago, South Koreans decided to invest in technology to spur economic development. Today over 70 percent of the country has high-speed Internet access, and South Korea boasts the world’s largest Wi-Fi network. South Koreans eagerly embrace the new technology, using it in ways unknown
in the United States. For example, they pay for the subway fare by swiping their cell phones through readers. Students access Webcast tutorials as they study for their version of the SAT. most evident in cell phones. South Koreans replace their cell phones as often as every six months. That puts pressure on companies to constantly develop upgraded models with new and exciting features. It also has turned South Korea into a nation-wide focus group on cell phones. The phone you purchase today may well have features that your South Korean peers tested for you 6 to 12 months earlier. substitutes competing products that can be used in place of one another Mike and Julia get a raise, which allows them to buy more CDs. Instead of Mike and Julia each buying 3 for a total of 6 when the price is $15, they can now each buy 5— for a total of 10. If we plot how many CDs would be purchased at every possible price in the market as demand curve D1 in Figure 4.4, then it appears as if the curve has shifted to the right. Exactly the opposite could happen if there was a decrease in income and Mike and Julia bought less. The demand curve would then shift to the left, showing a decrease in demand. Consumer Tastes Consumers sometimes change their minds about the products they buy. Advertising, fashion trends, and even changes in the season can affect consumer tastes. For example, when a product is successfully advertised, its popularity increases and people tend to buy more of it. As a result, the demand curve shifts to the right. On the other hand, people will buy less of a product if they get tired of it. This is exactly what happens when a rumor or unfavorable report about a product appears. When fewer people want the product at all possible prices, the demand curve shifts to the left, showing a decrease in demand. In addition, the development of new products can have a dramatic and relatively sudden impact on consumer preferences. For example, when music CDs were first introduced on the market, they reduced the demand for cassette players and tapes, shifting the demand curves for both to the left. When the iPod and similar devices arrived, the demand for CDs and CD players decreased. Sometimes the change in consumer tastes and preferences is relatively rapid, and sometimes the change occurs more slowly. In recent years, for example, consumer concerns about health have slowly increased the demand for healthful foods. Substitutes A change in the price of related products can cause a change in demand. Some products are known as substitutes because they can be
used in place of other products. For example, if people treat butter and margarine as substitutes, a rise in the price of butter will cause an increase in the demand for margarine. Likewise, a rise in the price of margarine would cause the demand for butter to increase. In general, the demand for a product tends to increase if the price of its substitute goes up. The demand for a product tends to decrease if the price of its substitute goes down. 100 UNIT 2 Microeconomics: Prices and Markets Motorola Student Web Activity Visit the Economics: Principles and Practices Web site at glencoe.com and click on Chapter 4—Student Web Activities for an activity on change in demand. complements products that increase the use of other products Complements Other related goods are known as complements, because the use of one increases the use of the other. Personal computers and software are two complementary goods. When the price of computers decreases, consumers buy more computers and more software. If the price of computers spirals upward, consumers would buy fewer computers and less software. Thus, an increase in the price of one good usually leads to a decrease in the demand for its complement. Expectations The way people think about the future can affect demand. For example, suppose that a company announces a technological breakthrough in television picture quality. Even if the new product might not be available for a year, some consumers might hold off buying a TV today due to their expectations. Purchasing less at every price would cause demand to decline, illustrated by a shift of the demand curve to the left. Of course, expectations can also have the opposite effect on market demand. For example, if the weather service forecasts a bad year for crops, people might stock up on some foods before these items actually become scarce. The willingness to buy more because of expected future shortages would cause demand to increase, shown by a shift of the demand curve to the right. Number of Consumers A change in income, tastes, and prices of related products affects individual demand schedules and curves—and hence the market demand curve. The market demand curve can also change if there is a change in the number of consumers. Suppose that Devan, one of Mike’s and Julia’s friends, decides to purchase CDs. We would add the number of CDs that Devan would buy at all possible prices to those for Mike and Julia. The market demand curve would shift to the right to reflect an increase in demand. If Mike or Devan should leave the market, the total number
of CDs purchased would decrease, shifting the market demand curve to the left. Reading Check Explaining How do changes in consumer income and tastes affect the demand curve? SECTION 2 Review Vocabulary 1. Explain the significance of change in quantity demanded, income effect, substitution effect, change in demand, substitutes, and complements. Main Ideas 2. Explaining What is the difference between a change in quantity demanded and a change in demand? 3. Describing Using a graphic organizer similar to the one below, describe the determinants of market demand. Determinants of market demand Critical Thinking 4. The BIG Idea How and why does a change in price affect the demand for substitutes? Provide an example. 5. Analyzing Visuals Look at Figure 4.4 on page 99. Assume that a new CD format will come out soon. What do you think will happen to the market demand curve D? Explain. 6. Interpreting Locate an article in your newspaper illustrating at least one determinant of demand. Write a brief explanation of the effect of the determinant(s). Applying Economics 7. Change in Demand Name a product that you recently purchased because it was on sale. Identify one substitute and one complement for the product and describe how your demand for the substitute and complement changed because of the sale. CHAPTER 4 Demand 101 ENTREPRENEUR Profiles in Economics Oprah Winfrey (1954– ) • first woman in history to produce and own her own talk show • first African American woman—and third woman in history— to own a major television and film studio The Gift of Gab Oprah Winfrey grew up in deep poverty. As a troubled teenager, she went to live with her father, who encouraged her education. Four years later Winfrey received a scholarship to attend Tennessee State University. At the same time, she got her first media job as a radio news announcer. Two years later Winfrey became cohost of a talk show—and found her calling. Winfrey felt comfortable talking in front of cameras, and viewers responded to her easygoing attitude by making her program the number-one talk show in the Baltimore market. In 1984 Winfrey relocated to Chicago to take over the failing talk show A.M. Chicago. Just as in Baltimore, the audience responded to her relaxed manner by watching in increasing numbers. Within two years, the show, renamed The Oprah Winfrey Show, became nationally syndicated, and today viewers watch her in more than 100 countries. The syndication deal made Winfrey the highestpaid entertain
er at the time, with estimated earnings of over $37 million in 1987. Building a Media Empire Winfrey used this money and her personal ambition to build a wide-ranging business empire. In 1986 she established her own company, Harpo Inc. (Harpo is Oprah spelled backward.) A production company and movie studio grew from that venture. Since then, Winfrey has become cofounder of the Oxygen television network and branched out into print media through the publications O, The Oprah Magazine, and O at Home. Success has allowed Winfrey to spend a portion of her income on charities that support education and help families. That portion is rising. Forbes magazine listed Winfrey as the first African American woman to become a billionaire. Her annual income, estimated at over $225 million by 2006, has increased ever since. Examining the Profile 1. Drawing Conclusions Why is Oprah Winfrey considered to be one of the most powerful women in America? 2. Analyzing What characteristics helped Winfrey become a successful talk show host and entrepreneur? Most people know Oprah Winfrey as a talk show host. Over the years, though, the likable Winfrey has developed many other talents to become one of the wealthiest, most successful, and most influential women in America. 102 UNIT 2 Microeconomics: Prices and Markets Brad Barket/Getty Images SECTION 3 Elasticity of Demand GUIDE TO READING Section Preview Reading Strategy In this section you will learn about the factors that influence the size of a change in quantity demanded. Content Vocabulary • elasticity (p. 103) • demand elasticity (p. 104) • elastic (p. 104) • inelastic (p. 104) • unit elastic (p. 105) Academic Vocabulary • technical (p. 106) • adequate (p. 108) Describing As you read about price elasticity, complete a web diagram like the one below to describe what effect a change in price has on quantity demanded if the demand curve is elastic, inelastic, or unit elastic. Change in Price COMPANIES IN THE NEWS Netflix, Blockbuster Battle It Out —www.entertainmentculture.com Netflix and Blockbuster continue to battle head to head in the online movie rental arena. The monthly rental prices have dropped for DVD entertainment delivered to your door, ordered online.... Entertainment culture at its best, it seems—lots of competition and that is normally a better price point for the consumer. [Reed Hastings, the CEO of Netflix
, says,] “One of the reasons our last year has been so successful is the market’s elasticity in response to our price cuts one year ago.... Obviously, if there’s enough elasticity to make additional price cuts work, this would increase the economic pressure on video stores, and the additional store closures would further increase Netflix growth for many years ahead.” In 2006, Netflix expects to grow to 5.65 million subscribers with pretax net income between $50 million and $60 million. ■ You can find cause-and-effect relation- ships everywhere, and they are especially important to businesses. For example, Netflix had hoped that lower prices would entice customers to rent more movies and thus increase its overall revenues. The gamble paid off. Company CEO Reed Hastings credited the market’s demand elasticity for the company’s success. Elasticity is a general measure of responsiveness—an important cause-and-effect relationship in economics. It tells us how a dependent variable, such as quantity demanded, responds to a change in an independent variable, such as price. Elasticity is a general concept that can also be applied to other measures such as income or supply. elasticity a measure of responsiveness that shows how one variable responds to a change in another variable Glencoe CHAPTER 4 Demand 103 demand elasticity a measure that shows how a change in quantity demanded responds to a change in price elastic type of elasticity where a change in price causes a relatively larger change in quantity demanded inelastic type of elasticity where a change in price causes a relatively smaller change in quantity demanded Demand Elasticity MAIN Idea When the price of an item changes, the change in quantity demanded can vary a little or a lot. Economics & You If there was a huge sale on table salt, would you stock up? Read on to learn how elasticity describes your response to the price change. Consumers react to a change in price by changing the quantity demanded, although the size of their reaction can vary. This response is known as demand elasticity— the extent to which a change in price causes a change in the quantity demanded. Elastic Demand Economists say that demand is elastic when a given change in price causes a relatively larger change in quantity demanded. To illustrate, look at how price and quantity demanded change between points a and b on the demand curve in Panel A of Figure 4.5. As we move from point a to point b, we see that price declines by one-third, or from
$3 to $2. At the same time, the quantity demanded doubles from two to four units. Because the percentage change in quantity demanded is relatively larger than the percentage change in price, demand between those two points is elastic. This type of elasticity is typical of the demand for products like green beans, corn, or other fresh garden vegetables. Because prices of these products are lower in the summer, consumers increase the amount they purchase during that time. When prices are considerably higher in the winter, consumers tend to buy canned or frozen products instead. Inelastic Demand For other products, demand may be inelastic, which means that a given change in price causes a relatively smaller change in the quantity demanded. We can see the case of inelastic demand in Panel B of Figure 4.5. In this case, the one-third drop in price from point a´ to b´ causes quantity demanded to increase by only 25 percent, or from two to two and one-half units. This is typical of the demand elasticity for a product like table salt. A change in the price for salt does not bring about much change in the quantity purchased. Even if the price was cut in half, the quantity Figure. 4.5 Demand Elasticity and the Total Expenditures Test A E LASTIC D EMAND B I NELASTIC D EMAND e c i r P $4 3 2 1 0 a Expenditure $6 = $3 per 2 units b Expenditure $8 = $2 per 4 units 1 2 3 Quantity 4 5 e c i r P $4 3 2 1 0 a’ b’ Expenditure $6 = $3 per 2 units Expenditure $5 = $2 per 2.5 units 1 2 3 Quantity 4 5 104 UNIT 2 Microeconomics: Prices and Markets unit elastic type of elasticity where a change in price causes a proportional change in quantity demanded demanded would not increase by much because people can consume only so much salt. Similarly, if the price doubled, we would still expect consumers to demand about the same amount, because people spend such a small portion of their budget on salt. Unit Elastic Demand Sometimes demand is unit elastic, so that a given change in price causes a proportional change in quantity demanded. When demand is unit elastic, the percentage change in quantity equals the percentage change in price. For example, a five percent drop in price would cause a five percent increase in quantity demanded. Unit elastic demand is shown in Panel C of Figure 4.5. Examples
of unit elasticity are difficult to find because the demand for most products is either elastic or inelastic. Unit elasticity is more like a middle ground that separates the other two categories of elasticity: elastic and inelastic. Reading Check Comparing What is the difference between elastic and inelastic demand? The Total Expenditures Test MAIN Idea The total expenditures test is used to estimate the demand elasticity of a product. Economics and You You just learned about demand elasticity. Read on to find out how businesses apply elasticity when setting prices. To estimate elasticity, it is useful to look at the impact of a price change on total expenditures, or the amount that consumers spend on a product at a particular price. This is sometimes called the total expenditures test. Determining Total Expenditures We find total expenditures by multiplying the price of a product by the quantity demanded for any point along the demand curve. To illustrate, the total expenditure under point a in Panel A of Figure 4.5 is $6, which is determined by multiplying two units times the price of $3. Likewise, the total expenditure under point b in Panel A is $8, or $2 times four units. By observing the change in total expenditures when the price changes, we can test for elasticity. C U NIT E LASTIC D EMAND D D ETERMINING E LASTICITY e c i r P $4 3 2 1 0 a’’ b’’ Expenditure $6 = $3 per 2 units Expenditure $6 = $2 per 3 units 1 2 3 Quantity 4 5 Type of demand Change in price Change in expenditure Elastic Inelastic Unit Elastic No change Panels A, B, and C show how quantity demanded responds to a price change for products with elastic, inelastic, and unit elastic demand. Panel D summarizes these changes in a chart. Economic Analysis Why is an understanding of elasticity important for a business? Three Results The relationship between changing prices and total expenditures is summarized in the four panels of Figure 4.5 on the previous page. The figure shows how a decrease in price from $3 to $2 impacts total expenditures for each of the demand curves. In each case, the change in expenditures depends on the elasticity of the demand curve. CAREERS Buyer The Work * Purchase merchandise for resale to the public * Study sales records, inventory levels of current stock, determine foreign and domestic suppliers, and determine supply and demand for products and materials * Choose suppliers
, negotiate the lowest price, and award contracts * Stay informed about new products and trends, attend trade shows, assist in sales promotions and advertising campaigns, check on displays Qualifications * Ability to plan, analyze data provided by suppliers, make decisions quickly, work under pressure, and identify products that will sell * Good communication, negotiation, and mathematical skills * Knowledge of supply-chain management * Bachelor’s degree with a business emphasis Earnings * Median annual earnings: $42,230 Job Growth Outlook * Slower than average Source: Occupational Outlook Handbook, 2006–2007 Edition 106 UNIT 2 Microeconomics: Prices and Markets Jeff Greenberg/Photo Edit The demand curve in Panel A is elastic. When the price drops by $1 per unit, the increase in the quantity demanded is large enough to raise total expenditures from $6 to $8. The relationship between the change in price and total expenditures for the elastic demand curve is described as “inverse.” In other words, when the price goes down, total expenditures go up. The demand curve in Panel B is inelastic. In this case, when the price drops by $1, the increase in the quantity demanded is so small that total expenditures fall below $6. For inelastic demand, total expenditures decline when the price declines. Finally, the demand curve in Panel C is unit elastic. This time, total expenditures remain unchanged when the price decreases from $3 to $2. Determining Elasticity The relationship between the change in price and the change in total expenditures is shown in Panel D of Figure 4.5. If the changes in price and expenditures move in opposite directions, demand is elastic. If they move in the same direction, demand is inelastic. If there is no change in expenditure, demand is unit elastic. Even though all the price changes we just discussed were decreases, the results would be the same if prices had gone up instead of down. If the price rises from $2 to $3 in Panel A, spending falls from $8 to $6. Prices and expenditures still move in opposite directions, as shown in the table. Elasticity and Revenues While this discussion about elasticity may seem technical and somewhat unnecessary to you, knowledge of demand elasticity is extremely important to most businesses. Suppose, for example, that you run your own business and want to do something that will raise your revenues. You could try to stay open longer, or you could try to advertise in order to increase sales. You might, however
, also be tempted to raise the price of your product in order to increase total revenue from sales. Total Expenditures and Demand Elasticity Some consumers, such as the painter in this cartoon, buy more than they need when items go on sale. What kind of demand elasticity is depicted in this cartoon, and what happened to total expenditures for green paint? Skills Handbook See page R36 to learn about Determining Cause and Effect. This might actually work in the case of table salt or medical services, because the demand for both products is generally inelastic. However, what would happen if you sold a product with elastic demand? If you raise the price, your total revenue— which is the same as consumer expenditures—will go down instead of up. This outcome is exactly the opposite of what you intended! This is exactly why some businesses experiment with different prices when they introduce a new product to the market. They may adjust prices repeatedly to see how customers respond to new prices. If a business can determine a new product’s demand elasticity, it can find the price that will maximize total revenues. This is why demand elasticity is more important than most people realize. Reading Check Explaining What happens to the total expenditures for a product with elastic demand when its price goes up? Determinants of Demand Elasticity MAIN Idea The answers to three questions help determine a product’s demand elasticity. Economics and You Can you think of an item you delayed buying because it was too expensive? Read on to learn how your decision to wait is a way to determine the elasticity of a product. What makes the demand for a specific good elastic or inelastic? To find out, we can ask three questions about the product. The answers will give us a reasonably good idea about the product’s demand elasticity. Can the Purchase Be Delayed? Sometimes consumers cannot postpone the purchase of a product. This tends to make demand inelastic, meaning that the quantity of the product demanded is not especially sensitive to changes in price. www.CartoonStock.com CHAPTER 4 Demand 107 Figure 4.6 Determinants of Demand Elasticity The elasticity of demand can usually be estimated by examining the answers to three key questions. All three answers do not have to be the same in order to determine elasticity, and in some cases the answer to a single question is so important that it alone might override the answers to the other two. Economic Analysis If you applied the three questions to a luxury product, what
would be the elasticity of demand for that product? P RODUCTS Determinants of elasticity If yes: elastic If no: inelastic Fresh tomatoes, corn, or green beans Table salt Gasoline from a particular station Gasoline in general Services of medical doctors Insulin Butter Can purchase be delayed? Are adequate substitutes available? Does purchase use a large portion of income? Yes Yes No No No No Yes Yes Yes No No Yes No No Yes No No No Yes Yes No Type of elasticity Elastic Inelastic Elastic Inelastic Inelastic Inelastic Elastic For example, persons with diabetes need insulin to control the disorder. An increase in its price is not likely to make diabetes sufferers delay buying and using the product. The demand for tobacco also tends to be inelastic because the product is addictive. As a result, a sharp increase in price will lower the quantity purchased by consumers, but not by very much. The change in quantity demanded is also likely to be relatively small for these products when their prices go down instead of up. If the products were corn, tomatoes, or gasoline from a particular station, however, people might react differently to a price change. If the prices of these products were to increase, consumers could delay buying any of these items without suffering any great inconvenience. Figure 4.6 summarizes some of these observations. If the answer to the question “Can the purchase be delayed?” is yes, then the demand for the product is likely to be elastic. If the answer to the question is no, then demand is likely to be inelastic. Are Adequate Substitutes Available? If adequate substitutes are available, consumers can switch back and forth between the product and its substitute to take advantage of the best price. If the price of beef goes up, buyers can switch to chicken. With enough substitutes, even small changes in the price of a product will cause people to switch, making the demand for the product elastic. The fewer substitutes available for a product, the more inelastic the demand. Sometimes only a single adequate substitute is needed to make demand elastic. For example, in the past there were few substitutes for sending a letter through the post office. Then fax machines allowed messages to be transmitted over phone lines. Today many people use e-mail on the Internet or send instant messages on their cell phones. Because of all these alternatives, it is more difficult for the U.S. Postal Service to increase its total revenues by raising the price of a first-class stamp
. 108 UNIT 2 Microeconomics: Prices and Markets Note that the size of the market is important. For example, the demand for gasoline from a particular station tends to be elastic because consumers can buy gas at another station. If we ask about the demand for gasoline in general, however, demand is much more inelastic because there are few adequate substitutes for gasoline. Does the Purchase Use a Large Portion of Income? The third determinant is the amount of income required to make the purchase. If the amount is large, then demand tends to be elastic. If the amount of income is small, demand tends to be inelastic. Finally, you may have noticed that the answers to our three questions is not always “yes” or “no” for each of the products shown in Figure 4.6. For example, some products such as salt may be easy to classify, since each of the answers is “no.” However, we have to use our judgment on others. For Inelastic Taxes? When you buy a product in a store, most states charge a sales tax when you get to the cash register. Many states also charge an excise tax, or a general revenue tax on the manufacture or sale of selected items, which is already included in the price of the item. The excise tax usually raises the price of the item. If demand for the product is inelastic, then so much the better for the tax collector, because the quantity demanded does not drop very much. That’s why so many excise taxes are on items like gasoline and concert admissions—items that have an inelastic demand. example, the demand for the services of medical doctors tends to be inelastic even though they require a large portion of income. This is because most people prefer to receive medical care right away rather than taking the time to look for adequate substitutes. Reading Check Identifying Can you think of other goods with inelastic demand? Why is the demand for those goods inelastic? SECTION 3 Review Vocabulary 1. Explain the significance of elasticity, demand elasticity, elastic, inelastic, and unit elastic. Main Ideas 2. Describing How do consumers react to price changes on products with elastic, inelastic, and unit elastic demand? 3. Explaining How do total expenditures relate to the demand elasticity for products? 4. Organizing Use a graphic organizer like the one below to describe the three determinants of demand elasticity. Determinant Description
Critical Thinking 5. The BIG Idea Why is the demand for airplane tickets inelastic for last-minute ticket purchases? 6. Understanding Cause and Effect A hamburger stand raised the price of its hamburgers from $2.00 to $2.50. As a result, its sales of hamburgers fell from 200 per day to 180 per day. Was the demand for its hamburgers elastic or inelastic? Why? 7. Analyzing Visuals Based on Figure 4.6 on page 108, create your own chart for the following products: an MP3 player, electricity, a gallon of milk, an ink pen, and a pound of onions. Explain. 8. Drawing Conclusions Airlines in the United States generally do not offer reduced round-trip airfares during holidays such as Easter, Thanksgiving, and Christmas. What can you conclude about the elasticity of demand for airplane travel at these times? Applying Economics 9. Elasticity of Demand Interview an owner or manager of a local business about the effects of recent price increases for a product. Is the demand for these goods or services elastic or inelastic? Why? CHAPTER 4 Demand 109 CASE STUDY The iPod The Idea Handheld music devices date back to the 1970s, when Sony introduced the Walkman. So why has the iPod dominated the MP3 market in the early 2000s? When the iPod hit store shelves in November 2001, other MP3 players were already on the market. Yet they were larger than the 6.5-ounce iPod, and they could not hold nearly as many songs. The iPod was an instant hit. Innovation Technology set off the iPod in other ways. The mechanical scroll wheel allowed easy scrolling and navigation. FireWire allowed much faster transfer of music from the computer to the iPod. In 2003 Apple CEO Steve Jobs announced that the iTunes software, formerly used to store and play digital music on a Mac, would become a gateway to the online iTunes Store. The owners of iPods now were able to download songs for just 99¢ each. While Apple makes only about.10¢ per U.S. M ARKET FOR MP3s 24% 2% APPLE’S REVENUE 2000–2006* $24 20 18 16 12 2001 2002 2003 2004 Year 2005 2006* Source: www.apple.com *2006 earnings projected sale, it generates many more iPod sales. On top of that, music from the iTunes Music Store can be played only on Apple devices because of Apple’s digital rights
management technology. This tempts more people to purchase iPods. Staying Ahead of the Pack Apple continues to innovate. In January 2004, Apple introduced the iPod mini. Its “click wheel” removed the need for buttons. Newer models can hold ever larger volumes of data, while tiny flashmemory chips keep the player size small. Today’s iPods can store up to 10,000 songs, hold hundreds of photos, and play entire movies. Adapters connect iPods with car or home stereo systems. By constantly updating, Apple has been able to keep its huge market share ever since the iPod was introduced. 74% Analyzing the Impact Apple Sony All others Source: BusinessWeek 1. Summarizing What features allowed Apple’s iPod to dominate the market? 2. Drawing Conclusions How does Apple continue to stay ahead of the competition? 110 UNIT 2 Microeconomics: Prices and Markets “Courtesy of Apple” www.apple.com CHAPTER CHAPTER 4 Visual Summary 4 Study anywhere, anytime! Download quizzes and flash cards to your PDA from glencoe.com. Law of Demand The Law of Demand states that when the price goes up, quantity demanded goes down. When the price goes down, quantity demanded goes up. quantity quantity demanded demanded goes goes down... down... When the When the price goes price goes down... down... When the When the price goes price goes up... up... quantity quantity demanded demanded goes up... goes up... Change in Demand When a change in demand occurs, people want to buy different amounts of a product at the same price. A change in demand can happen for several reasons. Consumer income Number of consumers Consumer tastes Change in Demand Expectations Price of substitutes Price of complements Demand and Elasticity Changes in price and total expenditures help determine the demand elasticity of a product. Type of Demand Change in Price Change in Expenditure Movement of Price and Expenditure Elastic Inelastic Unit elastic Opposite Same No change CHAPTER 4 Demand 111 CHAPTER 4 Assessment and Activities Review Content Vocabulary Review the Main Ideas On a separate sheet of paper, match the letter of the term best described by each statement below. a. demand b. demand elasticity c. change in demand d. demand curve e. Law of Demand f. complement g. elastic demand h. substitutes i. marginal utility j. unit elastic demand Section 1 (pages 91–95) 17.
Describe a demand schedule and a demand curve. How are they alike? How do they differ? 18. Discuss what is meant by the Law of Demand. 19. Explain how the principle of diminishing marginal utility is related to the downward-sloping demand curve. Section 2 (pages 97–101) 1. statement that more will be demanded at lower prices 20. Explain the difference between the income effect and and less at higher prices the substitution effect. 2. graph that shows the quantity demanded at all possible 21. Identify and describe the five factors that can cause a prices in the market at a given time 3. measure of responsiveness relating change in quantity demanded to a change in price 4. a given change in price causes a relatively larger change in quantity demanded 5. products that can be used in place of one another 6. a principle illustrating that consumers demand different amounts at every price, causing the demand curve to shift to the left or the right change in individual demand, using a graphic organizer similar to the one below. Change in Individual Demand 7. additional satisfaction or usefulness as more units of a Section 3 (pages 103–109) product are acquired 22. Describe the difference between elastic demand and 8. the desire, ability, and willingness to buy a product inelastic demand. 9. a given change in price causes a proportional change in 23. Explain how the total expenditures test can be used to quantity demanded determine demand elasticity. 10. product that increases the use of another product 24. Identify and then describe the determinants of demand elasticity. Review Academic Vocabulary Critical Thinking On a separate sheet of paper, use each of these terms in a sentence that reflects the term’s meaning in the chapter. 11. prevail 12. inversely 13. principle 14. illustrate 15. technical 16. adequate 25. The BIG Ideas Assume that demand for pizza has been steady for some time. How do you think the market demand curve for pizza would be affected by (1) an increase in everyone’s pay, (2) a successful pizza advertising campaign, (3) a decrease in the price of hamburgers, and (4) new people moving into the community? Explain your answers. 112 UNIT 2 Microeconomics: Prices and Markets Economics: Principles and Practices Web site at glencoe.com and click on Chapter 4—Self-Check Quizzes to prepare for the chapter test. Self-Check Quiz Visit the 26. Determining Cause and Effect Razor blades are complementary
goods for razor handles, while electric razors are substitutes. Copy the demand curves below on a sheet of paper. Then show how the rise in the cost of razor handles, if they were sold separately, would affect the demand curves for its complementary and its substitute products. R AZOR B LADES E LECTRIC R AZORS Analyzing Visuals 30. Look at Figure 4.2 on page 94. Suppose that Avi, a friend of Mike’s and Julia’s, is also willing to buy CDs. Create a new market demand schedule by adding the numbers that you think Avi is willing to purchase at different prices. Then draw a market demand curve reflecting the new numbers Quantity Quantity Thinking Like an Economist 31. Write a paragraph describing a business you might like to own. Describe the product your business makes. Then use the three determinants of demand elasticity to predict the elasticity of demand for that product. Explain the pricing policy you would use to get consumers to maximize their expenditures on that product. 27. Making Generalizations Do you think the Law of Demand accurately reflects most people’s behavior regarding certain purchases? Explain. 28. Synthesizing Assume that you are a business owner. How would you use your knowledge of demand elasticity to determine the price of your product? Interpreting Cartoons 32. Critical Thinking Look at the cartoon below. What do you think Snoopy’s doghouse represents? What message is the cartoonist trying to convey? Explain whether or not he found a good way to discuss the topic. Math Practice 29. Mindy is trying to estimate the elasticity of demand for a product she wants to sell at a craft fair. She has been told that she can expect to sell 10 items if she charges a price of $10, six items if she charges a price of $20, and 18 items at a price of $5. a. Make a demand schedule to show the quantities demanded at each price, and plot a demand curve. b. At which price would the total expenditures by consumers be greatest for the product? At what price would expenditures be the smallest Chris Britt, Copley News Service. CHAPTER 4 Demand 113 &The Global Economy YOU China’s Thirst for Gas Hurricanes in the Gulf of Mexico, deteriorating pipelines in Alaska, and conflict in Iraq can cause gasoline prices to rise by restricting supply. Often the events we see in the headlines affect the supply of oil available to consumers, but changes in the
level of world demand for petroleum products also affects the price of oil. China’s Growing Demand PROJECTED OIL CONSUMPTION, UNITED STATES AND CHINA (1994–2025) U.S. demand for petroleum products has been high for decades. The United States is the largest consumer of oil, using about a quarter of the world’s petroleum. This is quickly changing. Emerging nations are becoming thirsty for oil, and China is at the top of that list. How did such a rapid change happen? In the past, China has not needed much petroleum. As the country is industrializing, however, it needs more and more fuel to satisfy its growing energy needs. In fact, as the graph of oil consumption between 1995 and 2025 shows, China’s consumption is increasing much more rapidly than U.S. consumption. C OUNTRIES WITH H IGHEST O IL C ONSUMPTION ) 25,000 20,000 15,000 10,000 5,000 0 United States China Japan Germany Russia Countries 1995 2005 2025 1 barrel = 1 million barrels/day United States China While China still consumes considerably less petroleum than the United States, it has been responsible for over 25 percent of the growth in world petroleum consumption since 1994 and 30 percent of growth since 2000. This increase was enough to make China the second biggest consumer in the world market in 2003, and its demand is not expected to slow down soon. Worldwide Impact China’s growing energy needs have worldwide repercussions. The nation’s increasing demand has helped to push up prices for crude oil. In 2005 the International Monetary Fund (IMF), which promotes economic growth and cooperation, expressed concern that high oil prices could bring about a worldwide slowdown in economic growth because of these increased energy needs. 114 UNIT 2 Microeconomics: Prices and Markets Higher prices for food and items in stores because of higher transportation cost EFFECTS OF HIGHER OIL PRICES Higher Oil Prices Higher Oil Prices Cuts in school programs because of higher transportation costs Higher prices for plastics, paints, and other products made with petroleum Higher prices at the gas pump What Does It Mean for You? Why should you care whether China is increasing its demand for petroleum? Simply put, any increase in demand for oil on the world market can lead to rising prices for a variety of goods and services in the United States because so many other products are linked to energy costs. The results of all these increased costs are manifold. You may see a cut in school
programs to pay for higher transportation costs. The products you buy in stores may become more expensive. And of course the price of gas you put into your car may increase. If you are on a limited or fixed budget, like most students, such increases will leave you with less money to spend on other things. As you see, China’s higher demand for petroleum has a direct impact on you and your wallet. Analyzing the Issue 1. Identifying Why has China’s demand for petroleum increased in recent years? 2. Describing What is the effect of increased oil prices on your or your family’s budget? 3. Applying Check your local newspaper, news magazines, or Internet news sources for recent reports about global issues affecting oil prices. On a separate piece of paper, summarize the issues discussed in these articles and describe how they affect you. (t) Texas Energy Museum, Beaumont, Texas, (b) Jeff Greenberg/PhotoEdit CHAPTER 5 Supply Why It Matters In order to earn some extra money, you are considering opening a lawn or babysitting service. Brainstorm the resources you would need. What specific services would you offer? What prices would you charge? What information do you need to determine answers to these and other questions? Read Chapter 5 to find out about the factors that influence how businesses make production decisions. The BIG Ideas 1. Buyers and sellers voluntarily interact in markets, and market prices are set by the interaction of demand and supply. 2. The profit motive acts as an incentive for people to produce and sell goods and services. Firms base their supply of products on production costs and the price they can charge for the product. 116 UNIT 2 Laurence Dutton/Getty Images Economics: Principles and Practices Web site at glencoe.com and click on Chapter 5—Chapter Overviews to preview chapter information. Chapter Overview Visit the SECTION 1 What is Supply? GUIDE TO READING Section Preview Reading Strategy In this section, you will learn that the higher the price of a product, the more of it a producer will offer for sale. Content Vocabulary • supply (p. 117) • Law of Supply (p. 117) • supply schedule (p. 118) • supply curve (p. 118) • market supply curve (p. 119) • quantity supplied (p. 119) • change in quantity supplied (p. 119) • change in supply (p. 120) • subsidy (p. 122) • supply elasticity (p. 124)
Academic Vocabulary • various (p. 118) • interaction (p. 120) Describing As you read the section, complete a graphic organizer similar to the one below by describing the causes for a change in supply. Change in Supply —www.forbes.com COMPANIES IN THE NEWS Flu Shot Gold Rush Last year, the U.S. flu shot market was so unappealing that only two players were producing injectable vaccine—leading to a serious shortage when one of them, Chiron, had to shut down its plant. Now, it seems, non-U.S. firms are rushing to make influenza vaccine. Today, CSL Limited, a $2 billion biopharmaceutical firm based in Melbourne, Australia, is announcing plans to invest more than $60 million to enter the U.S. flu shot business. It expects to compete with Sanofi-Aventis, GlaxoSmithKline and Novartis, which plans to buy Chiron.... CSL [hopes to] be able to move 20 million doses, giving it a 10% to 15% market share. ■ The concept of supply is based on volun- tary decisions made by producers, whether they are proprietorships working out of their homes or large corporations. A producer might decide to offer one amount for sale at one price and a different quantity at another price. Supply, then, is defined as the amount of a product that would be offered for sale at all possible prices that could prevail in the market. Because producers receive payment for their products, it comes as no surprise that they will offer more at higher prices. This forms the basis for the Law of Supply, the principle that suppliers will normally offer more for sale at high prices and less at lower prices. The promise of high prices, and hopefully high profits, is what lured the company in the news story into entering the U.S. market. supply amount of a product offered for sale at all possible prices Law of Supply principle that more will be offered for sale at higher prices than at lower prices Robert Giroux/Getty Images CHAPTER 5 Supply 117 supply schedule a table showing how much a producer will supply at all possible prices supply curve a graph that shows the different amounts of a product supplied over a range of possible prices An Introduction to Supply MAIN Idea Supply can be illustrated by a supply schedule or a supply curve. Economics & You Earlier you learned how to illustrate demand using schedules and graphs. Read on to learn how to illustrate

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