Chapter Two
Economics: The Framework for Business

Review Questions

1. How did the global economic crisis unfold?

The economy changed for the worst when the dot.com bubble burst in 2000, and 9/11 terrorist attacks happened in 2001.

2. What steps did the Federal government and the Federal Reserve take to mitigate the crisis?

They decreased interest rates, and subprime mortgage came into play. They seized a few companies that controlled a lot of the mortgage. The congress passed a bill on dollar bailout plan. As the new administration began Obama passed a 825 billion dollar bailout plan.

3. Compare and contrast microeconomics and macroeconomics. How do the two approaches interrelate? Use a specific example to explain.

Macroeconomics is the study of a country’s overall economic issues such as performance, structure, behavior, decisions making, and study rates. Microeconomics focuses on smaller economic units such as individual consumers, families and businesses. They can affect how much and what you can buy for your family.

4. What is the difference between fiscal and monetary policy? What role does politics play in shaping these policies?

Fiscal policies refer to government efforts to influence the economy through taxation without representation and spending decisions that are designed to encourage growth. Monetary policies refer to actions that shape the economy by influencing interest rates and the supply of money. Politics plays a role by making taxes higher and by influencing interest rates.

5. What are the fundamental elements of the free market economic system? How can businesses thrive within this system?

The fundamental elements are rights to own a business and keep after tax profits, the right to private property, the right to free choice, and the right to fair competition. They can profit from these by getting extra money after taxes by owning their own property, and some freedom to do what they like.

6. Describe the difference between a monopolistic competition and a monopoly.

A monopoly is when a single company owns all or the majority of the market for a product or service sold. A monopolistic market is one where there are large number of buyers but a very few number of sellers.

7. Why does quantity supplied tend to increase when prices go up and decrease when prices go down? Why does quantity demanded move in the opposite direction?

Because if there isn’t any competition customers will by it. If there is competition the prices have to go down to sell it and there isn’t as many because other business are making money to and they may not want to over stock. Because there is something competition and sometimes there isn’t.

8. Describe the key principles of socialist and communist economic systems. Does more government control mean less economic opportunity? Why or why not?

The government should own and operate key enterprises that directly affect public welfare such as utilities and health care. Free heath care system that calls for public ownership of virtually all enterprises. The communist manifesto. Yes, it calls for less economic opportunity for example they can control how much health care one could get.

9. Why do most countries have neither “pure” market nor “pure” planned economies? Is the trend toward the market end of the spectrum likely to continue? Why?

Because, it would make insufficient provision for the old, the young, the sick, and the environment. A pure planned economy would not create enough value to support its people over the long term. Yes, so corruption can be cut down and so economic rights can be protected.

10. How do gross domestic product, the employment rate, and the inflation rate relate to the business cycle? Why is it difficult to predict changes in the business cycle?

Because, they are all always changing. It is difficult to predict changes in the business cycle because there are always changes going on whether they are for the good or the bad.

Application Questions

1. Research four industries—past or present—that represent the four degrees of competition (pure competition, monopolistic competition, oligopoly, and monopoly). For each example, describe the industry, explain how it came to embody that type of competition, and describe how difficult it would be for an entrepreneur to enter the industry. Finally, provide your opinion regarding whether certain industries are better suited to certain degrees of competition, or if all industries should strive toward one single type of competition in particular.

2. Over the last decade, a number of agricultural producers have broken free of pure competition, creating a meaningful difference—and commanding higher prices—for entire categories such as hormone-free milk and organic produce, and for individual brands such as Dole pineapples and Chiquita bananas. But many agricultural products remain undifferentiated. Examples include watermelons, carrots, and pears. Choose one example and develop a strategy to differentiate that product in the minds of consumers. Present your strategy to the class, and ask if they would be willing to pay extra for it. Why or why not?

3. How does America’s economic system affect your day-to-day life? How would your life be different if you lived under socialism or communism? How would it be different if you lived under a purely free market system?

4. Major events in our country tend to have significant economic consequences. Consider the following events, and determine the likely impact of each on the five measures of economic performance discussed in the book (gross domestic product, employment, the business cycle, price levels, and productivity): • The Hurricane Sandy aftermath • The influx of illegal immigrants in the U.S. • The subprime mortgage crisis

5. With the current size of the U.S. federal debt, you might think that it has been around forever, but the outsized federal debt is actually a fairly recent phenomenon. Use the Internet to research the history of the federal debt. What triggered the periods of growth and decline? How do you think the federal debt will affect you? Do you believe it will ever go down to zero? Why or why not?

Team Project

You are the governing council of a small but happy nation. Your country has a stable economy, a sustainable soybean industry, and a sizable army. You are on good terms with your four neighbors to the north, east, west, and south, but if you asked any favors of them, they would certainly want something in return.

Without warning, your neighbor to the west (and closest trading partner) collapsed under the weight of an economic crisis and fell into a state of anarchy. Its government has disappeared, its money is worthless, and its people are starving. If you can no longer trade with this neighbor, there’s a chance that your country will face an economic crisis of its own. If you provide too much aid, however, your own people will starve and your neighbor will come to rely on you. If you do nothing, you face the ire of a failed state with nothing to lose. Your people don’t have much to give, and they fear that economic ruin is just around the corner.

As a group, determine a creative path forward—what fiscal and/or monetary policies will you enact to sustain your own economy while dealing with your former trading partner? Create a list of action items, and write a brief narrative detailing how you expect your plan to play out. Share your decisions with the class, and discuss the similarities and differences in your action plans.

Case Connection

The Consumer Financial Protection Bureau: Too Far, or Not Far Enough?

Recall from the chapter that during the economic crisis of the late 2000s, subprime mortgages were sliced up and resold as specialized securities. As more and more households went upside-down, an estimated $2 trillion worth of these assets became toxic. The banks and investment houses that held these toxic assets could not sell them for even a fraction of their original worth, pushing those companies further into economic turmoil. As the crisis worsened and panic set in, some institutions took advantage of the lack of regulation and governmental oversight in the industry, selling these toxic assets to unsuspecting buyers as if they still held value.

Many of the participants in these schemes were eventually exposed, leading to a number of high profile, high stakes lawsuits. In October 2012, for example, federal prosecutors filed a $1 billion suit against Bank of America for knowingly committing mortgage fraud from 2007 to 2009. The discovery of rampant fraud in the financial sector also led to the creation of the Consumer Financial Protection Bureau (CFPB), a new federal agency tasked with regulating banks, payday lenders, and other financial services companies.

First proposed by Massachusetts Senator Elizabeth Warren in 2007 and signed into law in 2010, the CFPB proved a hot-button political issue from the moment it was announced. Lauded by consumer advocates eager for protection and loathed by Wall Street bankers who felt they were being unfairly punished, the CFPB captivated media attention as politicians debated the agency’s organizational structure. A congressional blockade forced President Barack Obama to skip over Warren as the agency’s first director, instead choosing Ohio Attorney General Richard Cordray in a controversial pro-forma recess appointment.

The CFPB’s core functions include writing and enforcing federal regulatory laws, restricting practices that it deems unfair or abusive, promoting financial education, and processing consumer complaints. Much of the controversy surrounding the agency revolves around its power to regulate business practices. In the first three months of 2013, for example, the CFPB issued 10 new regulations regarding credit card fees, automated teller machine (ATM) fee disclosures, and more. While some believe the CFPB is crucial to avoiding another economic crisis, others believe that the agency oversteps its bounds and stifles innovation.

Those who believe the CFPB should be allowed to maintain—even extend—its regulatory powers make the following points:

• Weighing the positive aspects of the agency, the Economist’s Schumpeter blog suggests that the financial sector has long eluded regulation thanks to weak, ineffective legislation. The CFPB is agile, powerful, and aggressive enough to contend with a deceitful industry that has operated under its own rules for too long.

• When you buy a new car, fresh produce, or ibuprofen, you can safely assume that the product has undergone rigorous testing to ensure that it is safe. When it comes to buying a mortgage or a credit card, however, you must rely solely on the word of the company trying to sell you the product. The CFPB serves as an independent advocate for the safety of individual consumers, says TIME’s Michael Grunwald.

• The CFPB can restrict the practices that led to the Great Recession, and perhaps even prevent the next economic crisis. To this end, consumer advocacy group Consumer Action contends, “To prevent another bailout, we need to extend the government's resolution authority – currently limited to FDIC-insured banks – to cover non-bank financial companies, as well.”

However, those who want to abolish the CFPB (or at least substantially limit its power) make several compelling counterpoints:

• Weighing the negative aspects of the agency, the Economist’s Schumpeter blog suggests that the CFPB is far too large. A financial firm might be sued by one wing of the agency for providing a financial product to a segment of the population, and sued by another wing for not providing that same product to the same segment of the population. Thus, the column argues, the CFPD is destined to devolve into a prosecutorial bureaucracy.

• According to CBS’s Marlys Harris, the CFPB will threaten the health of banks that provide financing for businesses, stifling job creation and innovation. By regulating the banking sector’s most profitable products and services, the CFPB will force banks to be more conservative with their money, making them less likely to grant loans to entrepreneurs and small businesses.

• The United States Congress has a constitutional right to oversee agency budgets. However, the CFPB’s funding comes directly from the Federal Reserve, sidestepping congressional approval. Without a congressional check on CFPB spending, economist George Will argues that the agency is answerable to no one—and may even be unconstitutional.

You Decide:

• In your opinion, is the Consumer Financial Protection Bureau necessary? Should its powers be extended, abridged, maintained, or abolished? Explain, citing the arguments you think are the most relevant to support your position.

• In Chapter 1, you learned that business moves at breakneck speeds. On balance, do you believe that the Consumer Financial Protection Bureau will have an effect on change in the financial industry? Will it affect the U.S. economy as a whole? Explain.

• How did the economic crisis of the late 2000s affect the United States’ overall economic environment? How does the Consumer Financial Protection Bureau fit into that environment? Use the chapter text to support your answer.

Sources: “U.S. Accuses Bank of America of a ‘Brazen’ Mortgage Fraud,” by Ben Protess, New York Times website: http://dealbook.nytimes.com/2012/10/24/federal-prosecutors-sue-bank-of-america-over-mortgage-program; “Interview: Richard Cordray: Consumer Finance Protection Bureau,” PBS website: http://www.pbs.org/wnet/need-to-know/economy/interview-richard-cordray-consumer-finance-protection-bureau/16774; “Treasury Unveils Plan to Buy Troubled Assets,” NBC News website: http://www.nbcnews.com/id/29817617/ns/business-stocks_and_economy/t/treasury-unveils-plan-buy-troubled-assets; “About Us,” Consumer Finance Protection Bureau website: http://www.consumerfinance.gov/the-bureau; “Regulations,” Consumer Finance Protection Bureau website: http://www.consumerfinance.gov/regulations; “Blessing or Bureaucracy,” Economist website: http://www.economist.com/blogs/schumpeter/2012/01/consumer-financial-protection-bureau; “The Case Against the Consumer Financial Protection Bureau,” by Marlys Harris, CBS News website: http://www.cbsnews.com/8301-505145_162-38141193/the-case-against-the-consumer-financial-protection-bureau. “Answerable to No One,” by George F. Will, Washington Post website: http://www.washingtonpost.com/opinions/george-will-a-government-agency-answerable-to-no-one/2012/11/16/27a4f604-2f53-11e2-9f50-0308e1e75445_story.html