Economic Forces Affecting Business

In the United States and in other free-enterprise systems, the distribution of resources and products is determined by supply and demand. Demand is the number of goods and services that consumers are willing to buy at different prices at a specific time. It is the immediate driving force of the economy. On the other hand, supply is the number of products that businesses are willing to sell at different prices at a specific time. In other words, demand describes the behavior of buyers, whereas supply refers to the behavior of sellers. Consumers would buy more when the price is low and less when the price is high. Producers would offer more when the price is high and less when the price is low. The forces of supply and demand determine the market price for goods and services. The quantity of a product supplied and the quantity of a product demanded would continuously interact, and the balance between them at any given moment would be reflected by the current price on the open market. The price at which the supply of a product equals demand at a specific point in time is the equilibrium price. When prices are not so high as the equilibrium price, there is excess demand (shortage) raising the price. At prices above the equilibrium price, there is excess supply (surplus) reducing the price.

In a free-market economy, customers are free to buy whatever and wherever they please. Therefore, companies must compete with rivals for potential customers. Competition then is the rivalry among businesses for consumers’ dollars. Companies compete in one of three ways: price, quality, or innovation. In fact, evidence of price competition is everywhere you look. Southwest Airlines competes on price. It offers the lowest fares of any of its competitors. So does Dell Computer. Fast-food restaurants sell special meal deals at reduced prices, carmakers offer rebates and discounts. These are all examples of using price to gain a competitive advantage – something that sets you apart from your rivals and makes your product more attractive to customers. When markets become filled with competitors and products start to look alike, price often becomes a company’s key competitive weapon. Competing on price often leads to exhausting price wars and companies find ways to add unique value to their products so that they can compete on something other than price, such as quality or innovation.

Economies are not stagnant; they expand and contract. In reality, a nation’s economy tends to flow through various stages of a business cycle: expansion, recession, depression, and recovery. Economic expansion occurs when an economy is growing and people are spending more money. Their purchases stimulate the production of goods and services, which in turn stimulates employment. The standard of living rises because more people are employed and have money to spend. Rapid expansions of the economy, however, may result in inflation, a continuing rise in prices. Inflation can be harmful if individuals’ incomes do not increase at the same pace as rising prices, reducing their buying power.

Economic contraction occurs when spending declines. Contractions of the economy lead to recession – a decline in production, employment, and income. Recessions last for six months or longer. Recessions are often characterized by rising levels of unemployment, which is measured as the percentage of the population that wants to work but is unable to find jobs. Unemployment may become a major economic and social problem. A severe recession may turn into a depression, in which unemployment is very high, consumer spending is low, and business output is sharply reduced, such as occurred in the United States in the early 1930s. In the recovery stage, the economy begins to improve after having been weak.

Countries measure the state of their economies to determine whether they are expanding or contracting. One commonly used measure is gross domestic product (GDP) – the sum of all goods and services produced in a country during a year. GDP per capita is the total output of a particular country divided by the number of people living there. Table 2.1 describes some of the other ways we evaluate our nation’s economy.

Unit of Measure	Description
Trade balance	The difference between our exports and our imports. If the balance is negative, it is called a trade deficit and is viewed as unhealthy for our economy.
Consumer Price Index	Measures the monthly average change in prices of goods and services purchased by typical urban consumers.
Per capita income	Indicates the income level of “average” citizens. Shows how much money consumers spend and how much money they are earning.
Unemployment rate	Indicates how many working age citizens are not working who otherwise want to work
Inflation	Monitors price increases in consumer goods and services over specified periods of time. Used to determine if costs of goods and services are exceeding worker compensation over time.
Worker productivity	The amount of goods and services produced for each hour worked.

Exhibit 2.1 How Do We Evaluate Our Nation’s Economy?