ECONOMICS BASICS FOR MBA

ECONOMICS BASICS FOR MBA

THE LAW OF SUPPLY AND DEMAND

ECONOMY CYCLES

ECONOMY HEALTH

THE LAW OF SCARCITY

THE LAW OF DIMINISHING RETURNS

An economic system is simply a set of laws institutions and activities that guide decision making. Every economic system seems to answer the questions about how to allocate scarce resources. We summarize the different systems for you here:

·        Traditional economic system

Economies that are based on farming and use simple barter trade have traditional economic systems. This system remains only in remote areas such as some parts of tribal africa.

·        Pure market system

This system is based on supply and demand with little or no government control. The ebay reverse auction system is a form of a pure market system.

·        Command economy

This system is run by a strong centralized government and focuses on industrial goods instead of consumer goods. The former soviet union had a command economy.

·        Free enterprise system

Most democratic nations have this economic form where individuals can make economic choices. This system is also called capitalism or market economy. It's characterized by competition and a profit motive. Entrepreneurs love this. Competition comes in four flavors:

1)     Perfect competition: you have a lot of buyers and sellers and no one giant company can affect price.

2)     Monopolistic competition: many sellers produce differentiated product and their goal is to dominate a niche in the market.

3)     Monopoly: a particular commodity has only one seller who controls supply and prices. Free market economies don't like monopolies.

4)     Oligopoly there are a few competitors that dominate an industry. The automobile industry is a great example of an oligopoly

The united states and the european union don't have pure free enterprise systems, they have mixed economies which means that they combine the principles of market and command economies: they have a centralized government for things such as national security and regulations for the common goods, but in business they generally display a free enterprise system.

 

THE LAW OF SUPPLY AND DEMAND

in a free enterprise system or mixed economy, the marketplace determines the price of a product. Supply and demand interact to produce a price that customers are willing to pay for the number of products that manufacturers are willing to make.

In a nutshell, supply and demand affects pricing in the following ways:

·        If a product is in great demand but is in short supply, the price will rise

·        If there is a large supply for a product and little demand for it, the price will go down

·        Prices stabilize when demand equals supply

 

ECONOMY CYCLES

The economy isn't really in equilibrium for very long. It's subject to many changes in the form of business cycles. If the economy is in a period of prosperity and inflation of prices and incomes, it will eventually taper off and a contraction will take place; during which activity slows. If the contraction lasts long enough, the economy will slide into a recession or collapse into a trough called a depression. The slow recovery from a trough is called expansion.

·        Inflation

Inflation is simply a period when prices rise sharply. During times of inflation, your dollar purchases less in terms of goods and services. Not all prices rise, but on average they do. So if you get a 3% raise and the price of the goods and services you buy goes up 7% for instance, you won't be able to buy as much with the same dollars.

Two different scenarios cause inflation:

1)     When there's too much demand and too little supply, prices rise. This is known as demand pull inflation. It often happens when: the government cuts taxes or when consumers save less.

2)     When production costs skyrocket, cost push inflation occurs. Manufacturers usually push the costs along to the customer in the form of higher prices. Of course then workers demand higher wages so that they can pay for these higher prices. As a result, unemployment typically is high during this time: because the higher costs aren't driven by demand, so companies aren't hiring.

·        Recession or depression

When the economy doesn't grow for a period of at least six months, it's said to be in a recession.both the 1980's and the 1990's started with recessions. During a recession, people typically cut their spending. A behavior that in turn causes the recession to get worse: because it slows down the economy even more. A very bad recession can turn into a depression which is: when many businesses failed, prices drop and supply exceeds demand.

How can your business prepare for change in the economy? Here are some tips: stay aware of what's going on by reading newspapers and surfing the web. The following websites are good places to start:

¾    The new york times;

¾    The wall street journal;

¾    Bloomberg;

¾    The department of commerce;

¾    Cnn money.

Watch for leading indicators for example: the leading index which consists of such things as the producer price index; the consumer confidence index and the manufacturer's order for durable goods index; declines for about nine months prior to the onset of a recession; the consumer price index; interest rates and unemployment; typically declined for thirteen months prior to the onset of a recession. You'll also hear these indices referred to regularly on national news programs, so watch for them. Stay as liquid as possible, you want to be able to have cash on hand to expand in good times and a cushion to help you survive the bad times.

 

ECONOMY HEALTH

Economists regularly measure the health of the economy during the year. What they find determines everything from whether the government raises interest rates to whether you get a raise, the sections that follow look at some of the more common indicators of economic health.

·        Gross domestic product

The gross domestic product also known as the gdp is the total dollar value of all goods and services produced in the country. It's essentially a record of how much workers produced for consumers to purchase.

·        The cost of living

Gdp looks at only new goods for example, new cars.

·        Consumer price index

The consumer price index also known as the cpi or the cost of living index, represents the change in price of a specific group of goods and services over time. This group of goods and services is called a market basket and it includes about 400 items in such categories as: food, housing, transportation, clothing, entertainment, medical care and personal care.

As a business owner you need to be aware of the cpi because it affects the rent you pay on your facility or the wages you pay your employees. The cpi actually is a measure of inflation when you read that inflation has gone up a certain percentage, more often than not, a change in the price of things people typically buy has taken place.

·        Income

Income is a way of measuring how much money is available to be spent by individuals and businesses. National income includes such things as wages and salaries self-employed income, rental income, corporate profits and interest on savings and investments. Economists are most interested in disposable and personal income. Personal income is all income received before taxes are paid and disposable income is what's left over after taxes.

·        Unemployment

The united states seems to take the issue of unemployment very seriously. And why not? It represents the percentage of the labor force that's actively looking for jobs. If the number is low, most everyone is happy but if the number is high people start to get nervous about their own jobs. From an economist's point of view, the united states is at full employment when the unemployment rate is less than 6.5%

·        Balance of trade

In the current global economy, you hear a lot about things such as balance of trade because nearly every business is affected by global conditions. The difference between the value of the united states is exports to other countries and its imports from other countries is termed the balance of trade.

In an ideal situation, a country wants to bring in more money from exports than it spends on imports. This situation is considered a positive balance of trade or a trade surplus. If on the other hand, a country spends more for imports than it takes in from exports it has a negative balance of trade or a trade deficit.

If you have a product that's suitable for exporting to other parts of the world, the department of commerce is ready and willing to help you. Actually far more ready and willing than if you were wanting to import products. Go to the doc website at doc.gov to find out what's available to you.

·        National debt

The united states as a whole hasn't done much better than its individual people about staying out of debt. For years the united states has been running a national debt in the trillions of dollars which means that the government is spending much more than it's taking in. The us government gets money to spend not by earning it the way you and i do but by selling various types of bonds. Perhaps you've even invested in some of these savings bonds and treasury bonds. Each time the government issues new bonds, it adds to the national debt. When you purchase a bond you're actually lending the government your money and the government agrees to pay you interest on that money over a specified period of time so you'll get back more money than you put in.

 

THE LAW OF SCARCITY

When you consider the three economic questions, the economic principle in play is the law of scarcity. That's because economic organizations wouldn't have to answer the questions if they had unlimited resources. Because organizations don't have unlimited resources they have to allocate their scarce resources between necessities and luxuries.

Your business certainly is an economic organization that must make decisions about scarce resources; which products or services to produce; how to produce them; and for whom. These will become key questions that you have to answer before you can successfully negotiate the marketplace.

How do you answer those questions? You answer all three by answering this one: who is your customer. Your customers target or current tell you: what to produce, when to produce it and how to get it to them. In addition, your suppliers and other entities in your industry can help you choose the most cost effective means to produce the product. Bottom line to answer the questions pound the pavement and talk to people in your industry

 

THE LAW OF DIMINISHING RETURNS

The law of diminishing returns describes how much extra return you get on your output as you add extra units of input. Suppose that you have a factory that produces widgets, as you add labor to the production process your ability to produce more goods increases to some point and then begins to diminish. This means that each person you add produces less than the previous person.

Maybe you can think of it this way: the first taste of ice cream is always better than the last. That's the law of diminishing returns. Remember! In business, you need to figure out the point at which your most productive. That point determines when you achieve the biggest gains for your efforts.