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Entrepreneurship: Why It Matters

Why learn about entrepreneurship? 

What do all of the following have in common?

The discovery of electricity and the invention of the light bulb have spawned countless other inventions

Walt Disney World is a premium vacation destination for families the world over

Virgin Atlantic has set the bar for efficient, convenient air travel

Electricity. Travel. Entertainment. These items play such commonplace roles in our daily lives we often take them for granted. But what if they were suddenly taken away? How many of your daily tasks could you accomplish without the illumination a light bulb provides? How limited would your personal and business activities become without the benefit of consumer air travel? Would your family vacation be the same without a visit to Cinderella’s Castle at Walt Disney World?

While the latter may not be the biggest loss for some, the conveniences each of these innovations enable have in common their origin in an entrepreneur’s willingness to take a risk and pursue a dream.

The fruits of entrepreneurs’ labors surround you every day. Did you use an iPhone today? Did you ask Google a question? Did you pick up lunch at Wendy’s? Stop by Walmart for batteries on the way home? Drop off your car for maintenance at your Ford dealership?

As consumers, we are the beneficiaries of the hard work, dedication, and fearlessness of the men and women who have taken the plunge and become entrepreneurs, and we are surrounded by the fruits of their labor. In this chapter, you’ll learn about some remarkable entrepreneurs as well as what it takes to launch your own business venture. Read on!

Licenses and Attributions

Entrepreneurship: Why It Matters  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Why It Matters: Entrepreneurship. Provided by: Lumen Learning and NGCC Team. License:  CC BY: Attribution

CC LICENSED CONTENT, SHARED PREVIOUSLY

· photograph of lightbulb. Authored by: Comfreak. Located at:  http://pixabay.com/en/light-bulb-current-light-glow-503881/ . License:  CC0: No Rights Reserved

· Photograph of aircraft. Authored by: Skeeze. Located at:  http://pixabay.com/en/airplane-aircraft-commercial-744861/ . License:  CC0: No Rights Reserved

· Photograph of CinderellasCastle. Authored by: bethgolz. Located at:  http://pixabay.com/en/disney-world-cinderella-s-castle-226618/ . License:  CC0: No Rights Reserved

Small Business

What you’ll learn to do: Discuss the contributions of small businesses to the U.S. economy

In this section you’ll discover some of the ways in which small businesses contribute to the U.S. economy, yielding results that aren’t small at all.

Small Businesses Are Essential to the Whole Economy

Small businesses are the engines that power most of this country’s economic activity

Learning Outcome

· Describe what small businesses are and explain their contributions to the US economy

What Is a Small Business?

So what makes a business “small”? The US Small Business Administration (SBA) has established two widely used standards determined by the number of people a business employed during the previous 12 months (a maximum of 500 for most manufacturing and mining industries), or a business’ average annual receipts during the previous three years ($7.5M or less for many non-manufacturing industries) (Beesley, 2014).

Businesses that go beyond these thresholds generally do not qualify as small businesses for most SBA and federal programs, although there are exceptions, depending on the industry. The SBA also stipulates that small businesses

· are organized for profit

· maintain a place of business in the United States

· operate primarily within the United States, or make a significant contribution to the US economy through the payment of taxes or the use of American products, materials, or labor

· are independently owned and operated

· are not dominant in their fields on a national basis     

Small Business Is Big Business

In many ways, America’s economy is built on small businesses. Consider the following:

· The 28 million small businesses in America account for 54 percent of all US sales.

· Small businesses currently provide 55 percent of all jobs, and they have provided 66 percent of all net new jobs since the 1970s.

· The 600,000+ franchised small businesses in the United States account for 40 percent of all retail sales and provide jobs for approximately 8 million people.

· The small business sector in the United States occupies 30 percent to 50 percent of all commercial space—an estimated 20 billion to 34 billion square feet.

And the small business sector is continuing to grow. In fact, the number of small businesses in the United States has increased 49 percent since 1982. While corporate America has been downsizing, the number of small business start-ups has grown, and the rate of small-business failure has declined.

Economic Contributions

Small businesses and entrepreneurs contribute to the larger economy in four distinct ways:

1. job creation

2. innovation

3. opportunities for financial success and independence

4. support for large businesses by providing component parts, services, and product distribution

Each of these contributions is critical to the overall economic growth and prosperity of the US economy.

Job Creation

Since 1990, as large businesses eliminated 4 million jobs, small businesses added 8 million more (Lou, 2014).

For example, in the first three quarters of 2014, small businesses added 1.4 million new jobs. Most recently, firms with 1 to 49 employees have contributed the most to job growth. The Bureau of Labor Statistics reports that firms of this size accounted for 39 percent of new jobs in the first three quarters of 2014, while ADP (a national payroll processing service) reported an even higher 44 percent during the same period. It’s clear that the economic recovery since the 2007-2009 recession, has, in large part, been fueled by small business growth.

Small Business Hiring Powers Economic Recovery

Small businesses are responsible for the lion’s share of hiring since the end of the 2007-2009 recession

In January 2015, Maria Contreras-Sweet of the US Small Business Association reported that “small businesses created nearly 2 million of the roughly 3 million private-sector jobs generated in 2014. More than 7 million of the 11 million jobs created during the recovery have been generated by start-ups and small enterprises. …Entrepreneurs have been our life preserver in this economic storm, because of their resilience in budgeting wisely and effectively deploying their capital.”

In a January 2015 report, Winslow Sargeant, Ph.D., Chief Counsel for Advocacy at the US Small Business Administration Office of Advocacy, stated:

“Innovation in the United States has been one of the driving forces in our development as one of the leading economies in the world. Innovations commercialized by US companies have also benefited our society by allowing us to attain prosperity and a good quality of life. While large corporations and the federal government play important roles in the development of innovative products and services, the story is incomplete without the significant contributions and role of individual entrepreneurs and small, agile, high-growth businesses in developing innovative products in the fields of science, technology, and engineering” (“Small Innovative Company Growth: Barriers, Best Practices, and Big Ideas,” 2010).

Innovation Means New Businesses

Small businesses in particular are leading the way when it comes to the innovative development of green technologies. For example, small innovative firms are 16 times more productive than large innovative firms in terms of patents per employee. In fact, small firms’ green technology patents are cited 2.5 times as often as large firms’ technologies in other patent applications, indicating that small firms’ patents are more original and influential. While four times as many large as small innovative firms have at least one green patent, small firms are more likely than larger ones to make green technology a core part of their business.

Of course, innovation is not confined to green technologies. A diverse array of the products and services we use on a daily basis are the result of innovations that took shape in small businesses.

Burt’s Bees: A Small Business That Went Big

Burt’s Bees, a mom-and-pop shop originally created to make and sell candles, evolved into a personal care company that sold for nearly $1 billion.

For example, Burt’s Bees is one of the biggest names in natural personal care products. But this multi-million-dollar enterprise had humble beginnings. In 1984, Burt Shavitz and Roxanne Quimby founded Burt’s Bees, a mom-and-pop candle company in Maine. At first, they manufactured candles by using excess beeswax from Shavitz’s honey business, working in an abandoned one-room schoolhouse.

In time, Quimby also began making homemade personal care products from wax and other natural ingredients. In 1991, Burt’s Bees incorporated, and the company started selling natural soap, perfume, and their now widely recognizable lip balm. In 2007, Shavitz and Quimby sold their company to Clorox for a reported $925 million.

Of course, sometimes small businesses can grow so much that, in addition to creating new products, they change our very behavior. When he founded Amazon—initially a small business—Jeff Bezos transformed the way we read books, watch movies, and shop for everyday household items.      

The following short video explains:

https://youtu.be/C8rGdwd03gg

Expanding Business Opportunities for Everyone

Increasingly, small business ownership is helping more women and minorities enter the economic mainstream. To be sure, the majority of small businesses are not owned by minorities. According to a 2016 study by Babson College, 72% of small business owners are men, 14% are Latino, 6% are black, and 6% are Asian. But recent decades have seen that imbalance getting smaller.

The SBA’s flagship 7(a) loan program, created to serve borrowers who face a capital opportunity gap, has successfully served more women- and minority-owned businesses than traditional lending programs. In 2008, the Urban Institute—a nonprofit research organization—wrote that the SBA’s 7(a) loans do a better job of reaching “credit-worthy women-owned firms, minority-owned firms, and start-up firms that do not meet standard small-business-lending underwriting standards as compared to other types of markets.”

From 2011 to 2016, the SBA 7(a) program increased lending to Hispanic-American small business owners by 65 percent, African-American small business owners by 45 percent, Asian-American small business owners by 44 percent, women small business owners by 34 percent, and veteran small businesses owners by 13 percent.

In 2016, the US Census Bureau released its inaugural Annual Survey of Entrepreneurs, which provides estimates of the number of employer firms by economic sector, gender, ethnicity, race, and veteran status. The survey found

· About one-third of firms in the accommodation and food services sector were minority owned.

· Among all firms in educational services, healthcare, and social assistance sectors, 28 percent were owned by women.

· About one-quarter (254,260) of all women-owned employer firms were minority owned. More than half (137,321) of these minority-women-owned firms were owned by Asians.

Demographic Characteristics of Business Owners, 2013
		Percentage of Owners
Age	Under 35 35 to 49 50 to 88	15.6 32.7 51.7
Gender	Male Female	64.6 35.4
Race	Non-Minority Minority	85.9 14.1
Education	High School or Less Some College Bachelor’s or Higher	28.0 32.8 39.2
Location	Metro Non-Metro Not Identified	79.1 16.7 4.2
Source: US Small Business Administration, Office of Advocacy. Source data from US Census Bureau, 2004 Survey of Income and Program Participation (SIPP), 2008 SIPP Wave 15 (2013 data).

Providing Essential Support to Larger Businesses

Small firms complement larger ones in a number of ways. For example, in many major industries, small businesses manufacture the component parts of larger products, which are then assembled by big-business name brands. This relationship was encouraged in a 2012 program that was part of the Obama administration’s American Supplier initiative.

As part of that program, IBM assembled a coalition of more than a dozen large companies that together typically spend $300 billion annually on goods and services provided by outside suppliers. The coalition encouraged small businesses to register online with the “Supplier Connection” to present themselves as potential suppliers to larger companies, which can use the connection to search for suppliers of specific goods and services.

Outsourcing is another service small businesses offer larger ones that must attend to so many details, they prefer to pay another firm to address some of them. Since smaller firms can provide fast, flexible, and cost-effective services, they are well situated to provide nonessential operations to large companies. Food service, accounting, customer service, and tech support are just a few examples of how small businesses meet the needs of larger companies.

Small businesses can also be effective distributors of the products manufactured by large corporations. From the local deli that sells Coca-Cola to the fashion boutique selling high-end handbags, these small retail businesses serve an essential role in the distributor/marketer/sales force.

Without a network of small retailers across the country, big business would have to establish a massive network of outlets and distribution chains to support those outlets. So when a small business opens in your hometown and starts sells brand-name clothing, computers, or sporting goods, they are fulfilling a critical role in the consumer market. Big business needs small business to survive.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade, and you can retake it as many times as you wish. Use this quiz to decide whether to study the section further or move on.

Choose the BEST answer.

Question 1

Small businesses are important to any economy. In the United States, small businesses have been credited with making significant contributions to the growth and prosperity of our economy. Identify one of the four ways in which small businesses can and have contributed to the US economy.

job creation

the leaders of production

limited innovation or creativity

Question 2

In determining the contribution of small businesses to the economy, four distinct reasons have been identified, one of which is innovation. Small business innovation has led to

greater competition between small and large companies

large companies becoming less innovative and going out of business

the invention of new products and the way we do things

Question 3

To qualify as a small business, the business

must be a corporation

may be a sole proprietorship, corporation, or any other legal form

must be a sole proprietorship

References

Babson College. (June 2016). The State of Small Business in America 2016. Retrieved from file:///C:/Users/bgabriel2/Downloads/goldman-10ksb-report-2016.pdf

Beesley, C. (October 20, 2014). How and Why to Determine if Your Business is ‘Small.’ U.S. Small Business Administration Blogs: Contracting. Retrieved from https://www.sba.gov/blogs/how-and-why-determine-if-your-business-small

Contreras-Sweet, M. (January 23, 2015). Small Businesses Create 2 Million Jobs. The Association of Mature American Citizens. Retrieved from https://amac.us/small-businesses-create-2-million-jobs/

Lou, S. (May 12, 2014.) 10 Stats That Show Why Small Businesses Rock. Thrive Hive. Retrieved from https://thrivehive.com/10-stats-that-show-why-small-businesses-rock/ 

U.S. Small Business Administration Office of Advocacy. (January 2010). Small Innovative Company Growth: Barriers, Best Practices, and Big Ideas. Retrieved from file:///C:/Users/bgabriel2/Downloads/FINAL_Innovation_Report.pdf

U.S. Small Business Association. (2017). SBA Accomplishments FY 2016. Retrieved from https://web.archive.org/web/20161115042530/https://www.sba.gov/about-sba/sba-performance/sba-accomplishments-fy-2016

U.S. Small Business Administration. (2016). SBA Lending Statistics for Major Programs as of 9-30-2016. Retrieved from file:///C:/Users/bgabriel2/Downloads/SBA_Lending_Statistics_for_Major_Programs_as_of_09-30-2016%20(1).pdf

The Urban Institute, prepared for the U.S. Small Business Administration. (January 2008). Competitive and Special Competitive Opportunity Gap Analysis of the 7(A) and 504 Programs. Retrieved from https://www.urban.org/research/publication/competitive-and-special-competitive-opportunity-gap-analysis-7a-and-504-programs/view/full_report

United States Census Bureau. (September 1, 2016). Nearly 1 in 10 Businesses With Employees Are New, According to Inaugural Annual Survey of Entrepreneurs. (Release Number CB16-148) Retrieved from https://www.census.gov/newsroom/press-releases/2016/cb16-148.html

Licenses and Attributions

Introduction to Small Business from Introduction to Business by Linda Williams and Lumen Learning is available under a Creative Commons Attribution 4.0 International license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Outcome: Small Business. Authored by: Linda Williams and Lumen Learning. License: CC BY: Attribution

Small Business from Introduction to Business by Linda Williams and Lumen Learning is available under a Creative Commons Attribution 4.0 International license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Revision and adaptation. Authored by: Linda Williams and Lumen Learning. License: CC BY: Attribution

· Check Your Understanding. Authored by: Lumen Learning. License: CC BY: Attribution

CC LICENSED CONTENT, SHARED PREVIOUSLY

· The Beginning of Amazon. Provided by: BBC. Located at: https://youtu.be/C8rGdwd03gg. License: CC BY-NC-ND: Attribution-NonCommercial-NoDerivatives

· OROX Grand Opening 8-1-13. Provided by: Portland Development Commission. Located at: https://www.flickr.com/photos/pdxdevelopmentcomm/9424725018/. License: CC BY-NC: Attribution-NonCommercial

· Authored by: WestportWiki. Located at: https://commons.wikimedia.org/wiki/File:Burt%27s_Bees_Hand_Salve,_Sep_2012.JPG. License: CC BY-SA: Attribution-ShareAlike

PUBLIC DOMAIN CONTENT

· Qualifying As a Small Business. Provided by: U.S. Small Business Administration. Located at: https://www.sba.gov/contracting/getting-started-contractor/qualifying-small-business. License: Public Domain: No Known Copyright

· Small Business Trends. Provided by: U.S. Small Business Administration. Located at: https://www.sba.gov/managing-business/running-business/energy-efficiency/sustainable-business-practices/small-business-trends. License: Public Domain: No Known Copyright

· Green Technology Innovation. Provided by: U.S. Small Business Administration. Located at: https://www.sba.gov/advocacy/small-businesses-lead-way-green-technology-innovation. License: Public Domain: No Known Copyright

· Nearly 1 in 10 Businesses With Employees Are New. Provided by: U.S. Census Bureau. Located at: https://www.census.gov/newsroom/press-releases/2016/cb16-148.html. License: Public Domain: No Known Copyright

· Demographic Characteristics of Business Owners and Employees: 2013. Provided by: Small Business Administration. Located at: https://www.sba.gov/sites/default/files/advocacy/Issue_Brief_6_Demographic_Characteristics_2013.pdf. License: Public Domain: No Known Copyright

Entrepreneurs

What you’ll learn to do: Identify the common traits of successful entrepreneurs

Entrepreneurs are the fuel that drive small businesses and, in turn, much of the US and the world’s economies. In this section you’ll learn how their creativity and willingness to take risks or follow their dreams have generated jobs, personal wealth, and national economic prosperity.

“An entrepreneur is an innovator, a job creator, a game-changer, a business leader, a disruptor, an adventurer.”—Sir Richard Branson

Learning Outcomes

· Define entrepreneur

· Identify the different categories of entrepreneurs

· Identify the common traits of successful entrepreneurs

· List common reasons for choosing to become an entrepreneur

What Is an Entrepreneur?

Entrepreneurs typically originate new ideas, services, and processes. They tend to have a knack for identifying unmet market needs and the corresponding business opportunities that will meet those needs. Their willingness to take risks makes them more likely to exploit the opportunities they find. Entrepreneurs head up their own businesses and oversee their operations, assuming all of the risks and rewards that may result from the venture, idea, or service they have created.

David Fox is one example.

As you’ll see in the following video, for this school teacher, board games aren’t just a hobby—they’re a way of life. David Fox travels to toy fairs pitching his ideas in hopes of landing a deal that will turn his big dreams into reality.

https://youtu.be/R8TTzUo8DwI

Types of Entrepreneurs

No two entrepreneurs are alike. Anyone with an entrepreneurial spirit who is willing to go out on a limb and assume the risk of starting a new business has unique reasons for doing so. That said, it is possible to generally classify entrepreneurs into the following broad categories: lifestyle entrepreneurs, social entrepreneurs, and serial entrepreneurs.

The Lifestyle Entrepreneur

The lifestyle entrepreneur creates or modifies a business to better his or her own lifestyle rather than to pursue profit. The entrepreneur’s own life—rather than his or her business—is the venture. These individuals want to lead fulfilling lives by cultivating their passions for their chosen activities. Unlike other entrepreneurs who create businesses in pursuit of financial gain, lifestyle entrepreneurs put their passions before profits by attempting to integrate their personal interests into their businesses.

Consider an attorney who puts in 80 hours of work a week for a multinational corporation and thus has little time for anything else. If this person is a lifestyle entrepreneur, he or she may choose to leave the corporate world behind to establish a small law practice in a rural town, enabling a more flexible schedule that allows time for family, friends, and other interests.

The Social Entrepreneur

Social entrepreneurs act as agents of change for society by building companies that solve problems, hire people in need, or both. Celebrity chef Jamie Oliver is a good example of a social entrepreneur. In 2002, Oliver launched his company, Fifteen Cornwall, to give disadvantaged youths (ages 16–24) a means to create better futures for themselves by offering them culinary training and experience. The restaurant initiative was named for the 15 young people who originally entered apprenticeships under Oliver’s program.

Fifteen Cornwall: Social Entrepreneurship in the UK

Jamie Oliver is a chef who used his success to promote the welfare of young people

Young apprentice chefs are the core of England’s Fifteen Cornwall program. Every person who joins the program has at least one thing in common: potential.

Fifteen Cornwall is a work-based, hands-on chef training program now in its eleventh year. In that time, 112 chefs have completed the apprenticeship, of which 91 percent are employed—80 percent as chefs. The program requires its apprentices to spend three months training at Cornwall College in England, four weeks working on-site at restaurant kitchens, and one year working in the Fifteen Cornwall Kitchen. Students are supported with wages and living expenses provided by the program. Profits from the Fifteen Cornwall restaurant are reinvested into the charity foundations that support the program.

Source: https://www.fifteencornwall.co.uk/apprentices/

The Serial Entrepreneur

A serial entrepreneur continually generates new ideas and launches new businesses with them. In contrast to an entrepreneur who takes an idea, turns it into a business, and then remains involved in the day-to-day operations over the long term, a serial entrepreneur is primarily interested in the initial creative stages of inventing and then launching an idea--and then leaving it to someone else to run. Then the serial entrepreneur moves onto the next big thing.

Elon Musk is the founder, CEO, and CTO of SpaceX; cofounder, CEO, and product architect of Tesla Motors; and cofounder and chairman of SolarCity

One of the most famous serial entrepreneurs of our time is Elon Musk, a South Africa–born Canadian American business magnate, investor, engineer, and inventor. He is the founder, CEO, and CTO of SpaceX; cofounder of Tesla Motors; cofounder and chairman of SolarCity; cochairman of OpenAI; cofounder of Zip2; and founder of X.com, which has merged with PayPal. In addition to his current business pursuits, Musk envisions a high-speed transportation system known as the Hyperloop, and he has proposed a supersonic jet aircraft with electric-fan propulsion.

Musk perceives his business ventures—most notably SolarCity, Tesla Motors, and SpaceX—as supporting his view of a transformed way of life for humanity. He aims to reduce global warming with products that rely on sustainable energy sources, and his ultimate goal is to enable the possibility of sustaining human life on Mars. As of 2018, Musk had a net worth of $21B.

Traits of an Entrepreneur

Despite their differences, entrepreneurs have some traits in common:

· Creativity: Conceptualizing an idea for a product or concept that doesn’t exist is essential to being an entrepreneur, and it takes exceptional creativity to do that. Some entrepreneurs identify problems and then invent a means for solving them. Other times they wait for technology to catch up with their creative vision. This was the case for movie director James Cameron, who said he postponed creating his blockbuster film Avatar until the technology he needed to make the movie became available. Other entrepreneurs have taken something that already exists and created a new use or new market for it. One example of the latter is Art Fry, who came up with a very practical and popular use for an otherwise failed product.

Art Fry and the Post-it Note

Art Fry, the accidental inventor of the Post-it note, displays his invention 

In 1968, a scientist working at 3M inadvertently developed a new type of adhesive in his quest to develop a very different product. A use for the reusable, pressure-sensitive adhesive created by accident eluded scientists at 3M, and its inventor failed in his promotion of it. That is, until Art Fry, another 3M employee, heard about it and came up with the idea of using the adhesive to anchor his bookmark to his book. Fry developed his idea of a self-adhesive, reusable notepad with the yellow scrap paper in his lab, and the now-ubiquitous Post-it note was born.

 

· Risk tolerance: Successful entrepreneurs tolerate risk and accept that it is a necessary part of any business venture—no matter how well-conceived or planned. Failure is not uncommon among start-up businesses, so risks are real.

· Persistence and resilience: Businesses take time to grow; very few are profitable right away. And they often encounter setbacks and failures along the way. Successful entrepreneurs persevere through unexpected challenges and bounce back despite adversity. Some of the most famous and accomplished entrepreneurs experienced significant initial failures. For example, Walt Disney was once fired by an editor because “he lacked imagination and had no original ideas.” His first animation company went bankrupt, and he was reportedly turned down hundreds of times when trying to secure financing for Disney World.

· Flexibility: Even the most well-planned business will encounter unexpected developments and challenges. There will inevitably be changes in the market, technology, and customer tastes that are beyond the entrepreneur’s expectations. The ability to be flexible and quickly respond to unexpected changes can be key to a business’s survival. For example, when Netflix launched, the company offered a subscription-based DVD home-delivery service. But in a short time, technology and consumer behavior changed: DVD use was declining and digital on-demand viewing was growing. Netflix adapted by expanding its offerings to include downloadable videos and other online options. Thanks to the flexibility of Netflix’s initial entrepreneurs, the company is now a leader in video entertainment, while video rental companies such as Blockbuster have long shut their doors.

· Passion: When successful entrepreneurs are asked how they tolerate taking significant risks regarding the uncertainty, demands, and setbacks of launching a business, many say a driving passion behind their ideas helps. Like persistence and resilience, passion can help fuel an entrepreneur through good times and bad, and it can be a key ingredient in the success of any start-up.

Why People Choose to Become Entrepreneurs

Entrepreneurs are seldom “off the clock”

What inspires someone to strike out on his or her own and start a business? Perhaps that person has been laid off one or more times. Perhaps she is frustrated with her current job and does not see any better career prospects on the horizon. Sometimes he realizes his job is in jeopardy; his firm may be contemplating cutbacks that could eliminate some positions or limit career or salary prospects. Perhaps she has already been passed over for promotion. Or there are no opportunities for someone with her interests and skills.

Others become entrepreneurs because they are disillusioned by the bureaucracy or politics involved in getting ahead in an established business or profession. Or they are tired of promoting a product, service, or way of doing business that is outside the mainstream operations of a large company.

And some are actually repulsed by the idea of working for someone else. They object to systems in which reward is often based on seniority rather than accomplishment, or where they have to conform to a specific corporate culture. They may be born entrepreneurs.

The following is an excerpt from an interview with a small business owner who talks about her lifelong desire to own her own business:

I don’t think I ever considered not owning my own business. My father was an entrepreneur and built his business from a hole in the wall to a very successful multi-location business just a block from the White House on Pennsylvania Avenue in Washington, DC. The whole family was involved in the business in some way. My mother did all the bookkeeping, my father ran the business, and when I was old enough to get a job, I went to work for him. It wasn’t always easy for the family. We didn’t take vacations like everybody else, sometimes we didn’t have as much money as everybody else, and some of my friends didn’t understand why my father didn’t have a “real job.” But, I believe that entrepreneurship can be an inherited trait. My great-grandfather was a clockmaker in Germany, my grandfather owned a jewelry store in Richmond, Virginia, my father had his business, my sister owned her own business, and now here I am running my own business. For me and my family, entrepreneurship is like breathing.  

—Julia Scheer, owner of Puzzles, Pranks & Games (Kitty Hawk, NC)

No one reason is more valid than another, and none guarantees success. But a strong desire and commitment to start a business, combined with a good idea, careful planning, and hard work, can lead to a very engaging and profitable endeavor.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade, and you can retake it as many times as you wish. Use this quiz to decide whether to study the section further or move on.

Choose the BEST answer.

Question 1

Entrepreneurs commonly share traits of

creativity, persistence, and resilience

endurance and durability

perseverance and by-the-book thinking

Question 2

Entrepreneurs are willing to accept risk when they start a business. However, there are reasons that motivate a person to become an entrepreneur and accept such risk, particularly financial risk. There are several reasons why an individual would want to become an entrepreneur, such as

the desire to get rich quickly without having to work very hard

dissatisfaction with current job or career

they lack the skills and ability to get a job with a company

Question 3

Entrepreneurs tend to be good at

accounting and finance

selling merchandise to customers

perceiving new business opportunities

The following short video is an example of the entrepreneurial spirit in action.

https://youtu.be/jrOXnWs8km0

 

Licenses and Attributions

Introduction to Entrepreneurs  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Outcome: Entrepreneurs. Authored by: Linda Williams and Lumen Learning. License:  CC BY: Attribution

Entrepreneurs  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution-ShareAlike 4.0 International  license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Revision and adaptation. Authored by: Linda Williams and Lumen Learning. License:  CC BY-SA: Attribution-ShareAlike

· Screenshot of Fifteen Cornwall Web Site . Provided by: Lumen Learning. License:  CC BY: Attribution

· Check Your Understanding. Authored by: Lumen Learning. License:  CC BY: Attribution

CC LICENSED CONTENT, SHARED PREVIOUSLY

· Entrepreneurship. Provided by: Wikipedia. Located at:  https://en.wikipedia.org/wiki/Entrepreneurshipu00a0 . License:  CC BY-SA: Attribution-ShareAlike

· Big Dreams - Board Games. Provided by: BBC. Located at:  https://youtu.be/R8TTzUo8DwI . License:  CC BY-NC-ND: Attribution-NonCommercial-NoDerivatives

· Elon Musk. Provided by: Wikipedia. Located at:  https://en.wikipedia.org/wiki/Elon_Musk . License:  CC BY-SA: Attribution-ShareAlike

· Richard Branson. Authored by: nrkbeta. Located at:  https://www.flickr.com/photos/nrkbeta/4628862538/ . License:  CC BY-SA: Attribution-ShareAlike

· Tesla Model 3. Authored by: Steve Jurvetson. Located at:  https://commons.wikimedia.org/wiki/File:Candy_Red_Tesla_Model_3_trimmed_2.jpg . License:  CC BY-SA: Attribution-ShareAlike

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Pros and Cons of Owning a Small Business

What you’ll learn to do: Discuss the advantages, disadvantages, and important considerations of starting a small business

In this section you will explore the pros and cons of small business ownership and evaluate more thoroughly whether starting a business is the right choice for you.

Launching a career as an entrepreneur takes courage and commitment

Learning Outcomes

· Describe the advantages and disadvantages of starting a small business

· Explain why some business ventures fail

· List important considerations in deciding to start a new business

Advantages of Small-Business Ownership

Independence. Entrepreneurs are their own bosses. They make the decisions. They choose whom to do business with and what work they will do. They decide what hours to work, what to pay themselves and their employees, and when to take vacations. For many entrepreneurs, the freedom to control their destiny is enough to outweigh any potential risks.

Financial gain. Entrepreneurship offers a greater potential of achieving significant financial rewards than does being someone else’s employee. Many entrepreneurs are inspired by the mega-millionaire entrepreneurs we see today, such as Elon Musk, Jeff Bezos, and Mark Zuckerberg.

Control. Entrepreneurship enables one to be involved in the total operation of a business, from concept to design to creation, from sales to business operations to customer response. This ability to be totally immersed in a business is very satisfying to entrepreneurs, who are typically driven by passion and creativity and possess a vision of what they want to achieve. This level of involvement allows business owners to truly create something of their own.

Prestige. Starting a business comes with the status of being the person in charge. Some entrepreneurs are attracted to the idea of being the boss. Pride of ownership can also be appealing. When someone asks, “Who did this?” the entrepreneur can answer, “I did.”

Equity. Being a successful entrepreneur gives an individual the opportunity to build equity, which can be kept, sold, or passed on to the next generation. It’s not uncommon for entrepreneurs to own multiple businesses throughout their lives. They establish a company, run it for a while, and later sell it to someone else. The income from these sales can then be used to finance the next venture. If a business owner is not interested in selling, the goal may be to build something that can be passed down to children to help ensure their financial future.

Opportunity. Entrepreneurship can create an opportunity for someone to contribute to society. While most new entrepreneurs help the local economy, a few—through their innovations—contribute to society as a whole.

The small businesses entrepreneurs launch have certain advantages over larger businesses. Flexibility, generally few employees, and the ability to develop close relationships with customers are among the key benefits of running small businesses. The digital communication revolution has significantly lowered the cost of reaching customers, and this has been a boon to small start-ups and big businesses alike.

Disadvantages of Small-Business Ownership

As a little boy said when he got off his first roller-coaster ride, “I like the ups, but not the downs!” There are several drawbacks to owning a small business.

Time. When someone opens a small business, it’s likely, at least in the beginning, that they will have few employees. This leaves all of the duties and responsibilities to the owner. Small-business owners often report working more than 80 hours a week handling everything from purchasing to banking to advertising. This time commitment can place a strain on family and friends, and add to the stress of launching a new business venture.

Risk. Even if the business has been structured to minimize risk and liability to the owner, risk cannot be completely eliminated. For example, if an individual leaves a secure job to follow an entrepreneurial dream and the business fails, this financial setback can be difficult to overcome. Beyond financial risk, entrepreneurs need to consider the risk from product liability, employee disagreements, and regulatory requirements.

Uncertainty. Even though the business may be successful at the start, external factors such as downturns in the economy, new competitors entering the marketplace, or shifts in consumer demand may stall the business’ growth. Even entrepreneurs who go through a comprehensive planning process will never be able to anticipate all of the potential changes in the business environment.

Financial commitment. Even the smallest business venture requires a certain amount of capital to start. For many people launching a small businesses, their initial source of funding is personal savings, investments, or retirement funds. Committing personal assets to a business venture makes them unavailable for personal or family needs. In most cases in which a small business receives start-up funding through a loan, the entrepreneur must secure that loan by pledging personal assets, such as a home. Risking equity based on the value of one’s own home is a financial commitment not all entrepreneurs are willing to make.

In spite of these potential risks, most small-business owners are pleased with their decision to start a business. A survey conducted by the Wall Street Journal and Cicco and Associates Inc. indicates that small-business owners and top-level corporate executives agree overwhelmingly that small-business owners are more satisfied with their work than their corporate executive counterparts.

Why Some Ventures Fail

Valuable Lessons

Nevertheless, the odds that entrepreneurs’ businesses will survive long-term are not in their favor. According to the US Small Business Administration, about half of all new establishments survive five years or longer, and about one-third survive 10 years or longer. The probability of survival increases with a firm’s age.

It’s essential to understand how and where things go wrong—such information can offer valuable lessons on what to avoid. There are six main reasons an entrepreneur’s business may fail.

Lack of Planning 

Starting a business without planning where you want to go is like starting a car journey with no idea of your final destination or a map to get there; you’re bound to get lost. Before starting out, entrepreneurs should have a clear goal of what they want to accomplish and how they plan to do so.

Failure to Delegate

Within every business someone needs to focus on the bigger picture and have an overview of everything happening both internally and externally to the company. That person should be the company’s founder, but if his or her head is buried in the business’s accounts, they won’t have the time they need to actually lead. Company heads should delegate and outsource these tasks that can be done by others to free themselves up to concentrate on the bigger picture.

Unwillingness to Change

Small businesses can’t afford to stand still while the market and consumer trends continually evolve. Entrepreneurs should construct their firms so they are forward-thinking and innovative, continually anticipating the future.

Forgetting That Cash Is King

A small business needs to monitor its cash flow closely. As soon as it loses track of the money, it’s vulnerable to failure. Entrepreneurs should plot and analyze their accounts payable and receivable to ensure their small businesses stay on the right financial track. New companies should not expect massive profits from the outset, but they should not accept losses, either.

Lack of Objective Targets

Failing to gauge the success of campaigns, products, or services can be disastrous for a small business. Is a company’s PR campaign really worth the investment? Does Twitter really direct traffic to the company’s website? If company heads know what to measure—and they do it well—they’ll know how successful they are.

Failure to Ask the Right Questions

It’s difficult for a small business start-up to know which questions to ask (and to whom). There are numerous resources, including the US Small Business Administration, local economic development agencies, and chambers of commerce, which are great places to start. For entrepreneurs just starting out, a big part of the process is figuring out what they don’t know, and there are organizations that can help them do that.

While avoiding these pitfalls won’t guarantee entrepreneurial success, knowing what not to do can help new business leaders be proactive and focus on the most important things.

Important Considerations

Different types of entrepreneurs can sustain different levels of risk.

The entrepreneur’s challenge is to balance decisiveness with caution—to be capable of seizing an opportunity, but also well-informed enough not to assume unnecessary risk. Preparatory work includes evaluating market opportunities, developing products or services, preparing detailed business plans, determining how much capital is needed, and making arrangements to obtain that capital.

Economists have analyzed a range of entrepreneurial successes and failures and identified key issues that up-and-coming business owners should consider carefully before launching a new enterprise. Taking these issues into account can reduce risk; ignoring them can contribute to failure. If you’re considering entrepreneurship, think about the answers to the following questions.

What is your incentive for starting a business? Is it profit alone? Are you prepared to spend the time and money necessary to get your business started? Many entrepreneurs do acquire great wealth. But money is almost always tight in the early phases of a new business. Many entrepreneurs don’t even take a salary until they can do so and still leave the firm with a positive cash flow.

Will the products or services your business will provide differentiate your company from others in the market? Who is your ideal customer? Who is your competition? Do you plan to compete solely on the basis of price? Price is important, but most economists agree that it’s very risky to compete on price alone. Large firms that produce huge quantities of consumer items have the advantage of being able to lower costs.

How much will it cost to get your business off the ground? Do you have a realistic vision of your enterprise’s potential? Will you need a loan? How long will it take to make your product or service available? How long will it take to start making a profit? Insufficient operating funds are the cause of many business failures. Entrepreneurs often underestimate their start-up costs and overestimate their sales revenues when creating their business plans. Some analysts advise entrepreneurs in the planning stages to add 50 percent to their final cost estimates and to reduce their sales projections. Would-be entrepreneurs need to closely examine their cash-flow projections to make informed decisions about whether to launch a new business.

Other Key Decisions and Planning

Entrepreneurs should take advantage of all of the informed advice they can get. Experts can help with many decisions regarding financing, taxes, insurance, location analysis, and supplier relationships. Some bankers and insurance agents will give advice at no charge to encourage a relationship. There are even experts to help with planning itself.

Ultimately, the business approach an entrepreneur adopts will be based on his or her personal, informed judgment. Those with the best prospects for success will gather as much information and advice as possible before making crucial business decisions.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade, and you can retake it as many times as you wish.

Use this quiz to decide whether to study the section further or move on.

Choose the BESTanswer

Question 1

Compared to working for an employer, an entrepreneur who starts a small business is likely to spend

about the same amount of time working but she enjoys her work more

significantly less time working because she is her own boss

significantly more time working because so much depends on her.

Question 2

Fred likes the idea of being a business owner and is now considering starting a business. Fred should think about

his motivation, a business strategy, and realistic projections of income and expenses

how the big businesses take advantage of their customers

how much he likes working for himself

Question 3

Andy has started a garage. The downside is the

financial commitment

prestige

independence

Licenses and Attributions

Introduction to Starting a Small Business  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Outcome: Opportunities and Challenges. Authored by: Linda Williams and Lumen Learning. License:  CC BY: Attribution

Pros and Cons of Owning a Small Business  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license.

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· Revision and adaptation. Authored by: Linda Williams and Lumen Learning. License:  CC BY: Attribution

· Check Your Understanding. Authored by: Lumen Learning. License:  CC BY: Attribution

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· Day 22. Authored by: David Childers. Located at:  https://www.flickr.com/photos/davidchilders/6799551981/ . License:  CC BY: Attribution

· Why Do So Many Small Business Startups Fail?. Authored by: Stefan Toepfer. Provided by: The Small Business Blog. Located at:  http://sme-blog.com/sme-blog/why-do-so-many-small-business-start-ups-fail . License:  CC BY: Attribution

· Scuba-shop illustration. Authored by: Frits Ahlefeldt FA-L.com. Located at:  https://www.flickr.com/photos/hikingartist/5727294500/ . License:  CC BY-NC-ND: Attribution-NonCommercial-NoDerivatives

· Decision. Authored by: Bill Collison. Located at:  https://www.flickr.com/photos/billcollison/7199498340/ . License:  CC BY-NC: Attribution-NonCommercial

PUBLIC DOMAIN CONTENT

· Why Become an Entrepreneur?. Provided by: U.S. Department of State. Located at:  http://iipdigital.usembassy.gov/st/english/publication/2008/06/20080603212324eaifas0.1164362.html#ixzz4Q5ikOKWu . License:  Public Domain: No Known Copyright

· Twenty Questions Before Starting a Business. Provided by: U.S. Small Business Association. Located at:  https://www.sba.gov/content/20-questions-before-starting-business . License:  Public Domain: No Known Copyright

· Decisions and Downfalls. Provided by: U.S. Department of State. Located at:  http://iipdigital.usembassy.gov/st/english/publication/2008/06/20080603213245eaifas0.3291284.html#ixzz4Q5w95PTt . License:  Public Domain: No Known Copyright

Ten Steps to Starting a Business

What you’ll learn to do: Describe the steps required to launch a small business

The information contained in this section describes best practices for launching a small business. The details, agencies, and contacts necessary to become an entrepreneur will vary from state to state, so additional research may be required for different circumstances. But regardless of your location, the steps detailed in this section generally apply to most new businesses.

Launching a business from scratch requires detail and dedication.

Learning Outcome

· List and briefly describe the steps necessary to start a new business

Starting a business involves planning, making key financial decisions, and satisfying a set of legal requirements. These ten steps can help you plan, prepare, and manage your new business.

Step 1: Write a Business Plan

A business plan generally contains the following elements.

· executive summary

· company description

· market analysis

· organization and management

· service or product line

· marketing and sales

· funding request

· financial projections

· appendix

Step 2: Get Business Assistance and Training

Take advantage of free training and counseling services on topics ranging from preparing a business plan to securing financing to expanding or relocating a business.

Step 3: Choose a Business Location

Get advice on how to select a customer-friendly location and comply with zoning laws. Choosing a business location is perhaps the most important decision a small business owner will make, so it requires precise planning and research. Potential entrepreneurs should evaluate their demographics, assess supply chains, scope the competition, determine how to stay on budget, learn state laws and tax requirements, and much more.

Here are some tips to help you choose the right business location:

Determine Your Needs

Most entrepreneurs choose a location that provides the most exposure to potential customers. There are additional less-obvious factors to consider.

· Brand image: Is the location consistent with the image you want to project?

· Competition: Are the businesses around you complementary or competitive?

· Local labor market: Do potential employees live near the business? What will their commute be?

· Plan for growth: If you anticipate growing your business, look for a building that has extra space should you choose to expand.

· Proximity to suppliers: They need to be able to find you easily.

· Safety: Consider the area's crime rate. Will employees feel safe alone in the building or walking to their vehicles?

· Zoning regulations: These determine whether you can conduct your type of business in certain properties or locations. You can determine how property is zoned by contacting your local planning agency.

Evaluate Your Finances

Besides determining what you can afford, you will need to be aware of other financial considerations.

· Hidden costs: Very few spaces are business-ready. Include in your calculations the costs of renovation, decorating, IT system upgrades, and so on.

· Taxes: What are the income and sales tax rates for your state? What about property taxes? Could you pay less in taxes by locating your business across a nearby state line?

· Minimum wage: While the federal minimum wage is $7.25 per hour, many states have a higher rates. Research the US Department of Labor’s list of minimum wage rates by state.

· Government economic incentives: Your business location can determine whether you qualify for government economic business programs such as state-specific small-business loans and other financial incentives.

Is the Area Business-Friendly?

Understanding the laws and regulations imposed on businesses in a particular location is essential. As you grow your business, it can be advantageous to work with a small-business specialist or counselor. Research the programs and support your state government and local community may offer small business owners. Many states offer online tools to help start-up businesses succeed. Local community resources such as SBA offices, small business development centers, women’s business centers, and other government-funded programs are specifically designed to meet the needs of small businesses.

The Bottom Line

Do your research. Talk to other business owners and potential co-tenants. Consult the small-business community and use available resources, such as free government-provided demographic data, to help you make informed decisions.

Step 4: Finance Your Business

The SBA offers a variety of loan programs for very specific purposes.

Take time to study the programs described on  this SBA website  to learn more about which types of businesses qualify for different loans.

 

Step 5: Determine the Legal Structure of Your Business

Decide which form of business ownership is best for you: sole proprietorship, partnership, limited liability company (LLC), corporation, S corporation, benefit corporation, nonprofit, or cooperative. (Refer to the chapter on Business Ownership, which discusses these forms ownership at length.)

Determine Your Federal Tax Obligations

Your form of business (e.g., sole proprietorship, partnership, LLC) determines which taxes you must pay and how you mst pay them. Most businesses must file annual income tax returns, pay quarterly estimated taxes, and collect and pay employment taxes for owners and employees.

The IRS details  here  the specific tax requirements for different business structures

State Income Taxes

Nearly every state levies a business or corporate income tax. Like federal taxes, your state tax requirement depends on the legal structure of your business. For example, if your business is an LLC, the LLC is taxed separately from the owners of the business, while sole proprietors report their personal and business income on the same form.

Consult the the SBA website to determine specific  state tax obligations .

Step 6: Register a Business Name (“Doing Business As”)

Register your business name with your state government. Naming your business is an important branding exercise, but if you choose to name your business as anything other than your own personal name, then you’ll need to register it with the appropriate authorities. This process is known as registering your “Doing Business As” (DBA) name.

Step 7: Get a Tax Identification Number

Learn which tax identification number you’ll need to obtain from the IRS and your state revenue agency. An Employer Identification Number (EIN) is also known as a Federal Tax Identification Number, and it is used to identify business entities. Generally, businesses need an EIN. You may apply for one in various ways, including online.

The IRS has more information about EINs  here .

Step 8: Register for State and Local Taxes

Register with your state to obtain a tax identification number, workers’ compensation, unemployment, and disability insurance. An accountant or lawyer can explain your state’s requirements for filing various forms for tax purposes.

Step 9: Obtain Business Licenses and Permits

Obtain a list of the federal, state, and local licenses and permits required for your business.

Federal Licenses and Permits

If your company is involved in activities supervised and regulated by a federal agency—such as alcohol, firearms, commercial fishing, etc.—you may need a federal license or permit to do business. For example, if your business broadcasts information by radio, television, wire, satellite, or cable, you may be required to obtain a license from the Federal Communications Commission. Or if you import or transport animals, animal products, biologics, biotechnology, or plants across state lines, you’ll need to apply for a permit from the US Department of Agriculture (USDA).

Visit the SBA’s  website  for more information on licenses and permits.

State Licenses and Permits

In addition to federal licenses and permits, virtually every business needs some form of state license to operate legally. But requirements vary depending on the type of business you operate, where it’s located, and what government rules apply.

To help you identify the  specific state licenses or permits  your business may need, visit the State Business License Office for the area in which your business is located.

Step 10: Understand Employer Responsibilities

Learn how to hire employees legally by consulting with an accountant and lawyer to get expert advice on employee law. Many organizations such as SCORE offer free advice on your responsibilities as an employer. The eight steps below cover the actions you must take during the hiring process to ensure you are compliant with key federal and state regulations.

1. Obtain an Employer Identification Number (EIN).

2. Set up records for withholding taxes.

3. Obtain employee eligibility verification.

4. Register with your state’s new-hire reporting program.

5. Obtain workers’ compensation insurance.

6. Post required notices.

7. File your taxes.

8. Get organized and keep yourself informed.

SCORE

In addition to requirements to retain employee payroll records for tax purposes, certain federal employment laws also require you to keep additional employee records. Complying with employee protection measures such as equal opportunity and fair labor standards is also essential. Following statutes and regulations for minimum wage, overtime, and child labor will help you avoid errors and lawsuits.

See the US Department of Labor’s  Employment Law Guide  for timely information on these statutes and regulations.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade, and you can retake it as many times as you wish.

Use this quiz to decide whether to study the section further or move on.

Choose the BEST answer.

Question 1

The first step in starting a business (as described in this section) is to

decide on the legal structure

finance your business

write a business plan

Question 2

Business may be required to acquire licenses and permits from

local government only

state, local, and federal governments

the state only

Question 3

William Sliwoski has been making furniture for two years under his own name. Sales have been picking up steadily and William has decided to conduct his furniture business as "Crafted Creations" from here on out. William will need to register Crafted Creations with state government as a

Debt and Business Assets

Doing Business As

Direct Business Association

Licenses and Attributions

Introduction to Steps of Starting a Business  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Outcome: Steps to Starting a Business. Authored by: Linda Williams and Lumen Learning. License:  CC BY: Attribution

CC LICENSED CONTENT, SHARED PREVIOUSLY

· Step by Step. Located at:  http://pixabay.com/en/success-gradual-career-stairs-413093/ . License:  CC0: No Rights Reserved

Ten Steps to Starting a Business  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

CC LICENSED CONTENT, ORIGINAL

· Revision and adaptation. Authored by: Linda Williams and Lumen Learning. License:  CC BY: Attribution

· Check Your Understanding. Authored by: Lumen Learning. License:  CC BY: Attribution

CC LICENSED CONTENT, SHARED PREVIOUSLY

· Day 22. Authored by: David Childers. Located at:  https://www.flickr.com/photos/davidchilders/6799551981/ . License:  CC BY: Attribution

· Why Do So Many Small Business Startups Fail?. Authored by: Stefan Toepfer. Provided by: The Small Business Blog. Located at:  http://sme-blog.com/sme-blog/why-do-so-many-small-business-start-ups-fail . License:  CC BY: Attribution

· Scuba-shop illustration. Authored by: Frits Ahlefeldt FA-L.com. Located at:  https://www.flickr.com/photos/hikingartist/5727294500/ . License:  CC BY-NC-ND: Attribution-NonCommercial-NoDerivatives

· Decision. Authored by: Bill Collison. Located at:  https://www.flickr.com/photos/billcollison/7199498340/ . License:  CC BY-NC: Attribution-NonCommercial

PUBLIC DOMAIN CONTENT

· Why Become an Entrepreneur?. Provided by: U.S. Department of State. Located at:  http://iipdigital.usembassy.gov/st/english/publication/2008/06/20080603212324eaifas0.1164362.html#ixzz4Q5ikOKWu . License:  Public Domain: No Known Copyright

· Twenty Questions Before Starting a Business. Provided by: U.S. Small Business Association. Located at:  https://www.sba.gov/content/20-questions-before-starting-business . License:  Public Domain: No Known Copyright

· Decisions and Downfalls. Provided by: U.S. Department of State. Located at:  http://iipdigital.usembassy.gov/st/english/publication/2008/06/20080603213245eaifas0.3291284.html#ixzz4Q5w95PTt . License:  Public Domain: No Known Copyright

Create Your Business Plan

What you’ll learn to do: List and describe the key components of a business plan

In many ways, a business plan is a map that depicts what you will sell and to whom, how you will run your business, who you will rely on, and where you will be located. In this section, you’ll learn how the components of a well-crafted, solid business plan can help entrepreneurs successfully launch a business and accomplish their goals.

Business plans may appear deceptively simple, but in reality they take significant time and research.

Learning Outcome

· List and briefly describe the components of a business plan

The following guide will help you create a business plan to guide you through a successful business launch and execution. The steps are described in the order in which they would appear in an actual business plan.

Executive Summary

This section is often considered the most important part of a business plan. It describes what your business does, where you want to take it, and why your idea will be successful. If you are seeking financing, the executive summary is your first opportunity to pique a potential investor’s interest.

Since the executive summary highlights the biggest strengths of your overall plan, write it after all of your other sections are complete.

Based on your business’ maturity, there are some key points you should include in this section.

If You Are an Established Business

If you are an established business, include the following information:

· The mission statement: This summarizes the purpose of your business; it should be between several sentences and a paragraph long.

· Company information: This is a short statement that details when your business was formed, the names of the founders and their roles, the number of employees, and your business location(s).

· Growth highlights: Include examples that illustrate the growth of your company, such as financial or market highlights. (e.g., “XYZ firm increased profit margins and market share year-over-year since its founding.”) Graphs and charts can be helpful in this section.

· Your products/services: Briefly describe the products or services you provide.

· Financial information: If you are seeking financing, include any information about your current bank and investors.

· Summarize future plans: Explain where you would like to take your business.

With the exception of the mission statement, all of the information in the executive summary should be kept as concise as possible, and the document should not run longer than one page. The executive summary is the first section of your business plan most people will see, so make each word count.

If You Are a Start-up or New Business

If you are just starting a business, you won’t have as much information as an established company. Focus instead on your experience and background and the decisions that led you to start this particular enterprise. Demonstrate that you have done a thorough market analysis to prove the viability of your idea. Convince your reader that you can succeed in your target market and then address your longer-term plans.

Company Description

Provide a high-level overview of the elements of your company that will make it succeed. The goal is to help potential investors quickly understand the goal of your business and its unique proposition.

What to Include in Your Company Description

· Describe the nature of your business and list the marketplace needs you aim to address.

· Explain how your products and services meet those needs.

· List the specific consumers, organizations, and businesses that your company will serve.

· Describe the competitive advantages that will make your business a success, such as your location, expert personnel, efficient operations, or ability to bring unique value to your customers.

Market Analysis

Use this section to illustrate your industry and market knowledge as well as any of your relevant research findings and conclusions.

What to Include in Your Market Analysis

· Industry description and outlook: Describe your industry, its current size, historic growth rate, and other relevant trends and characteristics (e.g., life cycle stage and  projected growth rate). List the major customer groups within your industry.

· Information about your target market: Describe your target market and explain why it would want to buy from you. Narrow your market to a manageable size; trying to appeal to too many people can make it appear you are overreaching. Provide your research, including the following information about the market you will target:

· Distinguishing characteristics: What are the critical needs of your potential customers? Are they being met? What are the demographics of the group, and where are they located? Are there any seasonal or cyclical purchasing trends that may affect your business operations?

· Size: Provide data about the annual purchases your market makes in your industry. What is the forecasted market growth for this group?

· Market share: What amount of market share and number of customers do you expect to gain in your defined geographic area? Describe how you came up with these numbers.

· Pricing and gross margin targets: Define your pricing structure, gross margin levels, and any discounts you plan to offer.

· Competitive analysis: Explain what customer needs are being ignored by your competitors. Creating a niche for your business is essential. Your competitive analysis should identify your competition by product line or service and market segment. Assess the characteristics of the competitive landscape (e.g., market share, strengths and weaknesses, barriers to market entry, etc.). Show potential investors that you can strategize in your chosen market and you don’t intend to try to become a jack-of-all-trades.

· Regulatory restrictions: Include any customer or governmental regulatory requirements that will affect your business and how you will comply with them.

Organization and Management

Who will do what in your company? What are their backgrounds, and why are you bringing them into your company? What will they be responsible for? Potential investors want to know who the decision makers will be, so provide detailed descriptions of each division or department and its function. Include your company’s organizational structure, details about company ownership, profiles of your management team, and the qualifications of your board of directors.

Service or Product Line

Describe your service or product, emphasizing the benefits to potential and current customers. Explain how your particular product will fill a need for your target market.

What to Include in Your Service or Product Line Section

·  A description of your product/service: Detail the specific benefits of your product or service from your customer's perspective. Discuss your ability to meet consumer needs and emphasize any advantages your product may have over that of the competition. Address the current development stage your product (e.g., idea, prototype, testing) is in.

· Details about your product’s life cycle: Include information about where your product or service is in its life cycle as well as any factors that may influence its cycle in the future.

· Intellectual property: If you have any existing, pending, or anticipated copyright or patent filings, list them here. Also disclose whether any key aspects of a product may be classified as trade secrets. Finally, include any information pertaining to existing legal agreements, such as nondisclosure or non-compete agreements.

· Research and development (R&D) activities: Outline any R&D activities you are planning or currently engaged in. What results do you anticipate? Also address the R&D activities of other businesses in your industry.

Marketing and Sales

Marketing is the process of creating customers, and customers are the lifeblood of your business. Use this section to comprehensively define your marketing strategy and then your sales strategy. This includes describing how you plan to actually sell your product. This leads to the next section—obtaining the necessary capital.

Funding Request

If you are seeking funding for your venture, use this section to outline your needs, including

· your current funding requirements

· any anticipated funding requirements during the next five years

· how you intend to use the funds you receive

· any future strategic financial situational plans, such as buyouts, being acquired, debt repayment plans, or selling your company

When outlining your funding requirements, include the amount you want now and the amount you anticipate needing in the future. Also include the time period that each request will cover, the type of funding you are requesting (e.g., equity, debt), and the terms you prefer. Is the funding request for capital expenditures? Working capital? Debt retirement? Acquisitions? Whatever it is, include it in this section.

Financial Projections

Develop this section after analyzing your market and setting clear objectives. This will allow you to allocate your resources efficiently. This section should include the critical financial statements that will make your business as financially transparent as possible.

Historical Financial Data

If you own an established business, supply historical data related to your company’s performance. Most creditors request such data from the past three to five years, depending on the length of time you have been in business. Typical financial data to include are your company’s income statements, balance sheets, and cash flow statements for each year you have been in business. Often, creditors are also interested in any collateral you may have that could be used to ensure your loan, regardless of the stage of your business.

Prospective Financial Data

All businesses, whether starting up or expanding, will be required by their creditors to supply prospective financial data. Most of the time, creditors will want to know what you expect your company to be able to earn within the next five years. Each year’s documents should include forecasted income statements, balance sheets, cash flow statements, and capital expenditure budgets. Make sure that your projections match your funding requests; creditors will be on the lookout for inconsistencies.

Appendix

Your appendix should not be included in the main body of your business plan; provide it on an as-needed basis. This section may contain your credit history, résumés of company leaders, letters of reference, and any other information a lender may request. Specific individuals (such as creditors) may require this information to make lending decisions, so it’s important to be able to provide it upon request.

Any copies of your business plan should be controlled; keep a distribution record of who you share it with. This will allow you to update and maintain it on an as-needed basis.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade, and you can retake it as many times as you wish. Use this quiz to decide whether to study the section further or move on.

Choose the BEST answer.

Question 1

To make your business plan stand out you must

learn to strategize

not give away any specifics so no one can steal your ideas

be broad and unspecific about what you have to offer

Question 2

XYZ is an established business, and its leaders have written a business plan to request additional funding from a local bank. Unlike a plan for a new business, the business plan will include which information?

mission statement

growth highlights

marketing strategy

Question 3

XYZ Inc. identified its main competing products, services, and market segments. This is an example of a ________ .

gross margin analysis

target market

competitive analysis

Licenses and Attributions

Introduction to Business Plans  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Outcome: Business Plans. Authored by: Linda Williams and Lumen Learning. License:  CC BY: Attribution

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Putting It Together: Entrepreneurship

Synthesis

We began this chapter by considering the contributions of entrepreneurs not only to the economy, but also to our daily lives. Reflecting on what you have learned in this chapter, think for a moment about how far entrepreneurs have taken us, our economy, and the world. From two brothers who owned a bicycle shop in Dayton, Ohio…

The Wright Brothers

Orville and Wilbur Wright get their first airplane off the ground at Kitty Hawk, North Carolina.

...to this: https://youtu.be/b2xYwVOJB-U

Summary

Small Business

Small businesses and entrepreneurs fuel the economic engine of the US. Without them, financial growth and recovery from cyclical downturns would be impossible. Small businesses make valuable contributions to the larger economy by creating jobs and providing opportunities for individuals to achieve financial success and independence. Large businesses depend upon their smaller counterparts for support by purchasing their component parts, services, and product distribution.

Entrepreneurs

Who are these entrepreneurs? You have seen that they are creative, risk-taking, determined individuals who, even after suffering setbacks, refuse to give up on their dreams and business aspirations.

Advantages, Disadvantages, and Considerations

There are both advantages and disadvantages to small-business ownership. Each individual must weigh the pros and cons to decide whether it is the right path for them. Time, lifestyle, finances, stress, and independence are just a few of the factors involved in making that decision. We would like to think that every business venture will be as successful as Apple or Starbucks, but the fact is that plenty start-ups don’t make it. Knowing why businesses fail is key to effective planning and avoiding common pitfalls. If you know where the land mines are, you can work your way around them to get to the other side of the field.

Steps to Starting a Business

Starting a business is a lot like baking a cake—there’s a recipe and a procedure. Baking requires a series of steps (measuring, mixing, baking, cooling, frosting) that, if done right, can result in a tempting dessert. Which ingredients you put into a cake depends on the type of cake you are baking. The ingredients (i.e., steps) you choose to launch a business likewise depend on the type of business you are launching.

In this chapter, you learned there’s a series of procedures and steps that every business owner must go through to establish their business. Additional steps depend on the nature of the business and its location.

Business Plans

A good, comprehensive, well-researched business plan can be an invaluable roadmap to business success. The components should cover everything from financial projections to physical location to products and services. Having a complete and thorough plan is essential to the success of any business venture—small or large. Remember, businesses never plan to fail, but they do fail to plan.

Licenses and Attributions

Putting It Together: Entrepreneurship from Introduction to Business by Linda Williams and Lumen Learning is available under a Creative Commons Attribution 4.0 International license. UMUC has modified this work and it is available under the original license.

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· Plans for Space Tourism. Provided by: BBC. Located at: https://youtu.be/b2xYwVOJB-U. License: CC BY-NC-ND: Attribution-NonCommercial-NoDerivatives

Stages of the Economy

What you’ll learn to do: Identify and explain the four stages of an economy (expansion, peak, contraction, and trough), and describe their impact on business operations

Spring, summer, fall, and winter: the four seasons of the year. Expansion, peak, contraction, and trough: the four seasons of an economy. In this next section you’ll learn about the cyclical nature of economies and how each of these “seasons” affects business operations.

Learning Outcomes

· Explain the business cycle

· Differentiate between expansion, recession, and depression

Economic Cycle

The term economic cycle (or boom-bust cycle) refers to economy-wide fluctuations in production, trade, and general economic activity. From a conceptual perspective, the economic cycle is the upward and downward movements of levels of the Gross Domestic Product (GDP), and refers to periods of expansion and contraction in the level of economic activities (business fluctuations) around a long-term growth trend.

Business Cycle

Stages of the Economy

Economic cycles are identified as having four distinct economic stages: expansion, peak, contraction, and trough.

An expansion is characterized by increasing employment, economic growth, and upward pressure on prices. A peak is the highest point of the business cycle, when the economy is producing at maximum allowable output, employment is at or above full employment, and inflationary pressures on prices are evident. Following a peak, the economy typically enters into a correction that is characterized by a contractionwhere growth slows, employment declines (unemployment increases), and pricing pressures subside. The slowing ceases at the trough, and at this point the economy has hit a bottom from which the next stage of expansion and contraction will emerge. In the United States, it is generally accepted that the National Bureau of Economic Research (NBER) is the final arbiter of the dates of the peaks and troughs of the economic cycle.

Since the economy is made up of businesses (both private and public), businesses are impacted by the stages of the economy or perhaps they cause the stages of the economy—or maybe a little of both!  When we move from talking about stages of the economy, the terms used to describe the business cycle differ slightly, but you will see that they are almost mirror images of the economic stages.

Business Cycle Fluctuations

Business cycle fluctuations occur around a long-term growth trend just like economic cycles, but unlike economic cycles they are measured in terms of the growth rate of Real Gross Domestic Product (Real GDP).This does not mean that the GDP is imaginary, but rather that GDP does not take into account inflation. Instead, Real GDP is the inflation-adjusted value of the goods and services produced by labor and property located in the United States.

An expansion is the period from a trough to a peak, and a recession is the period from a peak to a trough. The NBER identifies a recession as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in Real GDP, real income, employment, industrial production.” This is significantly different from the commonly cited definition of a recession being signaled by two consecutive quarters of decline in Real GDP.  If the economy does not begin to expand again, then the economy may be considered to be in a state of depression.

Impact of the Economic Cycle on Business Operations

How the economic cycle affects business operations may be best explained by looking at how one business responds to these cycles. Normal Maintenance is a small business that provides a variety of construction services to homeowners. They specialize in roofing, deck installations, siding, and general home maintenance. They employ three full-time workers, who typically work 40 hours per week for an average of $12 per hour. The company has been in business in the same town for more than 20 years and has a solid reputation for quality work and reliability.

Expansion

Normal Maintenance is busy and has recently had to turn down jobs because it lacks the capacity to do all the work offered. Homeowners now want to make home repairs and improvements that they had to put off during the sour economy. With the economy improving, others are fixing up their homes to sell. Faced with so much demand, the owner of Normal Maintenance must decide whether to pay his existing workers overtime (which will increase the costs for each job and reduce profits) or hire additional workers. The competition for qualified construction labor is steep, and he is concerned that he will have to pay more than his usual rate of $12 per hour or possibly get workers who are not as qualified as his current crew. He is, however, able to charge higher prices for his work because homeowners are experiencing long waits and delays getting bids and jobs completed. The owner purchases a new truck and invests in additional tools in order to keep up with the demand for services. Customers are willing to pay more than usual so they can get the work done. Business is expanding to such an extent that Normal Maintenance and its suppliers are starting to have trouble obtaining materials such as shingles and siding because the manufacturers have not kept pace with the economic expansion. In general, business is great for Normal Maintenance, but the expansion brings challenges.

Peak

At the peak of the business cycle, the economy can be said to be “overheated.” Despite hiring additional workers, the owner and crews of Normal Maintenance are working seven days a week and are still unable to keep up with demand. They can’t work any harder or faster. As a result, the crews are exhausted, and the quality of their work is beginning to decline. Customers leave messages requesting work and services, but the owner is so busy he doesn’t return phone calls. Jobs are getting started and completed late as the crews struggle to cover multiple job sites. As a result, customer complaints are on the rise, and the owner is worried about the long-term reputation of the business. Neither the business nor the economy can sustain this level of activity, and despite the fact that Normal Maintenance is making great money, everyone is ready for things to let up a little.

Contraction

As the economy begins to contract, business begins to slow down for Normal Maintenance. They find that they are caught up on work, and they aren’t getting so many phone calls. The owner is able to reduce his labor costs by cutting back on overtime and eliminate working on the weekends. When the phone does ring, homeowners are asking for bids on work—not just placing work orders. Normal Maintenance loses out on several jobs because bids are too high. The company begins to look for new suppliers who can provide materials at a cheaper price so it can be more competitive. The building material companies start offering “deals” and specials to contractors in order to generate sales. In general, competition for work has increased, and some of the businesses that popped up during the expansion are no longer in the market. In the short term, the owner is confident that he has enough work to keep his crew busy, but he’s concerned that if things don’t pick up, he might have to lay off some of the less experienced workers.

Trough

On Monday morning, the crew of Normal Maintenance shows up to work and the owner has to send them home: There’s no work for them. During the week before, they worked only three days, and the owner is down to his original crew of three employees. Several months ago he laid off the workers hired during the expansion. Although that was a difficult decision, the owner knows from hard experience that sometimes businesses fail not because their owners make bad decisions, but because they run out of money during recessions when there isn’t enough customer demand to sustain them. Without enough working capital to keep the doors open, some are forced to close down.

Representatives from supply companies are stopping by the office hoping to get an order for even the smallest quantity of materials. The new truck and tools that the owner purchased during the boom now sit idle and represent additional debt and costs. The company’s remaining work comes from people who have decided to fix up their existing homes because the economy isn’t good enough for them to buy new ones. The owner increases his advertising budget, hoping to capture any business that might be had. He is optimistic that Normal Maintenance will weather this economic storm—they’ve done it before—but he’s worried about his employees paying their bills over the winter.

The owner of Normal Maintenance has been in business for a long time, so he’s had some experience with the economic cycle. Though each stage has its stressors, he has learned to plan for them. One thing he knows is that the economy will eventually begin to expand again and run through the cycle all over again.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade in the class, and you can retake it as many times as you wish.

Use this quiz to decide whether to study the section further or move on.

Choose the BEST answer

Question 1

Rising economic indicators typically signal ________ in the economy.

expansion

depression

recession

Question 2

The point of a business cycle fluctuation during which growth slows, unemployment increases, and pricing pressures subside is called a(n)

peak

expansion

trough

contraction

Question 3

Which of the following describes a business cycle?

periods of increasing and decreasing real GDP

inflation sometimes, but not others

regular growth rate of consumer spending

Licenses and Attributions

Introduction to Economic Stages  from Introduction to Business by Linda Williams and Lumen Learning  is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Outcome: Economic Stages. Authored by: Linda Williams, Steve Greenlaw, Lumen Learning. License:  CC BY: Attribution

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Economic Environment: Why It Matters

Why learn about the economic environment?

Economics is about choices: namely, how we choose to allocate scarce resources and how our choices impact others. Beyond that, it’s about the choices made by businesses, government, and other countries. Let’s begin with ice cream—something familiar and tasty to most people—and use it as a framework for thinking about economics.

Let’s say you live in Boise, Idaho, and decide to go out for ice cream with your friend Charlie, who has been reading about ice cream flavored with Persian saffron. That’s the kind he wants, but none of the five ice-cream shops you visit has it. Why not? Why can’t they meet his demand? Because Charlie is the only person in Boise who has ever asked for it, and none of the shops has decided to carry something so expensive (the saffron costs nearly $1,000 per ounce) that is not popular locally. They have chosen to offer ice cream that is low-cost, high-demand, and easy to manufacture.

The next day, Charlie is still obsessed with saffron ice cream, and he’s discovered a shop in Dubai, where, for the mere price of $816 (per scoop, fancy toppings included), one can try this exotic treat. Now Charlie has some economic choices to make. Including the $1,800 airfare, plus the other travel expenses (hotel, cabs, etc.), the trip to Dubai will cost $2,600—at least. It will also cost Charlie time: the time it takes to plan the trip, the days off work, and travel time. Then, there’s the opportunity cost. While he is planning, traveling, and eating his ice cream, Charlie’s giving up the opportunity to do other things with his time and money. And there are unforeseen choices and expenses: What if he gets to Dubai and they’ve run out of saffron ice cream? Does he hang around in Dubai, investing more resources and waiting for them to restock? What if he tries Persian saffron ice cream and says, “Yuck!”—and wishes he’d bought banana ice cream back in Boise?

This is an extreme, unlikely situation, of course. However, the choices that ice-cream manufacturers, ice-cream shops, and people like Charlie make every day are all examples of economic decisions: at every turn, a choice has to be made about the allocation of limited resources. What economic decisions do you make in your life?

The purpose of this chapter is to give you an understanding of the fundamental principles of economics, some of the factors that drive economies, and how economics shapes the business environment. You will likely learn more about economics as you continue your education, but this section should serve as an excellent introduction and give you some tools to think about the impact of economics on your daily life.

Licenses and Attributions

Economic Environment: Why It Matters  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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What Is Economics?

What you’ll learn to do: Explain what economics is and why it’s important

In order to understand economics it’s important to master a set of key concepts and understand how they interconnect. We’ll cover these concepts next.

Learning Outcomes

· Explain scarcity

· Explain opportunity cost

· Explain division of labor and specialization

· Distinguish between macroeconomics and microeconomics

Scarcity and Choice

Throughout this chapter you’ll encounter short videos that explain complex economic concepts in very simple terms. Take the time to watch them! They’ll help you master the basics before heading to the readings (which tend to cover the same information in more depth).

[video]  https://youtu.be/yoVc_S_gd_0

As you watch the video, consider the following key points:

1. Economics is the study of how humans make choices under conditions of scarcity.

2. Scarcity exists when human wants for goods and services exceed the available supply.

3. People make decisions in their own self-interest, weighing benefits and costs.

Understanding Scarcity and Economics

Scarcity

The resources that we value—time, money, labor, tools, land, and raw materials—exist in limited supply. There are simply never enough resources to meet all our needs and desires. This condition is known as scarcity.

At any moment in time, there is a finite amount of resources available. Even when the number of resources is very large, it’s limited. For example, according to the US Bureau of Labor Statistics, in 2016, the labor force in the United States contained more than 158 million workers—that’s a lot, but it’s not infinite. Similarly, the total area of the United States is 3,794,101 square miles—an impressive amount of acreage, but not endless. Because these resources are limited, so are the numbers of goods and services we can produce with them. Combine this with the fact that human wants seem to be virtually infinite, and you can see why scarcity is a problem.

Economics

When faced with limited resources, we have to make choices. Again, economics is the study of how humans make choices under conditions of scarcity. These decisions can be made by individuals, families, businesses, or societies.

Let’s consider a few decisions that we make based on limited resources. Take the following:

1. What classes are you taking this term?

Are you the lucky student who is taking every class you wanted with your first-choice professor during the perfect time and at the ideal location? The odds are that you have probably had to make trade-offs on account of scarcity. There is a limited number of time slots each day for classes and only so many faculty available to teach them. Every faculty member can’t be assigned to every time slot. Only one class can be assigned to each classroom at a given time. This means that each student has to make trade-offs between the time slot, the instructor, and the class location.

2. Where do you live?

Think for a moment, if you had all the money in the world, where would you live? It’s probably not where you’re living today. You have probably made a housing decision based on scarcity. What location did you pick? Given limited time, you may have chosen to live close to work or school. Given the demand for housing, some locations are more expensive than others, and you may have chosen to spend more money for a convenient location or to spend less money for a place that leaves you spending more time on transportation. There is a limited amount of housing in any location, so you are forced to choose from what’s available at any time. Housing decisions always have to take into account what someone can afford. Individuals making decisions about where to live must deal with limitations of financial resources, available housing options, time, and often other restrictions created by builders, landlords, city planners, and government regulations.

The Problem of Scarcity

Every society, at every level, must make choices about how to use its resources. Families must decide whether to spend their money on a new car or a fancy vacation. Towns must choose whether to put more of the budget into police and fire protection or into the school system. Nations must decide whether to devote more funds to national defense or to protecting the environment. In most cases, there just isn’t enough money in the budget to do everything.

Economics helps us understand the decisions that individuals, families, businesses, or societies make, given the fact that there are never enough resources to address all needs and desires.

The Concept of Opportunity Cost

Two Doors

The Idea of Opportunity Cost 

Since resources are limited, every time you make a choice about how to use them, you are also choosing to forego other options. Economists use the term opportunity cost to indicate what must be given up to obtain something that’s desired. A fundamental principle of economics is that every choice has an opportunity cost. If you sleep through your economics class (not recommended, by the way), the opportunity cost is the learning you miss. If you spend your income on video games, you cannot spend it on movies. If you choose to marry one person, you give up the opportunity to marry anyone else. In short, opportunity cost is all around us.

The idea behind opportunity cost is that the cost of one item is the lost opportunity to do or consume something else; in short, opportunity cost is the value of the next best alternative.

Since people must choose, they inevitably face trade-offs in which they have to give up things they desire to get other things they desire more.

Opportunity Cost and Individual Decisions

In some cases, recognizing the opportunity cost can alter personal behavior. Imagine, for example, that you spend $8 on lunch every day at work. You may know perfectly well that bringing a lunch from home would cost only $3 a day, so the opportunity cost of buying lunch at the restaurant is $5 each day (that is, the $8 that buying lunch costs minus the $3 your lunch from home would cost). Five dollars each day does not seem to be that much. However, if you project what that adds up to in a year—250 workdays a year × $5 per day equals $1,250—it’s the cost, perhaps, of a decent vacation. If the opportunity cost were described as “a nice vacation” instead of “$5 a day,” you might make different choices.

Opportunity Cost and Societal Decisions

Opportunity cost also comes into play with societal decisions. Universal health care would be nice, but the opportunity cost of such a decision would be less housing, environmental protection, or national defense. These trade-offs also arise with government policies. For example, after the terrorist plane hijackings on September 11, 2001, many proposals, such as the following, were made to improve air travel safety:

· The federal government could provide armed “sky marshals” who would travel inconspicuously with the rest of the passengers. The cost of having a sky marshal on every flight would be roughly $3 billion per year.

· Retrofitting all U.S. planes with reinforced cockpit doors to make it harder for terrorists to take over the plane would have a price tag of $450 million.

· Buying more sophisticated security equipment for airports, like three-dimensional baggage scanners and cameras linked to face-recognition software, would cost another $2 billion.

However, the single biggest cost of greater airline security doesn’t involve money. It’s the opportunity cost of additional waiting time at the airport. According to the US Department of Transportation, more than 800 million passengers took plane trips in the United States in 2012. Since the 9/11 hijackings, security screening has become more intensive, and consequently, the procedure takes longer than in the past. Say that, on average, each air passenger spends an extra 30 minutes in the airport per trip. Economists commonly place a value on time to convert an opportunity cost in time into a monetary figure. Because many air travelers are relatively highly paid businesspeople, conservative estimates set the average “price of time” for air travelers at $20 per hour. Accordingly, the opportunity cost of delays in airports could be as much as 800 million (passengers) × 0.5 hours × $20—or, $8 billion per year. Clearly, the opportunity costs of waiting time can be just as substantial as costs involving direct spending. 

[video]  https://youtu.be/PSU-_n81QT0

Division of Labor and Specialization    

Red Wing Shoes Factory

The Division and Specialization of Labor

We have learned that there aren’t enough resources to fulfill all of our wants, and this reality forces us to make choices that have opportunity costs. How do we get the most we can from the resources we have? Over time, markets and trade have come into existence and have become highly efficient mechanisms for optimizing our use of resources and bringing us the most and best combination of goods and services.

Think back to pioneer days, when the average person knew how to do so much more on his or her own than someone today—everything from shoeing a horse to growing, hunting, and preserving food, to building a house and repairing equipment. Most of us don’t know how to do all—or any—of those things. It’s not because we’re not capable of learning them. It’s because we don’t have to. The reason for this is something called the “division and specialization of labor,” a production innovation first put forth by Adam Smith.

The formal study of economics began when Smith (1723–1790) published his famous book, The Wealth of Nations, in 1776. Many authors had written about economics in the centuries before Smith, but he was the first to address the subject in a comprehensive way.

Card of Old Pins

In the first chapter of the book, Smith introduces the idea of the division of labor, which means that the way a good or service is produced is divided into a number of tasks that are performed by different workers, instead of all the tasks being performed by the same person. To illustrate the division of labor, Smith counted how many tasks were involved in making a pin: drawing out a piece of wire, cutting it to the right length, straightening it, putting a head on one end and a point on the other, packaging pins for sale, and so on. Smith counted 18 distinct tasks that were typically performed by different people—all for a pin!

Modern companies divide tasks, too. Even a relatively simple business like a restaurant divides up the task of serving meals into a range of jobs: top chef, sous chefs, less-skilled kitchen help, host/hostess, waiters/waitresses, janitors, a business manager to handle accounts and paychecks, etc. A complex business like a large manufacturing factory or a hospital can have hundreds of job classifications.

Why the Division of Labor Increases Production

When the tasks involved with producing a good or service are divided and subdivided, workers and businesses can produce a greater quantity of those goods or services. In his study of pin factories, Smith observed that one worker alone might make 20 pins in a day, but that a small business of 10 workers (some of whom would need to do 2 or 3 of the 18 tasks involved in pin making), could make 48,000 pins in a day. How can a group of workers, each specializing in certain tasks, produce so much more than the same number of workers who try to produce the entire good or service by themselves? Smith offered three reasons.

First, specialization in a particular small job allows workers to focus on the parts of the production process in which they have an advantage. People have different skills, talents, and interests, so they will be better at some jobs than at others. The particular advantages may be based on educational choices, which are shaped, in turn, by interests and talents. Only those with medical training qualify to become doctors, for instance. For some goods, specialization will be affected by geography—it’s easier to be a wheat farmer in North Dakota than in Florida, but easier to run a tourist hotel in Florida than in North Dakota. If you live in or near a big city, it’s easier to attract enough customers to operate a successful dry-cleaning business or movie theater than if you live in a sparsely populated rural area. Whatever the reason, if people specialize in the production of what they do best, they will be more productive than if they produce a combination of things, some of which they are good at and some of which they are not.

Second, workers who specialize in certain tasks often learn to produce more quickly and with higher quality. This pattern holds true for many workers, including assembly-line laborers who build cars, stylists who cut hair, and doctors who perform heart surgery. In fact, specialized workers often know their jobs well enough to suggest innovative ways to do their work faster and better. A similar pattern often operates within businesses. In many cases, a business that focuses on one or a few products is more successful than firms that try to make a wide range of products.

Third, specialization allows businesses to take advantage of economies of scale, which means that, for many goods, as the level of production increases, the average cost of producing each individual unit declines. For example, if a factory produces only 100 cars per year, each car will be quite expensive to make on average. However, if a factory produces 50,000 cars each year, then it can set up an assembly line with huge machines and workers performing specialized tasks, and the average cost of production per car will drop. Economies of scale implies that production is becoming more efficient as the scale of production rises.

The ultimate result of workers who can focus on their preferences and talents, learn to do their specialized jobs better, and work in larger organizations is that society as a whole can produce and consume far more than if everyone tried to produce all of their own goods and services. The division and specialization of labor has been a force against the problem of scarcity.

Trade and Markets

Specialization only makes sense, though, if workers (and other economic agents such as businesses and nations) can use their income to purchase the other goods and services they need. In short, specialization requires trade. You do not have to know anything about electronics or sound systems to play music—you just buy an iPod or MP3 player, download the music, and listen. You don’t have to know anything about textiles or the construction of sewing machines if you need a jacket—you just buy the jacket and wear it. Instead of trying to acquire all the knowledge and skills involved in producing all of the goods and services that you wish to consume, the market allows you to learn a specialized set of skills and then use the pay you receive to buy the goods and services you need or want. This is how our modern society has evolved into a strong economy.

Microeconomics and Macroeconomics

[video]  https://youtu.be/w8tUIq7Blsg

Vermillion Lake

It should be clear by now that economics covers a lot of ground. That ground can be divided into two parts: Microeconomics focuses on the actions of individual agents within the economy, like households, workers, and businesses. Macroeconomics looks at the economy as a whole. It focuses on broad issues such as growth, unemployment, inflation, and trade balance. Microeconomics and macroeconomics are not separate subjects but are, rather, complementary perspectives on the overall subject of the economy.

To understand why both microeconomic and macroeconomic perspectives are useful, consider the problem of studying a biological ecosystem like a lake. One person who sets out to study the lake might focus on specific topics: certain kinds of algae or plant life; the characteristics of particular fish or snails; or the trees surrounding the lake. Another person might take an overall view and instead consider the entire ecosystem of the lake from top to bottom: what eats what, how the system remains in balance, and what environmental stresses affect this balance. Both approaches are useful, and both researchers study the same lake, but the viewpoints are different. In a similar way, both microeconomics and macroeconomics study the same economy, but each has a different starting point, perspective, and focus.

Whether you are looking at lakes or economics, the micro and the macro insights should illuminate each other. In studying a lake, the “micro” insights about particular plants and animals help us to understand the overall food chain, while the “macro” insights about the overall food chain help to explain the environment in which individual plants and animals live.

In economics, the micro decisions of individual businesses are influenced by the health of the macroeconomy—for example, firms will be more likely to hire workers if the overall economy is growing. In turn, the performance of the macroeconomy ultimately depends on the microeconomic decisions made by individual households and businesses.

Microeconomics

What determines how households and individuals spend their budgets? What combination of goods and services will best fit their needs and wants, given the budget they have to spend? How do people decide whether to work, and if so, whether to work full time or part time? How do people decide how much to save for the future, or whether they should borrow to spend beyond their current means?

What determines the products, and how many of each, a firm will produce and sell? What determines the prices a firm will charge? What determines how a firm will produce its products? What determines how many workers it will hire? How will a firm finance its business? When will a firm decide to expand, downsize, or even close? In the microeconomic part of this text, we will learn about the theory of consumer behavior and the theory of the firm.

Macroeconomics

What determines the level of economic activity in a society or nation—that is, how many goods and services does it actually produce? What determines how many jobs are available in an economy? What determines a nation’s standard of living? What causes the economy to speed up or slow down? What causes firms to hire more workers or lay them off? Finally, what causes the economy to grow over the long term?

An economy’s macroeconomic health can be assessed by a number of standards or goals. The most important macroeconomic goals are the following:

· Growth in the standard of living

· Low unemployment

· Low inflation

Macroeconomic policy pursues these goals through monetary policy and fiscal policy:

· Monetary policy, which involves policies that affect bank lending, interest rates, and financial capital markets, is conducted by a nation’s central bank. For the United States, this is the Federal Reserve.

· Fiscal policy, which involves government spending and taxes, is determined by a nation’s legislative body. For the United States, this is the Congress and the executive branch, which establishes the federal budget.

To keep the differences between these policies straight, remember that the term monetary relates to money, and the term fiscal relates to government revenue or taxes.

These are the main tools the government has to work with. In the United States, we tend to expect that government can fix whatever economic problems we encounter, but to what extent is that expectation realistic? These are just some of the issues that will be explored later in this course.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade in the class, and you can retake it as  many times as you wish.

Use this quiz to decide whether to study the section further or move on.

Choose the BEST answer.

Question 1

Which of the following items is not scarce?

air

money

land

Question 2

________ is the way a service or good is produced and divided into a variety of tasks performed by different workers, instead of the same person performing all the tasks.

Opportunity cost

Division of labor

Economics

Question 3

What will we never do in a world of scarcity?

Use all economic resources such that we satisfy the maximum amount of wants.

Satisfy all basic human needs.

Meet all of society’s wants.

Licenses and Attributions

Introduction to Economics  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Outcome: What Is Economics?. Authored by: Linda Williams, Steve Greenlaw, and Lumen Learning. License:  CC BY: Attribution

What Is Economics?  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Check Your Understanding. Authored by: Lumen Learning. License:  CC BY: Attribution

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· Principles of Microeconomics Chapter 1.1. Authored by: OpenStax College. Provided by: Rice University. Located at:  http://cnx.org/contents/ea2f225e-6063-41ca-bcd8-36482e15ef65 . License:  CC BY: Attribution

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· Principles of Microeconomics Chapter 2.1. Authored by: OpenStax College. Provided by: Rice University. Located at:  http://cnx.org/contents/ea2f225e-6063-41ca-bcd8-36482e15ef65@10.31:24/Microeconomics . License:  CC BY: Attribution

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· Zwei Tu00fcren / Two Doors. Authored by: Stefan W. Located at:  https://www.flickr.com/photos/stefan-w/5355424756/ . License:  CC BY: Attribution

· Episode 8: Opportunity Cost. Authored by: Dr. Mary J. McGlasson. Located at:  https://youtu.be/PSU-_n81QT0 . License:  CC BY-NC-ND: Attribution-NonCommercial-NoDerivatives

· Principles of Microeconomics Chapter 1.1. Authored by: OpenStax College. Provided by: Rice University. Located at:  http://cnx.org/contents/6i8iXmBj@10.170:6RH0nLs4@8/What-Economics-Is-and-Why-Its- . License:  CC BY: Attribution

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· Red Wing Shoes Factory Tour. Authored by: Nina Hale. Located at:  https://www.flickr.com/photos/94693506@N00/4643862950/ . License:  CC BY: Attribution

· Episode 4: Micro v Macro. Authored by: Dr. Mary J. McGlasson. Located at:  https://youtu.be/w8tUIq7Blsg . License:  CC BY-NC-ND: Attribution-NonCommercial-NoDerivatives

· Principles of Microeconomics Chapter 1.2. Authored by: OpenStax College. Provided by: Rice University. Located at:  http://cnx.org/contents/ea2f225e-6063-41ca-bcd8-36482e15ef65@10.31:4/Microeconomics . License:  CC BY: Attribution

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Economic Systems

What you’ll learn to do: Describe and differentiate major economic systems

In this section, you’ll learn about the basic organizing principles of different types of economies. Understanding the characteristics of a competitive market, in particular, is an important foundation for understanding the mechanisms of supply and demand, which you’ll learn about later in this chapter.

LEGO World - Fan Zone

Legoland, Billund, Denmark: Picture of a Planned Economy?

Learning Outcomes

· Distinguish between market, planned, and mixed economies

Types of Economies

Consider how complex a modern economy is. It includes all production of goods and services, all buying and selling, all employment. The economic life of every individual is interrelated, at least to a small extent, with the economic lives of thousands or even millions of other individuals. Who organizes and coordinates this system? Who insures that, for example, the number of televisions a society produces is the same as the amount it needs and wants? Who insures that the right number of employees works in the electronics industry? Who makes sure that televisions are produced in the best way possible? How does it all get done? The answer to these important questions depends on the kind of economic system a society uses.

In the modern world today, there is a range of economic systems, from market economies to planned (or command) economies.

Market Economies

A market is any situation that brings together buyers and sellers of goods or services. Buyers and sellers can be either individuals or businesses. In a market economy, economic decision making happens through markets. Market economies are based on private enterprise: The means of production (resources and businesses) are owned and operated by private individuals or groups of private individuals. Businesses supply goods and services based on demand. Which goods and services are supplied depends on what is demanded by consumers or other businesses. A person’s income is based on his or her ability to convert resources (especially labor) into something that society values. The more society values the person’s output, the higher the income they will earn (think Lady Gaga or LeBron James).

Examples of free-market economies include Hong Kong, Singapore, Australia, and the United States.

Free Markets 

In a market economy, decisions about what products are available and at what prices are determined through the interaction of supply and demand. A competitive market is one in which there is a large number of buyers and sellers, so that no one can control the market price. A free market is one in which the government does not intervene in any way. A free and competitive market economy is the ideal type of market economy, because what is supplied is exactly what consumers demand.

Price controls are an example of a market that is not free. When government intervenes, the market outcomes will be different from those that would occur in a free and competitive market model. When markets are less than perfectly competitive (e.g., monopolistic), the market outcomes will also differ.

Planned (or Command) Economies

Sphinx

Command economies operate very differently. In a command economy, economic effort is devoted to goals passed down from a ruler or ruling class. Ancient Egypt was a good example: A large part of economic life was devoted to building pyramids for the pharaohs. Medieval manor life is another example: The lord provided the land for growing crops and protection in the event of war. In return, vassals provided labor and soldiers to do the lord’s bidding. In the last century, communism emphasized command economies.

In a command economy, resources and businesses are owned by the government. The government decides what goods and services will be produced and what prices will be charged for them. The government decides what methods of production will be used and how much workers will be paid. Some necessities like health care and education are provided for free, as long as the state determines that you need them. Currently, North Korea and Cuba have command economies.

The primary distinction between a free and command economy is the degree to which the government determines what can be produced and what prices will be charged. In a free market, these determinations are made by the collective decisions of the market itself (which is comprised of producers and consumers). Producers and consumers make rational decisions about what will satisfy their self-interest and maximize profits, and the market responds accordingly. In a planned economy, the government makes most decisions about what will be produced and what the prices will be, and the market must follow that plan.

Most economies in the real world are mixed; they combine elements of command and market systems. The US economy is positioned toward the market-oriented end of the spectrum. Many countries in Europe and Latin America, while primarily market-oriented, have a greater degree of government involvement in economic decisions than in the US economy. China and Russia, while they are closer now to having a market-oriented system than several decades ago, remain closer to the command-economy end of the spectrum.

The following Crash Course video provides additional information about the broad economic choices that countries make when they decide between planned and market economies. The narrators talk fast, so you’ll need to listen closely and possibly watch the video a second time!

https://youtu.be/B43YEW2FvDs

Economic systems determine the following:

· what to produce

· how to produce it

· who gets it

In a planned economy, government controls the factors of production:

· In a true communist economy, there is no private property—everyone owns the factors of production. This type of planned economy is called a command economy.

· In a socialist economy, there is some private property and some private control of industry.

In a free-market (capitalist) economy, individuals own the factors of production:

· Privately owned businesses produce products.

· Consumers choose the products they prefer, causing the companies that product them to make more profit.

Even in free markets, governments will

· maintain the rule of law

· create public goods and services such as roads and education

· step in when the market gets things wrong (e.g., setting minimum wage, establishing environmental standards)

In reality, economies are neither completely free-market nor completely planned. Neither exists in “pure” form, since all societies and governments regulate their economies to varying degrees. Throughout this course we will consider a number of ways in which the US government influences and controls the economy.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade in the class, and you can retake it as many times as you wish.

Use this quiz to decide whether to study the section further or move on.

Choose the BEST answer.

Question 1

A competitive market is one in which:

government makes most decisions about what will be produced.

everyone owns the factors of production.

there are a large number of buyers and sellers.

Question 2

A free market is described by which of the following statements?

The government does not intervene in any way.

The price of outputs is controlled by the government.

Inputs are free to sellers.

Question 3

Which country has characteristics of a command economy?

United States

Singapore

Russia

Licenses and Attributions

Introduction to Economic Systems  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Outcome: Economic Systems. Authored by: Linda Williams, Steve Greenlaw, and Lumen Learning. License:  CC BY: Attribution

Economic Systems  by Steven Greenlaw and Lumen Learning from Introduction to Business is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Economic Systems and Macroeconomics: Crash Course Economics #3. Provided by: CrashCourse. Located at:  https://youtu.be/B43YEW2FvDs . License: All Rights Reserved. License Terms: Standard YouTube license

Health of the Economy

What you’ll learn to do: Describe how economists evaluate the health of an economy

This section will help you understand why economists use terms like GDP, CPI, and unemployment rates to assess how an economy is doing.

Part of a Dollar Bill

Learning Outcomes

· Explain the use of GDP as an economic indicator

Economic Indicators

When you go to the doctor with the flu, the nurse takes your temperature. If your temperature is much above 98.6 degrees, they declare you to have a fever. Depending on your other symptoms, they may prescribe medication to bring down your fever and fight the infection. How might you (or an economist) take the temperature of an economy, so to speak, to check for health or sickness? No single measurement like body temperature will give a complete picture, so instead economists rely on what are called economic indicators. An economic indicator is a statistic that provides valuable information about the economy. There is no shortage of economic indicators, and trying to follow them all would be an overwhelming task. Many different economic indicators are tracked in order to evaluate the economy in different ways, or from different perspectives.

Statistics that report the status of the economy a few months in the past are called lagging economic indicators. One such lagging indicator is the average length of unemployment. If unemployed workers have remained out of work for a long time, we may infer that the economy has been slow. Indicators that predict the status of the economy 3 to 12 months into the future are called leading economic indicators. For example, the number of building permits issued is often a good way to assess the strength of the housing market. An increase in this statistic—which tells us how many new housing units are being built—indicates that the economy is improving, because increased building brings money into the economy not only through new home sales but also through sales of furniture and appliances to furnish these homes. If a leading indicator rises, the economy is likely to expand in the coming year. If it falls, the economy is likely to slow down. Governments, businesses, and investors use economic indicators as a measure of how well an economy is meeting its goals.

Economic Goals

The world’s market-based economies all share the following three main goals:

1. growth

2. high employment

3. price stability

Economic indicators reveal information about how the economy is doing relative to these goals. Let’s look more closely at growth, employment, and price stability, and the means used to measure them.

Growth

GDP

The size of a nation’s overall economy is typically measured by its gross domestic product (GDP), which is the value of all officially recognized final goods and services produced within a country in a given period of time (usually a year). Intermediate goods (such as steel or plywood used as inputs in the production of other goods) are not included because they would cause double-counting. GDP only refers to goods produced within a particular country. For instance, if a firm is located in one country but manufactures goods in another, those goods are counted as part of the manufacturing country’s GDP, not the firm’s home country. BMW is a German company, but cars manufactured in the United States are counted as part of the US GDP.

The measurement of GDP involves counting up the production of millions of different goods and services—smartphones, cars, music downloads, computers, steel, bananas, college educations, and all other new goods and services produced in the current year—and summing them into a total dollar value. This task is straightforward: Take the quantity of everything produced, multiply it by the price at which each product sold, and add up the total. In 2014, the U.S. GDP totaled $17.4 trillion, the largest GDP in the world.

When a country’s GDP grows, its economy is likewise considered to be expanding and growing. Increases in GDP are expressed as a percentage rate of increase, and they are often expressed as GDP per capita (per person). In order to calculate GDP per capita, the GDP is divided by the total population of a country. Also, when measuring economic growth, agencies use “real GDP,” which is adjusted for inflation. If the GDP figures were not adjusted for inflation, then steep rises in prices (inflation) could be mistaken for growth. Likewise, if GDP is not expressed per capita, then a country like India with a massive population would always be regarded as having one of the largest, fastest growing economies. The map, below, shows the world’s GDP per capita by country.

GDP Per Capita by Country

High Employment

A country’s employment level—as defined by cyclical, structural, and frictional unemployment—is one of the most important economic indicators. Unemployment has an enormous impact on business operations, from the largest multinational corporation to the smallest mom-and-pop gift shop. When people are unemployed, even temporarily, they stop spending money on nonessential goods and services, which slows down the economy. Such a slowdown leads to a decrease in revenue for businesses, which causes companies to lay off more workers, which means more unemployed people who can’t purchase their goods and services. Because of this spiraling effect, unemployment is a closely watched economic indicator.

The Unemployment Rate

There are three important categories of unemployment levels that need to be understood in order to evaluate the effect of employment levels on overall economic performance: cyclical unemployment, structural unemployment, and frictional unemployment.

Cyclical Unemployment

Cyclical unemployment occurs when there is not enough total demand in the economy to provide jobs for everyone who wants to work. When demand for most goods and services falls, less production is needed, and, as a result, fewer workers are needed; wages generally stay put and do not fall to meet the equilibrium level, and mass unemployment results. With cyclical unemployment, the number of unemployed workers exceeds the number of job vacancies, so that even if full employment was reached and all open jobs were filled, some workers would still be without jobs. In economics, full employment is the level of employment rate where there is no cyclical unemployment.

Structural Unemployment

Structural unemployment occurs when a labor market is unable to provide jobs for everyone who wants to work, because there is a mismatch between the skills of the unemployed workers and the skills needed for the available jobs. Structural unemployment may develop or increase as a result of persistent cyclical unemployment: If an economy suffers from long-lasting low aggregate demand, many of the unemployed may become disheartened, and their skills (including job-searching skills) become rusty and obsolete. The implication is that sustained high demand may lower structural unemployment. Seasonal unemployment can be seen as a kind of structural unemployment, since it’s a type of unemployment that is linked to certain kinds of jobs (construction work or migratory farm work, for instance).

Frictional Unemployment

Frictional unemployment is the time period between jobs when a worker is searching for or transitioning from one job to another. It’s sometimes called search unemployment and can be voluntary depending on the circumstances of the unemployed individual. Frictional unemployment is always present in an economy, so the level of involuntary unemployment is really the unemployment rate minus the rate of frictional unemployment. Frictional unemployment exists because both jobs and workers are heterogeneous, and a mismatch can result between the characteristics of supply and demand. Such a mismatch can be related to any of the following reasons:

· skills

· payment

· worktime

· location

· seasonal industries

· attitude

· taste

There can be a range of other factors, too. New entrants (such as graduating students) and people reentering the workforce (such as former homemakers) can also suffer a spell of frictional unemployment. Workers as well as employers accept a certain level of imperfection, risk, or compromise, but usually not right away; they will invest some time and effort to find a better match. This is in fact beneficial to the economy, since it results in a better allocation of resources.

Price Stability

The third major goal of all economies is maintaining price stability. Price stability occurs when prices remain largely unchanged, and there isn’t rapid inflation or deflation. Inflation is a rise in the general price level of goods and services during a period of time. Deflation is a decrease in the general price level of goods and services. Price stability means that the average price for goods and services either doesn’t change or changes very little. Most economists believe that steady levels of low-to-moderate inflation are ideal.

As inflation pushes prices higher (slowly), businesses increase their revenues, people put more money into the system, and assets increase in value, which are all positive economic indicators. This is why economists are careful to say that a steady level of low inflation is a positive sign in the economy. As inflation rises, prices rise and values rise, which both contribute to an increase in GDP—another measure of the health of an economy. During the past three decades, inflation has been relatively low (well below 10 percent) in the US economy, and this has contributed to the general stability of the economy. Inflation doesn’t always increase slowly. A sudden, rapid rise in inflation is called hyperinflation. Argentina has recently (and repeatedly) experienced runaway inflation, with consumer prices increasing in some cases by 50 percent in a matter of days.

The figure, “US Inflation Rate,” below, shows the US inflation rate from 1989 to 2009. As you can see, looking back at the twentieth century, there have been several periods when inflation caused the price level to rise at double-digit rates, but nothing has come close to hyperinflation.

US Inflation Rate

Consumer Price Index (CPI)

The most commonly cited measure of inflation in the United States is the consumer price index (CPI). The CPI measures changes in the price level of consumer goods and services purchased by households. The CPI in the United States is defined by the Bureau of Labor Statistics (BLS) as “a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services.”

The CPI market basket represents all the consumer goods and services purchased by urban households. Price data are collected for over 180 categories, which BLS has grouped into 8 major groups. These major groups, with examples of categories in each, are as follows:

· food and beverages (ham, eggs, carbonated drinks, coffee, meals and snacks)

· housing (rent of primary residence, fuel oil, bedroom furniture)

· apparel (men’s shirts and sweaters, women’s dresses, jewelry)

· transportation (new vehicles, gasoline, tires, airline fares)

· medical care (prescription drugs and medical supplies, physicians’ services, eyeglasses and eye care, hospital services)

· recreation (television sets, cable TV, pets and pet products, sports equipment, admissions)

· education and communication (college tuition, postage, telephone services, computer software and accessories)

· other goods and services (tobacco and smoking products, hairuts and other personal care services, funeral expenses)

The CPI simplifies the measurement of changes in prices over time. By selecting an appropriate reference base and setting the average index level for that time period equal to 100, it is possible to compare this month’s (or last year’s) price index level with the reference base period or to any other time period. The current standard reference base period is 1982–1984=100. That is, all price changes are measured from a base (100) that represents the average index level of the 36-month period encompassing 1982, 1983, and 1984 (US Bureau of Labor Statistics, n.d.).                                           

Consumer Price Index 2006 to 2016 (Source: US BLS)

Consumer Confidence Index

Another important economic indicator is the consumer confidence index. This indicator measures the degree of optimism that consumers feel about the overall state of the economy and their personal financial situations. How confident people feel about the stability of their incomes determines their spending activity and therefore serves as one of the key indicators for the overall shape of the economy. In essence, if the economy expands, causing consumer confidence to be higher, consumers will be making more purchases. On the other hand, if the economy contracts or is in bad shape, confidence is lower, and consumers tend to save more and spend less. A month-to-month diminishing trend in consumer confidence suggests that in the current state of the economy most consumers have a negative outlook on their ability to find and retain good jobs.

The ability to predict major changes in consumer confidence allows businesses to gauge the willingness of consumers to make new purchases. As a result, businesses can adjust their operations, and the government can prepare for changing tax revenue. If confidence is dropping and consumers are expected to reduce their spending, most producers will tend to reduce their production volumes accordingly. For example, if manufacturers anticipate that consumers will reduce retail purchases, especially for expensive and durable goods, they will cut down their inventories in advance, and may delay investing in new projects and facilities. The government will get ready for the reduction in future tax revenues. On the other hand, if consumer confidence is improving, people are expected to increase their purchases of goods and services. In anticipation of that change, manufacturers can boost production and inventories. Large employers can increase hiring rates. Government can expect improved tax revenues based on the increase in consumer spending.

Consumer confidence is formally measured by the Consumer Confidence Index (CCI), a monthly release designed to assess the overall confidence, relative financial health, and spending power of the average USA consumer. The CCI is an important measure used by businesses, economic analysts, and the government in order to determine the overall health of the economy.

Check Your Knowledge

Answer the following questions to see how well you understand the topics covered in this section. This short quiz does not count toward your grade in the class, and you can retake it as many times as you wish.

Use this quiz to decide whether to study the section further or move on.

Question 1

The market value of all goods and services produced by the economy in a given year is known as

Rate of Inflation.

Consumer Price Index (CPI).

Gross Domestic Product (GDP).

Question 2

A business cycle reflects changes in economic activity, as measured by

Gross Domestic Product (GDP)

Consumer Price Index (CPI)

rate of unemployment

Question 3

Which of the following describes a business cycle?

regular growth rate of consumer spending

periods of increasing and decreasing real Gross Domestic Product (GDP)

inflation sometimes, but not others

References

US Bureau of Labor Statistic. (n.d.). Consumer price index. Retrieved from\ https://www.bls.gov/cpi/

Licenses and Attributions

Introduction to the Health of the Economy  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Outcome: Health of the Economy. Authored by: Linda Williams and Steve Greenlaw. License:  CC BY: Attribution

Health of the Economy  from Introduction to Business by Linda Williams and Lumen Learning is available under a   Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Check Your Understanding. Authored by: Lumen Learning. License:  CC BY: Attribution

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· Economic Indicators from Boundless Business. Provided by: Boundless. Located at:  https://www.boundless.com/business/textbooks/boundless-business-textbook/economics-and-business-2/measuring-economic-performance-29/economic-indicators-156-6981/ . License:  CC BY-SA: Attribution-ShareAlike

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· Measuring the Size of the Economy from Principles of Economics. Authored by: OpenStax. Provided by: Rice University. Located at:  https://cnx.org/contents/aWGdK2jw@11.330:ZX6Q1XMv@13/Measuring-the-Size-of-the-Econ%5D . License:  CC BY: Attribution

· Employment Levels from Boundless Business. Provided by: Boundless. Located at:  https://www.boundless.com/business/textbooks/boundless-business-textbook/economics-and-business-2/measuring-economic-performance-29/employment-levels-158-10172/ . License:  CC BY-SA: Attribution-ShareAlike

· Consumer Income, Purchasing Power, and Confidence from Boundless Marketing. Provided by: Boundless. Located at:  https://www.boundless.com/marketing/textbooks/boundless-marketing-textbook/the-marketing-environment-3/external-factors-31/consumer-income-purchasing-power-and-confidence-164-7604 . License:  CC BY-SA: Attribution-ShareAlike

· GDP per Capita. Provided by: Wikimedia. Located at:  https://commons.wikimedia.org/wiki/File:Countries_by_GDP_(PPP)_Per_Capita_in_2015.svg . License:  CC0: No Rights Reserved

· Economic Indicator: His Eyes Are Bloodshot. Authored by: Bill Morrow. Located at:  https://www.flickr.com/photos/billmorrow/7677126048/ . License:  CC BY: Attribution

· U.S. Inflation Rate. Provided by: Wikimedia. Located at:  https://commons.wikimedia.org/wiki/File:US_Inflation.png . License:  CC0: No Rights Reserved

Putting It Together: Economic Environment

Synthesis

In this chapter you learned about the fundamental economic principles that affect the environment in which businesses operate. Understanding the economy is like getting the weather forecast before you head out the door. Might you need to pack a sweater or an umbrella or grab some sunscreen? Perhaps, like Dorothy in The Wizard of Oz, head for the nearest cellar? If you ignore the forecast, you can find yourself unprepared and caught in a storm. Of course, economic forecasts aren’t totally reliable—sometimes there’s a freak weather event that no one saw coming. Nonetheless, having a basic understanding of how supply and demand work, how different economic systems function, and how the business cycle connects to the economy can help you make informed decisions—and make the best out of a rainy day.

Summary

In this chapter you learned about the fundamental principles of economics and how they shape the business environment. Below is a summary of the key points covered.

What Is Economics?

Economics focuses on the ways in which people, businesses, and governments make decisions when faced with scarce resources. Economists study the economy at either the microeconomic level (focus on individuals) or the macroeconomic level (focus on systems).

Economic Systems

Economic systems can be organized as traditional, planned, or market economies. Traditional systems are hunter-gatherer economies in which people consume what they produce. In command economies such as communism and socialism, the government exercises a high degree of control over production and pricing. In market economies such as capitalism, free-market supply and demand drives what is produced and consumed. The increasing complexity of the world has led to mixed economic systems that have characteristics of both command and market economies.

Demand

Demand is the amount that consumers are willing and able to purchase of a good or service at a given price. Quantity demanded is a specific quantity that will be supplied at a single point (price) on the demand curve.

Supply

Supply is the amount of a good or service that a business is willing to produce at a given price. Quantity supplied refers to a specific quantity that will be supplied at a single point (price) on the supply curve.

Equilibrium

Equilibrium is said to exist at the point where quantity supplied equals the quantity demanded, and therefore, there is no excess or shortage in the market. The market is “in balance.” The equilibrium price is the price where the amount that consumers want to purchase is equal to the quantity that the producers are willing to supply. The equilibrium quantity is the quantity supplied and demanded at the equilibrium price.

Health of the Economy

Economists use several measures to evaluate the health of an economy. Among the most important are GDP (Gross Domestic Product), the unemployment rate, and the CPI (Consumer Price Index). These three key economic indicators are used to measure how well the economy is achieving the goals of growth, high employment, and price stability.

Economic Stages

The business environment is cyclical, meaning it goes through a cycle of stages, each of which is characterized by a different set of economic conditions. The four stages of the business environment are expansion, peak, contraction, and trough.

Licenses and Attributions

Putting It Together: Economic Environment  from Introduction to Business by Linda Williams and Lumen Learning is available under a  Creative Commons Attribution 4.0 International  license. UMUC has modified this work and it is available under the original license.

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· Putting It Together: Economic Environment. Authored by: Linda Williams and Lumen Learning. License:  CC BY: Attribution

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