Fascinating economy

Imagine that you own a small bakery. You manage to sell enough cakes, rills, and doughnuts so that your revenues are greater than your costs. You can pay the rent, buy supplies, and pay your employees, and still earn a profit at the end of each month.

But what if your rent goes up? To break even at the end of the month, you increase the price of your goods. In this case, your revenues are equal to your costs. You are not making a profit, but you can continue with your business.

If you want to continue making a profit at the end of the month, you have to increase the price of your goods even more. Unfortunately, your customers might choose to stop buying your baked goods. In this case, you experience an economic loss because your costs are greater than your revenues.

The profit motive drives businesses to do two things:

– Reduce costs whenever possible

– Increase sales whenever possible

Inputs and Outputs

Profit is revenue minus cost. Simple. But what brings in revenue? And what counts as cost?

Revenue is all of the money a business brings in by selling its goods and services. In other words, it is the money derived from its output. For a business to have output, it needs input.

Inputs are what go into production. They can include the land, labor, and capital that are needed to produce any good or service.

Inputs cost money such as wages for workers, rent for land or capital for raw materials and equipment. They involve monetary costs for businesses. A producer’s costs account for all of the inputs necessary for production.

Opportunity Costs

Because profit dominates a producer’s thinking, businesses have to pay close attention to inputs and outputs. This involves making rational production decisions.

Consumers consider opportunity costs to make rational decisions. Businesses do the same. Remember that this is the cost of opportunities that are passed up when deciding to do one thing instead of another.

Business decisions about opportunity costs involve determining inputs and outputs. For example, if you have decided to open a bicycle factory, you have to decide what kinds of bicycles to make. You also have to decide what to use to make your bikes. Say you decide to make aluminum mountain bikes. The opportunity cost of that decision is what you could earn making steel mountain bikes, aluminum children’s bikes, or any of the various combinations available.

Production Possibilities Frontier

Businesses do not just try to guess about opportunity costs. Guesses are often wrong, and wrong answers lead to losses, not profits. Producers need a better tool of analysis. One tool is the production possibilities frontier, also known as the PPF.

A production possibilities frontier is a graph that shows producers how to set up production in an efficient manner. Efficient production allows a producer to maximize profit.

Production Possibilities Frontier

Businesses do not just try to guess about opportunity costs. Guesses are often wrong, and wrong answers lead to losses, not profits. Producers need a better tool of analysis. One tool is the production possibilities frontier, also known as the PPF.

A production possibilities frontier is a graph that shows producers how to set up production in an efficient manner. Efficient production allows a producer to maximize profit.

Working With the PPF

This graph represents the PPF of a bicycle-making business. The red line shows how many of each bike can be made with the inputs available, such as workers, aluminum, plastic, and other supplies in the factory. The points A, B, and C represent the points at which production of mountain bikes and racing bikes is the most efficient.

This table shows when production is the most efficient. Points A, B, and C show some of the many possibilities of producing bicycles where production is maximized. A maximum of 150 racing bikes and 200 mountain bikes can be produced given the set of inputs available.

Let us a look at that PPF graph again for an example of inefficient production. Point X shows an inefficient use of inputs. By making only 100 of each bike, the available workers and materials are not being used efficiently. No producer would want to choose a level of output that falls below the PPF. As long as the points of production stay on the red line, production is maximized.

How can you decide whether A, B, or C – or any other point on the PPF – is the best one? They are all equally efficient. However, unless mountain bikes and racing bikes sell for the same amount, one decision could lead to more revenue than another. To make a fully rational decision, the prices for each bike must be taken into consideration. The PPF cannot predict price so its usefulness is limited, but it is

still an important tool for creating efficient production.

Market Research

The PPF shows a producer how to maximize efficiency, but there is more to making a rational decision than efficiency. Getting the most output from your inputs – productive efficiency – gives you the possibility of maximum revenue with minimum cost.

Consider the previous example. The PPF tells us that any of the three mixes of production will be efficient.

But which one will generate the greatest revenue? Rational choice always requires information. To get this kind of information, producers do market research.

Producers can decide which type of efficient production will also be profit-maximizing production by

– Researching the price of competing goods in the market.

– Finding out what consumers are willing to pay.

– Determining whether consumers want or need what is being offered.

Getting the Profit Motive

Profits drive producers. After all, making a profit is the reason people start a business in the first place. Producers make decisions that are aimed at maximizing efficiency and profits. Making these decisions requires a lot of information about production and the potential market.

In a free-market system, producers are free to make decisions. This freedom creates competition among businesses as they pursue the same goal of selling goods or services.

A typical example of competition is the long-running contest between soda products Coca-Cola and Pepsi. The two companies that produce these popular beverages have engaged in direct competition with each other for over 100 years. Of course, there are lots of other drinks available, too, and Coke and Pepsi compete against all the available options for the biggest share of the multibillion dollar soda market.

Businesses want as big a share as possible in order to maximize profit. They clash in the free market to get consumers to purchase their goods and services instead of those offered by their rivals. Competition pushes businesses to be as efficient as possible so they can offer the lowest prices. It also drives them to develop new products and services in order to keep attracting new customers.

In a free-market system, producers are free to make decisions. This freedom creates competition among businesses as they pursue the same goal of selling goods or services.

A typical example of competition is the long-running contest between soda products Coca-Cola and Pepsi. The two companies that produce these popular beverages have engaged in direct competition with each other for over 100 years. Of course, there are lots of other drinks available, too, and Coke and Pepsi compete against all the available options for the biggest share of the multibillion dollar soda market.

Businesses want as big a share as possible in order to maximize profit. They clash in the free market to get consumers to purchase their goods and services instead of those offered by their rivals. Competition pushes businesses to be as efficient as possible so they can offer the lowest prices. It also drives them to develop new products and services in order to keep attracting new customers.

What Kind of Competition?

Competition is a clash of rivals pursuing the same goal, but not all competitions are the same. The way rivals compete depends on their goals and the number of competitors.

In a football game, for instance, two teams compete to score the most points. In a 100-meter race, on the other hand, there might be as many as nine runners competing against each other, and also the clock. While there is no victory for finishing in second place in a football game, in a foot race there is. You may not be the very fastest if you place second or even third, but you have beaten many competitors.

Businesses compete to make as much profit as possible. The amount of profit they can make depends on the kind of competition they face. The nature of competition faced by different businesses in different markets is known as the market structure.

Different markets are like different sports. The nature of the competition depends on the number of competitors. The competitors are always trying to maximize revenue and profit, but the number of other businesses selling the same things varies.

Economic competition comes in two different types: competition among the few and competition among the many. In a market with only a few producers making a specific thing, each producer has some control over the price. The distinction between a few producers and many producers tells us about the basic market structure.

But we can be even more specific about the types of competition. One extreme type of market structure is called a monopoly. When only a single producer sells a good or service, there is no competition at all. That is a monopoly. In a monopoly, the consumer is stuck with whatever decisions the producer makes, because there is no rival product to choose.

Oligopoly is another market structure characterized by few sellers. There are more producers than in a monopoly, but the range of businesses is very limited, and consumers have to choose from a short list of providers. Oligopoly offers some competition, but producers do not have to worry very much about competition.

At the other end of the spectrum of market structures is pure competition. In a purely competitive market, there are numerous businesses, and there is a wide variety of products sold. In a purely competitive market, consumers have a wide range of choices, and producers have to find ways to beat out their rivals. All this competition results in a lot of innovation, incentives to be efficient, and lower prices.

Pure Competition

The market structure that works best for consumers is pure competition. Pure competition is an ideal market structure that does not actually exist anywhere in the real world. We can, however, use pure competition as a standard for analyzing the market structures that do exist.

A purely competitive market has

– A large number of small businesses.

– Identical or easily substituted products.

– Freedom of entry into and exit out of the industry.

– Perfect knowledge of prices and technology.

Even though pure competition does not actually exist in the real world, there are places where it is close. The company eBay, an online retailer, created a marketplace on the Internet that functions with a market structure that comes quite close to pure competition.

Consumers can buy almost anything on eBay in a pure competition market structure. Pure competition exists when identical products are sold.

The sellers or producers on eBay set a minimum price for their goods. The consumer can then bid for the goods of his or her choosing. In this case, we have pure competition because everyone has perfect knowledge of the prices set.

Monopoly

Pure competition and monopoly are two extreme types of market structure.

While pure competition allows for perfect competition among a large number of sellers, a monopoly creates a total lack of competition. The monopoly has complete control over its market. This gives the producer complete control over what products to provide and what prices to charge.

The characteristics of a monopoly are

– A single producer.

– A unique product with no close substitutes.

– A price controlled by the producer.

– Entry is blocked to competitors.

The Near Monopoly

A pure monopoly is nearly as rare as pure competition. Most actual monopolies, such as a city’s utility provider, are heavily regulated by the government.

But there are some companies that control a particular market so thoroughly that they come close to creating a monopoly.

Microsoft is one of these near monopolies. While Microsoft is not a monopoly by definition – Apple also creates operating-system software – Microsoft dominates the market so effectively that it has been accused of acting like a monopoly.

The Microsoft Monopoly

Bill Gates and his company Microsoft control the market when it comes to operating systems, such as Windows 95, Office 2003, and other software applications.

Did you know that 90% of the world’s personal computers run on Microsoft software from the minute they are turned on? Microsoft has managed to automatically set up its operating systems in most computers being sold in the world. It has a monopoly, because its products are unique, and its rivals cannot compete against it. Microsoft is also able to control the price of its operating systems because there are no similar products on the market.

In 1998, a court case was filed against Microsoft Corporation. Microsoft rivals accused Microsoft of abusing its monopoly in the way it sold its operating systems and web browsers. The main issue was whether Microsoft was allowed to sell its Internet Explorer web browser software with its Microsoft Windows operating system.

Many technology companies have fought legally against Microsoft’s monopoly, including Apple Computer, Netscape, and Sun Microsystems. However, Microsoft still holds the majority of the market of operating software. It has the monopoly, because it has blocked the entry or has made it very difficult for competitors to enter the same market.

Monopolistic Competition

Monopolistic competition is a market structure that includes many producers providing products or services that are almost the same, but not quite identical.

A market structure of this sort allows some price control. But businesses generally accept the prices charged by rivals, ignoring the impact of their own costs. Monopolistic competition resembles pure competition except that different producers are selling similar products.

Oligopoly

In a system of monopolistic competition, there are a large number of small businesses. In an oligopoly, there are a small number of large businesses dominating a particular market. Businesses keep a close eye on the decisions made by the few other businesses in the industry.

Because there is not much competition, businesses in this type of market do not change prices often. In order to attract customers away from the small number of competitors they face, businesses in an oligopoly offer incentives, including bonuses and rebates.

The characteristics of an oligopoly are

– An industry dominated by a small number of large businesses.

– Businesses sell either identical or slightly differentiated products.

– Businesses give incentives instead of changing prices.

– Significant barriers exist to enter industry.

Oligopoly Models

Oligopoly is a common market structure because many industries are difficult to break into. Anyone can open a lemonade stand with just a few dollars, but it takes millions and millions to build and operate a car factory. As a result, lemonade is a pretty competitive market, while the automobile industry is an oligopoly.

The automobile industry is considered an oligopoly because it is dominated by a small number of large companies. These companies all sell similar cars, such as four-door sedans, minivans, and SUVs.

Another good example of an oligopoly is the airline industry. This industry is dominated by a small number of large companies. These businesses offer their customers similar products. However, certain airlines go to certain cities, while others do not. Airline companies also have incentives to attract customers, such as ticket upgrades or free air miles.

Considering Competition

Businesses compete with each other as they pursue the profit motive, but they take into account the type of competition they face before they make decisions.

The four different market structures you have examined show the differences between the competitive situations faced by producers operating in different markets.

Remember that the level of competition varies depending on the number and size of competitors, the type and quality of their products and services, and their degree of market control over price.

The continuum of market structures

Market Structure Review

From the largest corporation to the humblest small business, participating successfully in the free-market system requires a good plan, lots of determination, and the willingness to take some risks. A person who starts a new business is a risk taker. We call these people entrepreneurs. An entrepreneur is an individual who begins, manages, and bears the risks of a business.

Entrepreneurs play an important role in economics by offering consumers new ideas, new products, or new services. They compete in existing markets and sometimes create entirely new markets. Entrepreneurship is difficult and risky because many new businesses fail. But when successful, entrepreneurship contributes to the growth and prosperity of the overall free-market economy. Entrepreneurs create jobs and encourage a greater exchange of goods and services.

An Entrepreneur’s Motivation

There are many reasons why entrepreneurs decide to start a business. Henry Ford wanted to produce cars more efficiently; Oprah Winfrey wanted to help people make their lives better; Steve Jobs wanted to provide customers with user-friendly personal computers and new entertainment ideas. These are just three examples of innovative and successful entrepreneurs. Entrepreneurs often share common motivations. The also share common characteristics.

Motivations and Characteristics of Entrepreneurs

– Autonomy: Entrepreneurs like to work for themselves.

– Profits: Entrepreneurs are driven by their quest for profits. Successful entrepreneurs can create wealth rapidly.

– Risk: Entrepreneurs have a low level of risk aversion, since investing money in their own businesses is very risky.

– Innovation: Entrepreneurs need innovation in the product, service, or business process in order to be successful.

Innovation

One key to becoming a successful entrepreneur is innovation. The development of new devices, ideas, or ways of doing things helps entrepreneurs sell more goods or provide more services. Innovation is how businesses create new solutions to satisfy their customers’ needs and wants. Innovation includes the creation of more effective products, systems, services, or technology.

Entrepreneurs’ Innovations

Entrepreneurs innovate by creating

– New products.

– New production methods.

– New markets.

– New sources of supply.

The Innovation Game

Entrepreneurs innovate by introducing new means of production, new products, and new forms of organization. Innovations consist of inventions, discoveries, and new methods of production. Sometimes, innovations can change the entire economy.

One of the biggest business sectors in the world is the media industry. The media provide a service that nearly every person consumes in one way or another.

Because the media are a part of nearly every consumer’s life, they are important to producers. Businesses use the media to advertise their message to potential customers. Almost every business relies on the media in some way to stay in business.

Unlike some businesses with a specialized customer base, media companies can sell to everyone – consumers and producers alike.

If a satellite turns in the desert and there is no one there to see it, does it still reach thousands of viewers?

Advertising Dollars

Media companies can make money by selling magazines, newspapers, televisions subscriptions, Internet services, and more directly to consumers. But for most media companies, the bulk of their profits come from selling advertisements. In fact, the mass media and news media make 90 percent of their revenues from advertising. If it were not for advertising, most media companies would not exist.

Businesses spend a lot of money on advertising. In 2012, companies spent more than $152 billion on advertising in the United States and more than $490 billion worldwide.

What Advertisers Are Buying

Advertisers pay a lot of money to media companies, but what exactly are they buying? In one sense, they are simply purchasing time or space: ink on a page, pixels on a screen, or 30 seconds of time. But what advertisers are really paying for is the audience – viewers, listeners, readers, browsers, or whoever might be exposed to the ads. Advertising is all about buying access to an audience.

Media companies provide content – shows, articles, information – to attract an audience so that they can turn around and sell that audience to advertisers. In the world of the media, the consumers are also the product.

How Visible Is It?

Because they pay high prices to advertise their goods and services, businesses want as many people as possible to see their ads. Visibility is an important measurement.

Businesses try to advertise in places where they feel they will have high visibility in front of a large audience.

Visibility is determined by a few factors. One is the size of the advertisement. A full-page image attracts more attention than a half-page image, so a full-page advertisement costs more. A one-minute commercial is more expensive than a 30-second commercial because it has greater visibility.

Another important factor is popularity. Popularity determines the rate for a specific amount of advertising space. If a lot of people read a particular magazine, then a full-page ad will be expensive. If only a few people read it, that same page will be much less expensive.

Expensive Advertising Slots

The Super Bowl regularly has the most expensive advertising on television. A 30-second commercial during Super Bowl XLI costs $2.4 million – that is $80,000 per second. Because of the high cost and high visibility of these ads, advertisers often use the Super Bowl to show innovative or unusual commercials or to launch new ad campaigns.

The Olympics is another sporting event with high visibility. Ad rates vary depending on the time of day, but the average cost of a 30-second commercial during the 2006 Olympics was $700,000. That is a lot less than a Super Bowl ad, but NBC made a total of $900 million selling ads during that Olympics.

Popular TV series also command high ad rates. American Idol, one of the top-rated shows in recent years, charges as much as $700,000 for a single 30-second commercial. The same 30-second ad on CSI costs only $465,000. Survivor and The Apprentice each get $350,000 for a 30-second spot. As ratings drop, ad rates drop, too. ER charged $440,000 for a 30-second commercial in 2004, but its ratings went down the following year, so the rates went down to $400,000.

Measuring the Audience

The cost of advertising depends on the size of the audience and the size of the advertisement. The bigger the audience, the more it will cost a business to advertise to that audience. Advertisers buy access to the audience’s attention, and more audience members means more sales, which means more money.

But how can advertisers know how big the audience is going to be?

What is the Medium?

The method of measurement of the audience size depends on the medium. It is easy to measure consumers on the Internet. A Web page can count the number of times a page has been viewed.

In other forms of media, the count needs to be estimated. For print sources, circulation counts the number of magazines or newspapers that are printed and distributed. Not every magazine or newspaper will actually get read by somebody, and some will get read more than once. However, circulation is still a pretty good measurement of the size of the potential audience. For TV and radio, audience size is measured by a ratings system.

Advertising Outlets

Media companies are not limited to a single way of selling advertisements. In fact, the more ways they can sell ads, the more money they can make. Most media companies use a variety of methods to advertise.

Magazines and newspapers, for instance, have traditionally sold advertising to raise revenues while also charging subscription fees to people who receive the publication in the mail. With the advent of the Internet, many magazines and newspapers have continued to enjoy advertising revenues but have struggled to find ways to charge subscription fees, because so many websites are available for free.

American Media

People get the information they need to make decisions primarily from the media. People watch TV, browse the Internet, read newspapers and magazines, and listen to the radio. What they see, read, and hear affects how they think and choose.

There are thousands of media sources for people to choose from, but a large number are owned by a few large companies. These companies are known as media conglomerates. Their dominance of the media industry creates a market structure that closely resembles an oligopoly because a few large companies control nearly all the media industry.

Global Media Giants

The centralized global media system is a very recent development. Until the 1980s, the basic broadcasting systems and newspaper industries were domestically owned and regulated. Starting in the 1980s, the U.S. government, along with its Federal Communications Commission (FCC), began to deregulate, or remove the legal restrictions that had been in place on media and communication systems.

With the rise of satellite and digital technologies, deregulation resulted in the success of global media giants. There are only a few global media giants today.

The Internet Media Revolution

The Internet operates differently from other forms of media. Because it is relatively easy and inexpensive to build an Internet site, it is easy for many different producers to have an Internet presence.

Millions of people contribute to the information available on the Internet. The popularity of blogging, instant messaging, and social media sites means that more and more people get their information and entertainment from sources that are not controlled by large media companies.

Despite the possibilities of the Internet, many of the most popular websites today belong to large media conglomerates. While it may always remain inexpensive to put information on the Internet, the most popular websites will likely come from large global corporations.

The Business of Media Review

Media companies are unique types of producers. They create content for people to consume, but these consumers are themselves something that is sold to other producers who buy advertisements.

Media companies play an important role in the game of economics. They provide information that affects the decisions of consumers, and they provide advertising services that nearly every producer needs to purchase.

People start new businesses every day. It requires a lot of planning and organizing, not to mention hard work and determination. It also takes money. Potential business owners can use their own money. They can borrow it from the bank, take on a business partner, or have a third party, sometimes called a venture capitalist, invest what it takes to open for business.

There are many kinds of businesses. Some businesses only have one owner. Others have multiple partners who own the company together. In the end, all businesses try to accomplish the same goals: providing goods and services to satisfy the needs and wants of consumers.

The first thing any aspiring business owner has to do is decide which goods or services to offer for sale. The variety of goods and services available from businesses is wide, and new entrepreneurs are always trying to come up with new ideas about what to sell and how to sell it.

Sole Proprietorships

One way to start a business is to operate alone, with little or no help from anyone else. This kind of business is called a sole proprietorship. The owner of a sole proprietorship is completely in charge of the operation of the business. If there are other employees, the owner is the boss. The owner receives all the profits but also bears all the financial risks (that is, the losses).

Many entrepreneurs prefer to open a new business as a sole proprietorship. It is the most common type of business, and it is also the easiest type to build. Almost all small businesses are sole proprietorships. Many medium-sized businesses and large businesses begin as sole proprietorships but grow with success and add partners and investors.

The Risks and Rewards of a Sole Proprietorship

With a sole proprietorship, a business is much like an extension of the business owners. It has no separate existence.

There are many benefits to a sole proprietorship. For instance, business owners can make their own decisions without having to consult other people.

Another advantage is that business owner pay personal income taxes, not corporate taxes, on profits. This makes accounting much simpler. And, of course, business owners also get to keep all the profits.

But there are also downsides. A sole proprietor has unlimited liability. That means that the business owner is responsible for all the debts and financial losses of the business. If the business fails, the owner can lose all assets. This includes not just business assets like equipment and supplies, but also personal assets like real estate and savings.

Sole proprietors also need to have enough money to start the business in the first place. Some potential business owners borrow money from a bank to start a company, but this is risky because of unlimited liability. The bank can collect personal assets if an owner defaults on a small-business loan.

Partnerships