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CHAPTER 2

INFLUENCE OF
ECONOMICS IN
BUSINESS

Chapter 2

2.1 Introduction to economics

2.2 Economic systems

2.3 Basic market models

2.4 Business environments

INTRODUCTION TO
ECONOMICS
Economics: study of how wealth is created and distributed by
men

As anything that is of value to people


- Includes any kind of goods, services
that are produced
and sold to customers
Anything that a customer wants or needs
Include food, houses, clothing, luxury item

3 IMPORTANT QUESTIONS
Therefore, in understanding an economic
theory people/business is required to
answer 3 important questions

1. What
2. How
3. For Whom

3 IMPORTANT QUESTIONS

1. What?
producers have to think what kinds of
goods and services are to be produced.
Producers would usually produce goods
that are demanded by society
Eg: to satisfy peoples needs of food,
many businessman operate
restaurants to sell variety of foods
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3 IMPORTANT QUESTIONS
2. How?
Producers would need to determine how much of
each type of goods and services to produce
There is a need to think how will these goods and
services be produced, which means: who will
produced them
Answering basic question of how much of goods to be
produced will require a business to determine a rough
estimate of the number of people needing them, and
making sure they employ the right people to produce
the goods

3 IMPORTANT QUESTIONS
3. For Whom?
Who will get the goods and services
produced by business?
Therefore, businessman who aim to
make as much profit must ensure
they know the group of people that
will buy the goods and services they
produce.
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ECONOMIC SYSTEM
Economic

system

is

defined

as

the

mechanism by which labor and other


economic resources are brought together
to produce and distribute the goods and
services to serve people need and wants.

ECONOMIC
SYSTEM
Can be defined as a nation system for
allocating resources among its citizen.
Basically, it deals with allocating its limited
resources to fulfill unlimited wants of
individuals.
As human needs are unlimited, every
economic system has to deal with the
scarcity of factors of production (economic
*Natural resources
resources)

*Labor
*Capital resources
*Entrepreneur

FACTORS OF PRODUCTION
1. Natural resources
2. Labor
3. Capital or capital goods
4. Entrepreneurs
Since all the above factors are limited and there are limits to
what
can be produced, who will produce them, and what resources
will
be used, basic choices must be made
Different choices to the above questions result in different
types of
economic systems
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FACTORS OF PRODUCTION
1. Natural resources
Include all resources such as raw materials,
water, land, minerals
2. Labor
Consist of people who perform the work in
producing the goods and services
3. Capital or capital goods
Includes all buildings, machinery, tools, and
equipments used in actual production of
goods and services
4. Entrepreneurs

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People who start the business and make


decisions and ensure all resources are used
effectively and the goals of the organization
are achieved

TYPES OF ECONOMIC SYSTEM


1.

1)
2)
3)
4)

Capitalism
An economic system based on the private ownership where all
economic decisions are taken by individual households and firms
with no government intervention. It also known as laissez-faire.
Individuals have right to accumulate wealth & maximize their
potential.
Work hard -> get rewards.
Individuals have 4 basic rights:
To own private property
To own a business & keep all its profits after taxes
Freedom to compete in wealth accumulation & consumption of
goods & services
Freedom of choice based on the ability to pay

Characteristics of Capitalism Economic System


1.

Business ownership

Private ownership of property

2.

Degree of central
control

Relatively low with products. Pricing


determined by competition.

3.

Extent of managerial
decision making

Limited role of government private


managerial initiative

4.

Products prices and


availability

Prices are determined by supply and


demand

5.

Occupational choice

Individual free to choose jobs they like

6.

Incentive

Profit motive
Individuals can keep profit and use it
whenever they want

2. Socialism
An economic system which the basic industries are
owned either by the government itself or by private
sector under strong government control.
Government or the Central Authority makes the major
economic decisions regarding production and
distribution of goods and services to ensure whole
society gets the benefits.

Characteristics of Socialism Economic System


1.

Business ownership

Public ownership of basic


industries

2.

Degree of central
control

Major goals of economic set by


government

3.

Extent of managerial
decision making

Managers of major firms must follow


the governments central plan

4.

Products prices and


availability

Prices are determined by supply and


demand

5.

Occupational choice

Individuals may own small businesses


and choose jobs within the statecontrolled economy

6.

Incentive

Many non-monetary incentives


Profits from government owned
industries go back to government
Profit from small business reinvested
in the business.

COMMUNISM (CENTRALLY PLANNED SYSTEM)


An economic system which all economic resources
would be owned collectively by the state rather than
by individuals.
People receive the economic benefits based in their
needs, they work according to their abilities and would
receive goods and services according their needs.
Resources are fairly distributed among the members
of society.
Not encourage entrepreneurs to be creative &
capitalize their maximum potential.
Even work hard not be rewarded.

Characteristics of Communism Economic System


1.

Business ownership

Public ownership of virtually all


productive activities.

2.

Degree of central
control

Central determination of all


productive activities.

3.

Extent of managerial
decision making

Managers selected through state


political party and highly
bureaucratized.

4.

Products prices and


availability

Prices are usually high. Consumers


have limited choice of goods.

5.

Occupational choice

Government owns all business and


jobs are prescribed by state. Little
choice in choosing career.

6.

Incentive

Excess profit goes to government.

MIXED ECONOMIC SYSTEM


Economic decisions are made partly by the government &
partly through market.
Freedom of individual choice & decisions to maximize their
satisfaction.
Market is allowed to operate freely as long as it does not fail.
Markets fail, the government will intervene.
Recognize individual interest & freedom of competition among
individuals & firms.
Address social issues such as inequality of income distribution
& externalities such as the cost of pollution as the economy
goes through industrialization.
Government strongly supports privatization, it often intervenes
in pricing decisions, especially those of monopolists.

BASIC MARKET
MODELS
In analyzing business environment, we must
examine the
types of market situations that exist there
are 4 basic
models / 4 different degree of competition

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1.

Pure monopoly

2.

Oligopoly

3.

Monopolistic competition

4.

Pure/perfect competition

MONOPOLY
Situation in which a single company owns all or
nearly all of the market for a given type of product
or service.
There is a barrier to market entry into the industry
that allows the single company operate without
competition.
Only one seller or producer
There are many buyers
No substitute for the products
They have a power to influence the market price.

OLIGOPOLY
An oligopoly is a market or industry is dominated by a
small number of sellers.
A general lack of competition can lead to higher costs for
consumers.
Because there are few sellers, each oligopolist is llikely to
be aware of the actions of the others.
The decisions of one firm influence the decisions of other
firms.
The product either homogeneous or differentiate from one
another
(e.g :each firm attempts to have differentiation of a
standardized product.
Their goods are very similar in nature and the firms would
try to distinguish their products from those of their
competitors).

MONOPOLISTIC COMPETITION
A type of imperfect competition such that many
producers sell products that are differentiated from one
another but not perfect substitutes (such as from
branding, quality or location).
There are large number of buyer and seller.
Easy to enter and leave the industry.
Seller try to differentiate their product from their rival
by brand names, design or advertising.

PURE/PERFECT
COMPETITON
This is market structure
where there are many independent
sellers, each offering its products in the same basic way.

All of the products are standardized i.e. there are almost


identical and buyers are in different to which one they purchase.
Each firm has no significant control over the products price
because none of them is supplying more than a small fraction of
the total output being demanded.
Firms can enter or leave the industry easily.
There is no use of non-product competition, as the product is
standardized.
In pure competition, sellers and buyers must accept the going
price. The price of each product is determined by the actions of
all buyers and sellers together, through the forces of supply
and demand.

COMPARISON IN MARKET
STRUCTURE
Characteristic
s

Perfect
Competition

Pure
Monopoly

Monopolistic
competition

Oligopoly
Few

Number of
Market

Many

One

Many, but fewer


than perfect
competition

Ability to Control
Price

None

High

Some

Some

None

Subject to
govt.
regulation

Few

Many

Very little

No product
that
compete
directly

Emphasis on
showing
perceived
differences in
product

Some
differences

Barriers To Entry

Product
Differentiation

Examples

Farm products
such as wheat
and corn

Utilities such
as gas,
water,

Retail specialty
clothing

Steel,
automobiles,
airlines,
aircraft

BUSINESS
ENVIRONMENT

Business: must aware of changes and be responsive to many environmental


factors
change and adapt to the changes

1. Historical
2. Natural-physical
3. Political and legal
4. Social and cultural
5. Economic
6. International
7. Technological

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HISTORICAL

26

Consists of records of events and activities that


have taken place daily - provides background for
all the other environments

Business need to look at historical records of


various companies performance - useful guide to
run business effectively & efficiently

By examining its historical past, a business is


better able to anticipate new developments and
plan for them

NATURAL PHYSICAL ENVIRONMENT

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Consists of all natural resources (water, oil, gas, iron)


and many other raw materials

Business is restricted by its natural environment


whenever it relies on the availability of natural
resources to produce goods resources become
reduced as we produce more and more goods &
sometimes not replaceable

Problems of pollution would arise and have a very


serious business impact on the ecology is the
study of relationship between people and
environment

ContNATURAL PHYSICAL ENVIRONMENT

Other depressing situations related to pollution of


the water, noise and waste cost of cleaning up the
environment has to be borne by business
organizations and societies
Therefore, business needs to be innovative and
proactive in its effort to develop its business
production of goods and services using naturalphysical resources may have to be reduced with
substitutes to be invented

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POLITICAL & LEGAL

29

Consists of law, regulations, and activities of


the government and its agencies which
restrict business activities and protect the
customers

Government intervention into business


affairs have been increasing because need
to protect customers right from unfair
business practices, preservation of the
environment and to reduce discrimination in
the work place

Cont.POLITICAL & LEGAL


Roles of government in business areas are:
1.

Government as a business regulator and promoter

By implementing favorable budget policies, government


promotes business activities that stimulate economies
By encouraging certain business activities, government can
target the standard living of nations
Government will also hand out certain guidelines concerning
price fixing, advertising, minimum wage and working
conditions which the business must follow
Legislation directed towards improving and maintaining the
nations physically quality has been set up to regulate
business interaction with the environment

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Cont..POLITICAL & LEGAL


Roles of government in business areas are:
2.

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Government as a customer
Government buys goods and services, ranging from office
machines, computers to war materials for defense purpose from
private firms
Government acts as owner and competitor by providing goods and
services in the market place. They also act as suppliers as they own
a great deal of the nations natural resources. Eg: land which is
occasionally sells to a business
Current MSC project launched in early 1997 will open up new
opportunities for many companies such as TELEKOM, HSBC, SAPURA
in providing related services, and providing other infrastructures

SOCIAL & CULTURAL

Includes demographics and consumer preferences represent


social tendencies to which business is
exposed.

Characteristics of the human population or specific segments of the


population, eg: increase in the elderly population has led to an
increased demand for many prescription drugs.

changes in consumers demand may also affect the demand for


products produced, eg: technology advances: SEGA to
PLAYSTATION, X-BOX, VIDEO to CD, DVD, Download Music Online.
Societys values and customs have become guidelines to many
organizations methods of operation.

Social and cultural environment are made of beliefs, attitudes,


customs and norms of every group in society.

Eg: drive-thru of McDonald & KFC due to our busy lifestyle.

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ECONOMIC

33

Have a strong impact on the performance of each business

When company is strong, employment is high and compensation


paid to employees is also high
Since people have good income under this conditions, they
purchase large amount of products
Firms that produce the products benefit from the large
demand
Will hire many employees to ensure that they can
produce a sufficient amount of products to satisfy the
demand
Can also afford to pay wages to employees
Expand their operations results in increased demand
for supplies, materials, construction services
In the end, many working opportunity can be created

Cont..ECONOMIC

Economy is weak firms tend to lay off some of their


employees
Cannot afford to pay high wages people will
receive low income
People will purchase small amount of product
affect the producer
Producer will facing losses retrenched many
employees
Employees lose their jobs

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INTERNATIONAL

35

International Trade transactions made


between countries.
Include exchange of goods and services and
financial flows.
It become possible due to diplomatic ties
established among the governments.

INTERNATIONAL

May affect business directly or indirectly


1. Attract foreign demand
some companies unable to increase
their market share in US because of
intense competition within their
industry - try to find foreign market
where potential demand may exist

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Cont.. INTERNATIONAL
2. Capitalize in technology many US companies
established new businesses in the so-called
developing countries which have relatively low levels
of technology (Latin America)
3. Use inexpensive resources
Labor and land costs can vary significantly among
countries firms often attempt to set up
production at a location where land and labor are
inexpensive
Cost of labor is much higher in developed
countries (US, UK) than other countries (Mexico,
India)
Therefore, numerous US company has established
subsidiaries in those low cost labor countries

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Cont.INTERNATIONAL
4.

Use inexpensive resources


Labor and land costs can vary significantly among
countries firms often attempt to set up
production at a location where land and labor are
inexpensive
Cost of labor is much higher in developed
countries (US, UK) than other countries (Mexico,
India)
Therefore, numerous US company has established
subsidiaries in those low cost labor countries

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Cont.INTERNATIONAL

39

Some firms rely on foreign countries for raw materials


supply or sell their products in various countries
firms establish subsidiaries in foreign countries where
they can produce and sell the products
Even if firm is not planning to sell its products in foreign
countries, it must be aware of the global environment
because it may face foreign competition when it sells its
products locally
Furthermore, global economic conditions can affect local
economic conditions if economic weaken in foreign
countries, the foreign demand and sales for Malaysian
products will decrease
General income level for affected firm will
decline & consumer will have less money to
spent

TECHNOLOGY

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Includes scientific and technological breakthrough


and advancement in industries as well as society
Nowadays, many organizations used high level of
technology to assist them in the process of
producing goods
Companies are competing with one another to
produce quality products more efficient and
effective with the help of technology
Eg: telecommunication industry, construction
industry

HOW TO CONDUCT
INTERNATIONAL BUSINESS
1.
2.
3.
4.
5.
6.
7.

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Importing
Exporting
FDI (foreign direct
investment)
Licensing
Strategic alliances
Franchising
Joint venture

1.

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Importing

Buying of products or services from


another country through a supplier.

Eg: Malaysia consumers purchase


automobile, clothing, cameras and other
products from US.

Many firms import materials that are used


to produce products.

Even if these firms sell the products locally,


they can benefit from importing materials.

They import foreign materials that are less


expensive or of a higher quality than
alternative local supplies

2. Exporting

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Selling of local products to another


country directly or through third
parties such as trading companies.

Advantage in reducing risks since it


allows the business to penetrate the
global market on a gradual basis based
on the demand from the foreign
customers.

3.

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FDI (Foreign Direct Investment)

Foreign-owned corporations that set up


their physical base in a foreign country
through direct investment.

Eg: Ford Motors, Honda, has facilities in


various countries that produce automobiles
and sell them in those locations

Justification:

To avoid trade barriers: firm that has


been exporting products is informed that
the foreign government will impose trade
barriers therefore, firm establishes a
subsidiary that can manufacture and sell
products in that country

To reduce labor costs

4. Licensing

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An agreement to produce & market


another companys product in
exchange for a royalty or fee.

Licensing allows a firm (licensor) to


appoint a foreign company as the
licensee to produce it prodcts.

The licensee pays royalty or fee to


licensor.

5. Strategic Alliances

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A long-term partnership between two or


more business entities established to help
each other to build competitive market
advantages.

To reach their individual but


complementary goals, these outfits
normally share ideas, expertise, resources,
technologies, investment tools, risk,
management as well as profits.

6. Franchising

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A system where companies


(franchisee) are granted the right
to operate a business according
to a special contract with parent
organization. (franchiser).

Eg: McD, Pizza Hut, Secret


Recipe.

7. Joint venture

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An agreement between two or


more parties to invent in a single
business or property.

In a joint venture both parties


would agree to create a new entity
by contributing in terms of equity,
revenues, expenses and control of
enterprise would be shared.