Understanding Economic Systems and Business

Think about the many types of businesses you encounter daily: gas stations, fast-food chains, banks, and online stores. These organizations exist to meet your needs and those of other customers.

Businesses meet the needs of consumers by providing medical care, autos, and countless other goods and services. Goods are tangible items like laptops; services are intangible offerings like those from physicians, lawyers, hairstylists, car washes, and airlines.

Not every organization exists to make a profit. A not-for-profit organization exists to achieve some goal other than the usual business goal of profit. Charities such as Habitat for Humanity, the United Way, and the American Cancer Society are not-for-profits, as are most hospitals, zoos, arts organizations, civic groups, and religious organizations. Government is the largest not-for-profit group, and more than 1.5 million nongovernmental ones operate in the U.S., contributing over $900 billion annually to the economy.

Like for-profit businesses, not-for-profits set goals and need resources to meet them, but their goals aren't about profit—they might be feeding the poor, preserving the environment, increasing ballet attendance, or preventing drunk driving. They don't compete directly with each other the way Ford and Honda do, but they do compete for talented employees, people's limited volunteer time, and donations. The boundaries between the sectors have blurred: for-profit businesses now address social issues, and successful not-for-profits apply business principles to operate more effectively. Not-for-profit managers worry about the same things as for-profit managers: developing strategy, budgeting carefully, measuring performance, encouraging innovation, improving productivity, demonstrating accountability, and fostering an ethical workplace.

Businesses do not operate in a vacuum. They sit inside an external business environment—the outside organizations and forces that shape how they operate and whether they reach their goals. That environment splits into seven sectors: economic, political and legal, demographic, social, competitive, global, and technological. Each one throws its own challenges and opportunities at a business.

Every economy must answer three questions: what goods and services to produce, how to produce them, and for whom. These decisions are made by the marketplace, the government, or both. In the United States, the government and the free-market system together guide the economy.

The world's major economic systems fall into two broad categories: free market, or capitalism; and planned economies, which include communism and socialism. In reality, many countries use a mixed market system that incorporates elements from more than one economic system. The major differentiator among economic systems is whether the government or individuals decide how to allocate limited resources, what goods and services to produce, how and by whom they are produced, and how to distribute them to consumers.

Socialism is an economic system in which the basic industries are owned by the government or by the private sector under strong government control. A socialist state controls critical, large-scale industries such as transportation, communications, and utilities. Smaller businesses and those considered less critical, such as retail, may be privately owned. To varying degrees, the state also determines the goals of businesses, the prices and selection of goods, and the rights of workers.

Socialist countries typically provide their citizens with a higher level of services, such as health care and unemployment benefits, than do most capitalist countries. As a result, taxes and unemployment may also be higher in socialist countries. For example, in 2017, the top individual tax rate in France was 45 percent, compared to 39.6 percent in the United States.

Economics splits into two main subareas. Macroeconomics looks at the economy as a whole, using aggregate data for large groups of people, companies, or products. Microeconomics focuses on individual parts, like a single household or firm. Both offer valuable outlooks. For example, Ford deciding on a new vehicle line would weigh macroeconomic factors—national personal income, unemployment, interest rates, fuel costs, national sales of new vehicles—and microeconomic ones, such as consumer demand versus supply, competing models, labor and material costs, and current prices and incentives.

To see how the sectors interact, trace the circular flow of inputs and outputs among households, businesses, and governments. Households provide inputs—natural resources, labor, capital, entrepreneurship, knowledge—to businesses, which convert them into goods and services. In return, households receive income from rent, wages, interest, and ownership profits. Businesses receive revenue from consumer purchases. Governments supply publicly provided goods and services—highways, schools, police, courts, health services, unemployment insurance, social security—and receive taxes from households and businesses to complete the flow.

A key macroeconomic goal is full employment—having jobs for all who want to and can work. But full employment doesn't mean 100% employment. Some people choose not to work (to attend school or raise children), and others are temporarily between jobs. So the government defines full employment as the situation when about 94 to 96 percent of those available to work actually have jobs. During the 2007–2009 recession, the U.S. unemployment rate peaked at 10% in October 2009; today it hovers around 4%.

In the past, cyclical unemployment hit mainly less-skilled workers and those in heavy manufacturing, who were typically rehired when economic growth picked up. Since the 1990s, however, global competition has forced many American companies to downsize to survive, and these job cuts have affected workers in every category—including middle management and other salaried positions. Firms keep reevaluating their workforces to stay competitive against Asian, European, and other U.S. firms.

Seasonal unemployment is a separate type from cyclical unemployment. Retail workers hired for the holiday shopping season, lettuce pickers in California, and restaurant employees in ski country during the summer all face seasonal unemployment.

Inflation is not a single phenomenon. Economists distinguish two types based on what triggers the price rise.

To reach macroeconomic goals, countries must often choose among conflicting alternatives. Sometimes political needs override economic needs. For example, bringing inflation under control may call for a politically difficult period of high unemployment and low growth. Or, in an election year, politicians may resist raising taxes to curb inflation. Still, the government must try to guide the economy to a sound balance of growth, employment, and price stability. The two main tools it uses are monetary policy and fiscal policy.

In the United States, the Federal Reserve System (the Fed) is the central bank. It prints money and controls how much of it will be in circulation, and it also regulates certain bank activities. When the Fed increases or decreases the amount of money in circulation, it affects interest rates—the cost of borrowing money and the reward for lending it. The Fed can change the interest rate on money it lends to banks to signal the banking system and financial markets that it has changed its monetary policy. These changes have a ripple effect: banks may pass along the change to consumers and businesses that receive loans. If the cost of borrowing increases, the economy slows because interest rates affect decisions to spend or invest. The housing industry, business, and investments react most to changes in interest rates.

To cover a deficit, the government borrows money, just like a business or household. The accumulated total of all past deficits is the national debt. In 1998, the U.S. had a rare surplus of about $71 billion, but by 2005 the deficit exceeded $318 billion, and in fiscal year 2009 it hit an all-time high of over $1.413 trillion. By the end of 2015, the deficit had fallen to $438 billion, yet the national debt still amounted to about $19.8 trillion—about $61,072 per person—with total interest on the debt exceeding $2.5 trillion a year.

In a free market, consumers and businesses constantly make choices based on prices. Consumers want the best quality at the lowest price; businesses want to keep costs down and revenues high. These choices determine what gets produced and at what price.

For example, if Mexican food becomes popular, high demand attracts entrepreneurs who open more Mexican restaurants, competing on price, quality, or features.

Market structure describes the competitive environment of an industry, shaped by the number of firms and the barriers to entry. The spectrum runs from perfect competition to pure monopoly, with two structures in between.

The U.S. workforce now spans five generations, from recent college graduates to traditionalists in their 70s. Older workers bring experience, while younger workers tend to be experimental and open to risk.

Diversity and inclusion are becoming key corporate strategies. Women continue to make progress toward management, though fewer than 5 percent of Fortune 500 companies have female CEOs. The most successful organizations recognize diversity and inclusion as part of their ongoing strategy.