Organizational Control

Exploring BusinessExploring Business

Exploring BusinessExploring Business

[AUTHOR REMOVED AT REQUEST OF ORIGINAL PUBLISHER]

UNIVERSITY OF MINNESOTA LIBRARIES PUBLISHING EDITION, 2016. THIS EDITION ADAPTED FROM A WORK ORIGINALLY PRODUCED IN 2010 BY A PUBLISHER WHO HAS REQUESTED THAT IT NOT RECEIVE

ATTRIBUTION. MINNEAPOLIS, MN

Exploring Business by University of Minnesota is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 4.0 International License, except where otherwise noted.

Contents

Publisher Information x

Chapter 1: The Foundations of Business

1.1 Introduction 2 1.2 Getting Down to Business 4 1.3 What Is Economics? 9 1.4 Perfect Competition and Supply and Demand 15 1.5 Monopolistic Competition, Oligopoly, and Monopoly 21 1.6 Measuring the Health of the Economy 24 1.7 Government’s Role in Managing the Economy 31 1.8 Cases and Problems 35

Chapter 2: Business Ethics and Social Responsibility

2.1 Misgoverning Corporations: An Overview 40 2.2 The Individual Approach to Ethics 46 2.3 Identifying Ethical Issues 54 2.4 The Organizational Approach to Ethics 61 2.5 Corporate Social Responsibility 65 2.6 Environmentalism 76 2.7 Stages of Corporate Responsibility 82 2.8 Cases and Problems 87

Chapter 3: Business in a Global Environment

3.1 The Globalization of Business 94 3.2 Opportunities in International Business 103 3.3 The Global Business Environment 113 3.4 Trade Controls 123 3.5 Reducing International Trade Barriers 127

3.6 Preparing for a Career in International Business 133 3.7 Cases and Problems 135

Chapter 4: Selecting a Form of Business Ownership

4.1 Factors to Consider 140 4.2 Sole Proprietorship 142 4.3 Partnership 146 4.4 Corporation 151 4.5 Other Types of Business Ownership 156 4.6 Mergers and Acquisitions 162 4.7 Cases and Problems 166

Chapter 5: The Challenges of Starting a Business

5.1 What Is an Entrepreneur? 173 5.2 The Importance of Small Business to the U.S. Economy 182 5.3 What Industries Are Small Businesses In? 188 5.4 Advantages and Disadvantages of Business Ownership 193 5.5 Starting a Business 197 5.6 The Business Plan 204 5.7 How to Succeed in Managing a Business 211 5.8 Cases and Problems 217

Chapter 6: Managing for Business Success

6.1 What Do Managers Do? 223 6.2 Planning 225 6.3 Organizing 233 6.4 Directing 245 6.5 Controlling 249 6.6 Managerial Skills 252 6.7 Cases and Problems 258

Chapter 7: Recruiting, Motivating, and Keeping Quality Employees

7.1 Human Resource Management 266 7.2 Developing Employees 275 7.3 Motivating Employees 280 7.4 What Makes a Great Place to Work? 287 7.5 Performance Appraisal 297 7.6 Labor Unions 305

7.7 Cases and Problems 312

Chapter 8: Teamwork and Communications

8.1 The Team and the Organization 317 8.2 Why Teamwork Works 324 8.3 The Team and Its Members 330 8.4 The Business of Communication 339 8.5 Communication Channels 346 8.6 Forms of Communication 356 8.7 Cases and Problems 363

Chapter 9: Marketing: Providing Value to Customers

9.1 What Is Marketing? 369 9.2 The Marketing Mix 377 9.3 Pricing a Product 385 9.4 Placing a Product 389 9.5 Promoting a Product 400 9.6 Interacting with Your Customers 405 9.7 The Product Life Cycle 413 9.8 The Marketing Environment 418 9.9 Careers in Marketing 428 9.10 Cases and Problems 431

Chapter 10: Product Design and Development

10.1 What Is a Product? 436 10.2 Where Do Product Ideas Come From? 441 10.3 Identifying Business Opportunities 446 10.4 Understand Your Industry 450 10.5 Forecasting Demand 453 10.6 Breakeven Analysis 457 10.7 Product Development 460 10.8 Protecting Your Idea 466 10.9 Cases and Problems 468

Chapter 11: Operations Management in Manufacturing and Service Industries

11.1 Operations Management in Manufacturing 473 11.2 Facility Layouts 480 11.3 Managing the Production Process in a Manufacturing Company 484

11.4 Graphical Tools: PERT and Gantt Charts 489 11.5 The Technology of Goods Production 493 11.6 Operations Management for Service Providers 496 11.7 Producing for Quality 505 11.8 Cases and Problems 511

Chapter 12: The Role of Accounting in Business

12.1 The Role of Accounting 517 12.2 Understanding Financial Statements 523 12.3 Accrual Accounting 537 12.4 Financial Statement Analysis 547 12.5 The Profession: Ethics and Opportunities 559 12.6 Cases and Problems 566

Chapter 13: Managing Financial Resources

13.1 The Functions of Money 572 13.2 Financial Institutions 577 13.3 The Federal Reserve System 585 13.4 The Role of the Financial Manager 592 13.5 Understanding Securities Markets 601 13.6 Financing the Going Concern 608 13.7 Careers in Finance 612 13.8 Cases and Problems 615

Chapter 14: Personal Finances

14.1 Financial Planning 633 14.2 Time Is Money 645 14.3 The Financial Planning Process 650 14.4 A House Is Not a Piggy Bank: A Few Lessons from the Subprime Crisis 662 14.5 Cases and Problems 671

Chapter 15: Managing Information and Technology

15.1 Data versus Information 674 15.2 Managing Data 681 15.3 Types of Information Systems 686 15.4 Computer Networks and Cloud Computing 693 15.5 Data Communications Networks 700 15.6 Security Issues in Electronic Communication 707

15.7 Careers in Information Management 715 15.8 Cases and Problems 717

Chapter 16: The Legal and Regulatory Environment of Business

16.1 Law and the Legal System 721 16.2 Criminal versus Civil Law 725 16.3 Negligence Torts 731 16.4 Product Liability 738 16.5 Some Principles of Public Law 752 16.6 Cases and Problems 770

Please share your supplementary material! 772

Publisher Information

Exploring Business is adapted from a work produced and distributed under a Creative Commons license (CC BY-NC-SA) in 2010 by a publisher who has requested that they and the original author not receive attribution. This adapted edition is produced by the University of Minnesota Libraries Publishing through the eLearning Support Initiative.

This adaptation has reformatted the original text, and replaced some images and figures to make the resulting whole more shareable. This adaptation has not significantly altered or updated the original 2010 text. This work is made available under the terms of a Creative Commons Attribution-NonCommercial-ShareAlike license.

x

Chapter 1: The Foundations of Business

1.1 Introduction 1.2 Getting Down to Business 1.3 What Is Economics? 1.4 Perfect Competition and Supply and Demand 1.5 Monopolistic Competition, Oligopoly, and Monopoly 1.6 Measuring the Health of the Economy 1.7 Government’s Role in Managing the Economy 1.8 Cases and Problems

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1.1 Introduction

As the story of Apple suggests, today is an interesting time to study business. Advances in technology are bringing rapid changes in the ways we produce and deliver goods and services. The Internet and other improvements in communication (such as smartphones, video conferencing, and social networking) now affect the way we do business. Companies are expanding international operations, and the workforce is more diverse than ever. Corporations are being held responsible for the behavior of their executives, and more people share the opinion that companies should be good corporate citizens. Plus—and this is a big plus—businesses today are facing the lingering effects of what many economists believe is the worst financial crisis since the Great Depression (Hilsenrath, et. al., 2008). Economic turmoil that began in the housing and mortgage industries as a result of troubled subprime mortgages quickly spread to the rest of the economy. In 2008, credit markets froze up and banks stopped making loans. Lawmakers tried to get money flowing again by passing a $700 billion Wall Street bailout, yet businesses and individuals were still denied access to needed credit. Without money or credit, consumer confidence in the economy dropped and consumers cut back their spending. Businesses responded by producing fewer products, and their sales and profits dropped. Unemployment rose as troubled companies shed the most jobs in five years, and 760,000 Americans marched to the unemployment lines1. The stock market reacted to the financial crisis and its stock prices dropped by 44 percent while millions of Americans watched in shock as their savings and retirement accounts took a nose dive. In fall 2008, even Apple, a company that had enjoyed strong sales growth over the past five years, began to cut production of its popular iPhone. Without jobs or cash, consumers would no longer flock to Apple’s fancy retail stores or buy a prized iPhone (Gallagher, 2008). Things have turned around for Apple, which reported blockbuster sales for 2011 in part because of strong customer response to the iPhone 4S. But not all companies or individuals are doing so well. The economy is still struggling, unemployment is high (particularly for those ages 16 to 24), and home prices remain low.

As you go through the course with the aid of this text, you’ll explore the exciting world of business. We’ll introduce you to the various activities in which businesspeople engage—accounting, finance, information technology, management, marketing, and operations. We’ll help you understand the roles that these activities play in an organization, and we’ll show you how they work together. We hope that by exposing you to the things that businesspeople do, we’ll help you decide whether business is right for you and, if so, what areas of business you’d like to study further.

1“How the Economy Stole the Election,” CNN.com, http://money.cnn.com/galleries/2008/news/0810/ gallery.economy_election/index.html (accessed January 21, 2012).

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ReferencesReferences

Gallagher, D., “Analyst says Apple is cutting back production as economy weakens,” MarketWatch, November 3, 2008, http://www.marketwatch.com/news/story/apple-cutting-back-iphone-production/ story.aspx?guid=%7B7F2B6F99-D063-4005-87AD-D8C36009F29B%7D&dist=msr_1 (accessed January 21, 2012).

Hilsenrath, J., Serena Ng, and Damian Paletta, “Worst Crisis Since ’30s, With No End Yet in Sight,” Wall Street Journal, Markets, September 18, 2008, http://online.wsj.com/article/SB122169431617549947.html (accessed January 21, 2012).

1.1 INTRODUCTION • 3

1.2 Getting Down to Business

Learning Objective

1. Identify the main participants of business, the functions that most businesses perform, and the external forces that influence business activities.

A business is any activity that provides goods or services to consumers for the purpose of making a profit. When Steve Jobs and Steve Wozniak created Apple Computer in Jobs’s family garage, they started a business. The product was the Apple I, and the company’s founders hoped to sell their computers to customers for more than it cost to make and market them. If they were successful (which they were), they’d make a profit.

Before we go on, let’s make a couple of important distinctions concerning the terms in our definitions. First, whereas Apple produces and sells goods (Mac, iPhone, iPod, iPad), many businesses provide services. Your bank is a service company, as is your Internet provider. Hotels, airlines, law firms, movie theaters, and hospitals are also service companies. Many companies provide both goods and services. For example, your local car dealership sells goods (cars) and also provides services (automobile repairs).

Second, some organizations are not set up to make profits. Many are established to provide social or educational services. Such not-for-profit (or nonprofit) organizations include the United Way of America, Habitat for Humanity, the Boys and Girls Clubs, the Sierra Club, the American Red Cross, and many colleges and universities. Most of these organizations, however, function in much the same way as a business. They establish goals and work to meet them in an effective, efficient manner. Thus, most of the business principles introduced in this text also apply to nonprofits.

Business Participants and ActivitiesBusiness Participants and Activities

Let’s begin our discussion of business by identifying the main participants of business and the functions that most businesses perform. Then we’ll finish this section by discussing the external factors that influence a business’s activities.

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ParticipantsParticipants

Every business must have one or more owners whose primary role is to invest money in the business. When a business is being started, it’s generally the owners who polish the business idea and bring together the resources (money and people) needed to turn the idea into a business. The owners also hire employees to work for the company and help it reach its goals. Owners and employees depend on a third group of participants—customers. Ultimately, the goal of any business is to satisfy the needs of its customers in order to generate a profit for the owners.

Functional Areas of BusinessFunctional Areas of Business

Figure 1.1

Hospitals specialize in an intangible product—health care.

ReSurge International – CC BY-NC-ND 2.0.

The activities needed to operate a business can be divided into a number of functional areas: management, operations, marketing, accounting, and finance. Let’s briefly explore each of these areas.

ManagementManagement

Managers are responsible for the work performance of other people. Management involves planning for, organizing, staffing, directing, and controlling a company’s resources so that it can achieve its goals. Managers plan by setting goals and developing strategies for achieving them. They organize activities and resources

1.2 GETTING DOWN TO BUSINESS • 5

to ensure that company goals are met. They staff the organization with qualified employees and direct them to accomplish organizational goals. Finally, managers design controls for assessing the success of plans and decisions and take corrective action when needed.

OperationsOperations

All companies must convert resources (labor, materials, money, information, and so forth) into goods or services. Some companies, such as Apple, convert resources into tangible products—Macs, iPhones, iPods, iPads. Others, such as hospitals, convert resources into intangible products—health care. The person who designs and oversees the transformation of resources into goods or services is called an operations manager. This individual is also responsible for ensuring that products are of high quality.

MarketingMarketing

Marketing consists of everything that a company does to identify customers’ needs and designs products to meet those needs. Marketers develop the benefits and features of products, including price and quality. They also decide on the best method of delivering products and the best means of promoting them to attract and keep customers. They manage relationships with customers and make them aware of the organization’s desire and ability to satisfy their needs.

AccountingAccounting

Managers need accurate, relevant, timely financial information, and accountants provide it. Accountants measure, summarize, and communicate financial and managerial information and advise other managers on financial matters. There are two fields of accounting. Financial accountants prepare financial statements to help users, both inside and outside the organization, assess the financial strength of the company. Managerial accountants prepare information, such as reports on the cost of materials used in the production process, for internal use only.

FinanceFinance

Finance involves planning for, obtaining, and managing a company’s funds. Finance managers address such questions as the following: How much money does the company need? How and where will it get the necessary money? How and when will it pay the money back? What should it do with its funds? What investments should be made in plant and equipment? How much should be spent on research and development? How should excess funds be invested? Good financial management is particularly important when a company is first formed, because new business owners usually need to borrow money to get started.

Figure 1.2 Business and Its Environment

6 • EXPLORING BUSINESS

External Forces that Influence Business ActivitiesExternal Forces that Influence Business Activities

Apple and other businesses don’t operate in a vacuum: they’re influenced by a number of external factors. These include the economy, government, consumer trends, and public pressure to act as good corporate citizens. Figure 1.2 “Business and Its Environment” sums up the relationship among the participants in a business, its functional areas, and the external forces that influence its activities. One industry that’s clearly affected by all these factors is the fast-food industry. A strong economy means people have more money to eat out at places where food standards are monitored by a government agency, the Food and Drug Administration. Preferences for certain types of foods are influenced by consumer trends (eating fried foods might be OK one year and out the next). Finally, a number of decisions made by the industry result from its desire to be a good corporate citizen. For example, several fast- food chains have responded to environmental concerns by eliminating Styrofoam containers (Baron, 2006). As you move through this text, you’ll learn more about these external influences on business. (Section 1.3 “What Is Economics?” will introduce in detail one of these external factors—the economy.)

Key Takeaways

• The main participants in a business are its owners, employees, and customers.

• Businesses are influenced by such external factors as the economy, government, consumer trends, and public pressure to act as good corporate citizens.

• The activities needed to run a business can be divided into five functional areas:

1.2 GETTING DOWN TO BUSINESS • 7

1. Management involves planning, organizing, staffing, directing, and controlling resources to achieve organizational goals.

2. Operations transforms resources (labor, materials, money, and so on) into products.

3. Marketing works to identify and satisfy customers’ needs.

4. Finance involves planning for, obtaining, and managing company funds.

5. Accounting entails measuring, summarizing, and communicating financial and managerial information.

Exercises

1. (AACSB) Analysis The Martin family has been making guitars out of its factory in Nazareth, Pennsylvania, factory for more than 150 years. In 2004, Martin Guitar was proud to produce its millionth instrument. Go to http://www.martinguitar.com to link to the Martin Guitar Web site and read about the company’s long history. You’ll discover that, even though it’s a family-run company with a fairly unique product, it operates like any other company. Identify the main activities or functions of Martin Guitar’s business and explain how each activity benefits the company.

2. (AACSB) Analysis Name four external factors that have an influence on business. Give examples of the ways in which each factor can affect the business performance of two companies: Wal-Mart and Ford.

ReferencesReferences

Baron, D., “Facing-Off in Public,” Stanford Business, April 15, 2006, http://www.gsb.stanford.edu/news/bmag/ sbsm0308/feature_face_off.shtml (accessed January 21, 2012).

8 • EXPLORING BUSINESS

1.3 What Is Economics?

Learning Objectives

1. Define economics and identify factors of production.

2. Explain how economists answer the three key economics questions.

3. Compare and contrast economic systems.

To appreciate how a business functions, we need to know something about the economic environment in which it operates. We begin with a definition of economics and a discussion of the resources used to produce goods and services.

Resources: Inputs and OutputsResources: Inputs and Outputs

Economics is the study of the production, distribution, and consumption of goods and services. Resources are the inputs used to produce outputs. Resources may include any or all of the following:

• Land and other natural resources

• Labor (physical and mental)

• Capital, including buildings and equipment

• Entrepreneurship

Resources are combined to produce goods and services. Land and natural resources provide the needed raw materials. Labor transforms raw materials into goods and services. Capital (equipment, buildings, vehicles, cash, and so forth) are needed for the production process. Entrepreneurship provides the skill and creativity needed to bring the other resources together to produce a good or service to be sold to the marketplace.

Because a business uses resources to produce things, we also call these resources factors of production. The factors of production used to produce a shirt would include the following:

• The land that the shirt factory sits on, the electricity used to run the plant, and the raw cotton from which

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the shirts are made

• The laborers who make the shirts

• The factory and equipment used in the manufacturing process, as well as the money needed to operate the factory

• The entrepreneurship skill used to coordinate the other resources to initiate the production process and the distribution of the goods or services to the marketplace

Input and Output MarketsInput and Output Markets

Many of the factors of production (or resources) are provided to businesses by households. For example, households provide businesses with labor (as workers), land and buildings (as landlords), and capital (as investors). In turn, businesses pay households for these resources by providing them with income, such as wages, rent, and interest. The resources obtained from households are then used by businesses to produce goods and services, which are sold to the same households that provide businesses with revenue. The revenue obtained by businesses is then used to buy additional resources, and the cycle continues. This circular flow is described in Figure 1.3 “The Circular Flow of Inputs and Outputs”, which illustrates the dual roles of households and businesses:

• Households not only provide factors of production (or resources) but also consume goods and services.

• Businesses not only buy resources but also produce and sell both goods and services.

Figure 1.3 The Circular Flow of Inputs and Outputs

10 • EXPLORING BUSINESS

The Questions Economists AskThe Questions Economists Ask

Economists study the interactions between households and businesses and look at the ways in which the factors of production are combined to produce the goods and services that people need. Basically, economists try to answer three sets of questions:

1. What goods and services should be produced to meet consumers’ needs? In what quantity? When should they be produced?

2. How should goods and services be produced? Who should produce them, and what resources, including technology, should be combined to produce them?

3. Who should receive the goods and services produced? How should they be allocated among consumers?

1.3 WHAT IS ECONOMICS? • 11

Economic SystemsEconomic Systems

The answers to these questions depend on a country’s economic system—the means by which a society (households, businesses, and government) makes decisions about allocating resources to produce products and about distributing those products. The degree to which individuals and business owners, as opposed to the government, enjoy freedom in making these decisions varies according to the type of economic system. Generally speaking, economic systems can be divided into two systems: planned systems and free market systems.

Planned SystemsPlanned Systems

In a planned system, the government exerts control over the allocation and distribution of all or some goods and services. The system with the highest level of government control is communism. In theory, a communist economy is one in which the government owns all or most enterprises. Central planning by the government dictates which goods or services are produced, how they are produced, and who will receive them. In practice, pure communism is practically nonexistent today, and only a few countries (notably North Korea and Cuba) operate under rigid, centrally planned economic systems.

Under socialism, industries that provide essential services, such as utilities, banking, and health care, may be government owned. Other businesses are owned privately. Central planning allocates the goods and services produced by government-run industries and tries to ensure that the resulting wealth is distributed equally. In contrast, privately owned companies are operated for the purpose of making a profit for their owners. In general, workers in socialist economies work fewer hours, have longer vacations, and receive more health care, education, and child-care benefits than do workers in capitalist economies. To offset the high cost of public services, taxes are generally steep. Examples of socialist countries include Sweden and France.

Free Market SystemFree Market System

The economic system in which most businesses are owned and operated by individuals is the free market system, also known as capitalism. As we will see next, in a free market, competition dictates how goods and services will be allocated. Business is conducted with only limited government involvement. The economies of the United States and other countries, such as Japan, are based on capitalism.

How Economic Systems CompareHow Economic Systems Compare

In comparing economic systems, it’s helpful to think of a continuum with communism at one end and pure capitalism at the other, as in Figure 1.4 “The Spectrum of Economic Systems”. As you move from left to right, the amount of government control over business diminishes. So, too, does the level of social services, such as health care, child-care services, social security, and unemployment benefits.

Figure 1.4 The Spectrum of Economic Systems

12 • EXPLORING BUSINESS

Mixed Market EconomyMixed Market Economy

Though it’s possible to have a pure communist system, or a pure capitalist (free market) system, in reality many economic systems are mixed. A mixed market economy relies on both markets and the government to allocate resources. We’ve already seen that this is what happens in socialist economies in which the government controls selected major industries, such as transportation and health care, while allowing individual ownership of other industries. Even previously communist economies, such as those of Eastern Europe and China, are becoming more mixed as they adopt capitalistic characteristics and convert businesses previously owned by the government to private ownership through a process called privatization.

The U.S. Economic SystemThe U.S. Economic System

Like most countries, the United States features a mixed market system: though the U.S. economic system is primarily a free market system, the federal government controls some basic services, such as the postal service and air traffic control. The U.S. economy also has some characteristics of a socialist system, such as providing social security retirement benefits to retired workers.

The free market system was espoused by Adam Smith in his book The Wealth of Nations, published in 17761. According to Smith, competition alone would ensure that consumers received the best products at the best prices. In the kind of competition he assumed, a seller who tries to charge more for his product than other sellers won’t be able to find any buyers. A job-seeker who asks more than the going wage won’t be hired. Because the “invisible hand” of competition will make the market work effectively, there won’t be a need to regulate prices or wages.

Almost immediately, however, a tension developed among free market theorists between the principle of laissez- faire—leaving things alone—and government intervention. Today, it’s common for the U.S. government to intervene in the operation of the economic system. For example, government exerts influence on the food and pharmaceutical industries through the Food and Drug Administration, which protects consumers by preventing unsafe or mislabeled products from reaching the market.

To appreciate how businesses operate, we must first get an idea of how prices are set in competitive markets. Thus, Section 1.4 “Perfect Competition and Supply and Demand” begins by describing how markets establish prices in an environment of perfect competition.

1.3 WHAT IS ECONOMICS? • 13

Key Takeaways

• Economics is the study of the production, distribution, and consumption of goods and services.

• Economists address these three questions: (1) What goods and services should be produced to meet consumer needs? (2) How should they be produced, and who should produce them? (3) Who should receive goods and services?

• The answers to these questions depend on a country’s economic system. The primary economic systems that exist today are planned and free market systems.

• In a planned system, such as communism and socialism, the government exerts control over the production and distribution of all or some goods and services.

• In a free market system, also known as capitalism, business is conducted with only limited government involvement. Competition determines what goods and services are produced, how they are produced, and for whom.

Exercises

1. If you started a business that made surfboards, what factors of production would you need to make your product? Where would you get them? Where would you find the money you’d need to pay for additional resources?

2. Which three key questions do economists try to answer? Will answers to these questions differ, depending on whether they’re working in the United States or in Cuba? Explain your answer.

1According to many scholars, The Wealth of Nations not only is the most influential book on free-market capitalism but remains relevant today.

14 • EXPLORING BUSINESS

1.4 Perfect Competition and Supply and Demand

Learning Objective

1. Describe perfect competition, and explain how supply and demand interact to set prices in a free market system.

Under a mixed economy, such as we have in the United States, businesses make decisions about which goods to produce or services to offer and how they are priced. Because there are many businesses making goods or providing services, customers can choose among a wide array of products. The competition for sales among businesses is a vital part of our economic system. Economists have identified four types of competition—perfect competition, monopolistic competition, oligopoly, and monopoly. We’ll introduce the first of these—perfect competition—in this section and cover the remaining three in the following section.

Perfect CompetitionPerfect Competition

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Figure 1.5

Produce, like these apples, is a standardized product available from numerous businesses.

Mike Mozart – Apples – CC BY 2.0.

Perfect competition exists when there are many consumers buying a standardized product from numerous small businesses. Because no seller is big enough or influential enough to affect price, sellers and buyers accept the going price. For example, when a commercial fisher brings his fish to the local market, he has little control over the price he gets and must accept the going market price.

The Basics of Supply and DemandThe Basics of Supply and Demand

To appreciate how perfect competition works, we need to understand how buyers and sellers interact in a market to set prices. In a market characterized by perfect competition, price is determined through the mechanisms of supply and demand. Prices are influenced both by the supply of products from sellers and by the demand for products by buyers.

To illustrate this concept, let’s create a supply and demand schedule for one particular good sold at one point in time. Then we’ll define demand and create a demand curve and define supply and create a supply curve. Finally, we’ll see how supply and demand interact to create an equilibrium price—the price at which buyers are willing to purchase the amount that sellers are willing to sell.

16 • EXPLORING BUSINESS

Demand and the Demand CurveDemand and the Demand Curve

Demand is the quantity of a product that buyers are willing to purchase at various prices. The quantity of a product that people are willing to buy depends on its price. You’re typically willing to buy less of a product when prices rise and more of a product when prices fall. Generally speaking, we find products more attractive at lower prices, and we buy more at lower prices because our income goes further.

Figure 1.6 The Demand Curve

Using this logic, we can construct a demand curve that shows the quantity of a product that will be demanded at different prices. Let’s assume that the diagram in Figure 1.6 “The Demand Curve” represents the daily price and quantity of apples sold by farmers at a local market. Note that as the price of apples goes down, buyers’ demand goes up. Thus, if a pound of apples sells for $0.80, buyers will be willing to purchase only fifteen hundred pounds per day. But if apples cost only $0.60 a pound, buyers will be willing to purchase two thousand pounds. At $0.40 a pound, buyers will be willing to purchase twenty-five hundred pounds.

Supply and the Supply CurveSupply and the Supply Curve

Supply is the quantity of a product that sellers are willing to sell at various prices. The quantity of a product that a business is willing to sell depends on its price. Businesses are more willing to sell a product when the price rises

1.4 PERFECT COMPETITION AND SUPPLY AND DEMAND • 17

and less willing to sell it when prices fall. Again, this fact makes sense: businesses are set up to make profits, and there are larger profits to be made when prices are high.

Figure 1.7 The Supply Curve

Now we can construct a supply curve that shows the quantity of apples that farmers would be willing to sell at different prices, regardless of demand. As you can see in Figure 1.7 “The Supply Curve”, the supply curve goes in the opposite direction from the demand curve: as prices rise, the quantity of apples that farmers are willing to sell also goes up. The supply curve shows that farmers are willing to sell only a thousand pounds of apples when the price is $0.40 a pound, two thousand pounds when the price is $0.60, and three thousand pounds when the price is $0.80.

Equilibrium PriceEquilibrium Price

We can now see how the market mechanism works under perfect competition. We do this by plotting both the supply curve and the demand curve on one graph, as we’ve done in Figure 1.8 “The Equilibrium Price”. The point at which the two curves intersect is the equilibrium price. At this point, buyers’ demand for apples and sellers’ supply of apples is in equilibrium.

Figure 1.8 The Equilibrium Price

18 • EXPLORING BUSINESS

You can see in Figure 1.8 “The Equilibrium Price” that the supply and demand curves intersect at the price of $0.60 and quantity of two thousand pounds. Thus, $0.60 is the equilibrium price: at this price, the quantity of apples demanded by buyers equals the quantity of apples that farmers are willing to supply. If a farmer tries to charge more than $0.60 for a pound of apples, he won’t sell very many and his profits will go down. If, on the other hand, a farmer tries to charge less than the equilibrium price of $0.60 a pound, he will sell more apples but his profit per pound will be less than at the equilibrium price.

What have we learned in this discussion? We’ve learned that without outside influences, markets in an environment of perfect competition will arrive at an equilibrium point at which both buyers and sellers are satisfied. But we must be aware that this is a very simplistic example. Things are much more complex in the real world. For one thing, markets rarely operate without outside influences. Sometimes, sellers supply more of a product than buyers are willing to purchase; in that case, there’s a surplus. Sometimes, they don’t produce enough of a product to satisfy demand; then we have a shortage.

Circumstances also have a habit of changing. What would happen, for example, if income rose and buyers were willing to pay more for apples? The demand curve would change, resulting in an increase in equilibrium price. This outcome makes intuitive sense: as demand increases, prices will go up. What would happen if apple crops were larger than expected because of favorable weather conditions? Farmers might be willing to sell apples at lower prices. If so, the supply curve would shift, resulting in another change in equilibrium price: the increase in supply would bring down prices.

1.4 PERFECT COMPETITION AND SUPPLY AND DEMAND • 19

Key Takeaways

• In a free market system, buyers and sellers interact in a market to set prices.

• When the market is characterized by perfect competition, many small companies sell identical products. Because no company is large enough to control price, each simply accepts the market price. The price is determined by supply and demand.

• Supply is the quantity of a product that sellers are willing to sell at various prices.

• Demand is the quantity of a product that buyers are willing to purchase at various prices.

• The quantity of a product that people will buy depends on its price: they’ll buy more when the price is low and less when it’s high.

• Price also influences the quantity of a product that producers are willing to supply: they’ll sell more of a product when prices are high and less when they’re low.

• In a competitive market, the decisions of buyers and sellers interact until the market reaches an equilibrium price—the price at which buyers are willing to buy the same amount that sellers are willing to sell.

Exercise

(AACSB) Analysis

You just ran across three interesting statistics: (1) the world’s current supply of oil is estimated to be 1.3 trillion barrels; (2) the worldwide use of oil is thirty billion barrels a year; and (3) at this rate of consumption, we’ll run out of oil in forty-three years. Overcoming an initial sense of impending catastrophe, you remember the discussion of supply and demand in this chapter and realize that things aren’t as simple as they seem. After all, many factors affect both the supply of oil and the demand for products made from it, such as gasoline. These factors will influence when (and if) the world runs out of oil. Answer the following questions, and provide explanations for your answers:

1. What’s the major factor that affects the supply of oil? (Hint: It’s the same major factor affecting the demand for oil.)

2. If producers find additional oil reserves, what will happen to the price of oil?

3. If producers must extract oil from more-costly wells, what will happen to the price that you pay to fill up your gas tank?

4. If China’s economy continues to expand rapidly, what will happen to the price of oil?

5. If drivers in the United States start favoring fuel-efficient cars over SUVs, will gas be cheaper or more expensive?

6. In your opinion, will oil producers be able to supply enough oil to meet the increasing demand for oil-related products, such as gasoline?

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1.5 Monopolistic Competition, Oligopoly, and Monopoly

Learning Objective

1. Describe monopolistic competition, oligopoly, and monopoly.

Economists have identified four types of competition—perfect competition, monopolistic competition, oligopoly, and monopoly. Perfect competition was discussed in the last section; we’ll cover the remaining three types of competition here.

Monopolistic CompetitionMonopolistic Competition

In monopolistic competition, we still have many sellers (as we had under perfect competition). Now, however, they don’t sell identical products. Instead, they sell differentiated products—products that differ somewhat, or are perceived to differ, even though they serve a similar purpose. Products can be differentiated in a number of ways, including quality, style, convenience, location, and brand name. Some people prefer Coke over Pepsi, even though the two products are quite similar. But what if there was a substantial price difference between the two? In that case, buyers could be persuaded to switch from one to the other. Thus, if Coke has a big promotional sale at a supermarket chain, some Pepsi drinkers might switch (at least temporarily).

How is product differentiation accomplished? Sometimes, it’s simply geographical; you probably buy gasoline at the station closest to your home regardless of the brand. At other times, perceived differences between products are promoted by advertising designed to convince consumers that one product is different from another—and better than it. Regardless of customer loyalty to a product, however, if its price goes too high, the seller will lose business to a competitor. Under monopolistic competition, therefore, companies have only limited control over price.

OligopolyOligopoly

Oligopoly means few sellers. In an oligopolistic market, each seller supplies a large portion of all the products sold in the marketplace. In addition, because the cost of starting a business in an oligopolistic industry is usually high, the number of firms entering it is low.

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Companies in oligopolistic industries include such large-scale enterprises as automobile companies and airlines. As large firms supplying a sizable portion of a market, these companies have some control over the prices they charge. But there’s a catch: because products are fairly similar, when one company lowers prices, others are often forced to follow suit to remain competitive. You see this practice all the time in the airline industry: When American Airlines announces a fare decrease, Continental, United Airlines, and others do likewise. When one automaker offers a special deal, its competitors usually come up with similar promotions.

MonopolyMonopoly

In terms of the number of sellers and degree of competition, monopolies lie at the opposite end of the spectrum from perfect competition. In perfect competition, there are many small companies, none of which can control prices; they simply accept the market price determined by supply and demand. In a monopoly, however, there’s only one seller in the market. The market could be a geographical area, such as a city or a regional area, and doesn’t necessarily have to be an entire country.

There are few monopolies in the United States because the government limits them. Most fall into one of two categories: natural and legal. Natural monopolies include public utilities, such as electricity and gas suppliers. Such enterprises require huge investments, and it would be inefficient to duplicate the products that they provide. They inhibit competition, but they’re legal because they’re important to society. In exchange for the right to conduct business without competition, they’re regulated. For instance, they can’t charge whatever prices they want, but they must adhere to government-controlled prices. As a rule, they’re required to serve all customers, even if doing so isn’t cost efficient.

A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process. Patents are issued for a limited time, generally twenty years (United States Patent and Trademark Office, 2006). During this period, other companies can’t use the invented product or process without permission from the patent holder. Patents allow companies a certain period to recover the heavy costs of researching and developing products and technologies. A classic example of a company that enjoyed a patent-based legal monopoly is Polaroid, which for years held exclusive ownership of instant-film technology (Bellis, 2006). Polaroid priced the product high enough to recoup, over time, the high cost of bringing it to market. Without competition, in other words, it enjoyed a monopolistic position in regard to pricing.

Key Takeaways

• There are four types of competition in a free market system: perfect competition, monopolistic competition, oligopoly, and monopoly.

• Under monopolistic competition, many sellers offer differentiated products—products that differ slightly but serve similar purposes. By making consumers aware of product differences, sellers exert some control over price.

• In an oligopoly, a few sellers supply a sizable portion of products in the market. They exert some control over price, but because their products are similar, when one company lowers prices, the others follow.

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• In a monopoly, there is only one seller in the market. The market could be a geographical area, such as a city or a regional area, and does not necessarily have to be an entire country. The single seller is able to control prices.

• Most monopolies fall into one of two categories: natural and legal.

• Natural monopolies include public utilities, such as electricity and gas suppliers. They inhibit competition, but they’re legal because they’re important to society.

• A legal monopoly arises when a company receives a patent giving it exclusive use of an invented product or process for a limited time, generally twenty years.

Exercise

Identify the four types of competition, explain the differences among them, and provide two examples of each. (Use examples different from those given in the text.)

ReferencesReferences

Bellis, M., “Inventors-Edwin Land-Polaroid Photography-Instant Photography/Patents,” April 15, 2006, http://inventors.about.com/library/inventors/blpolaroid.htm (accessed January 21, 2012).

United States Patent and Trademark Office, General Information Concerning Patents, April 15, 2006, http://www.uspto.gov/web/offices/pac/doc/general/index.html#laws (accessed January 21, 2012).

1.5 MONOPOLISTIC COMPETITION, OLIGOPOLY, AND MONOPOLY • 23

1.6 Measuring the Health of the Economy

Learning Objective

1. Understand the criteria used to assess the status of the economy.

Every day, we are bombarded with economic news. We’re told that the economy is struggling, unemployment is high, home prices are low, and consumer confidence is down. As a student learning about business, and later as a business manager, you need to understand the nature of the U.S. economy and the terminology that we use to describe it. You need to have some idea of where the economy is heading, and you need to know something about the government’s role in influencing its direction.

Economic GoalsEconomic Goals

All the world’s economies share three main goals:

1. Growth

2. High employment

3. Price stability

Let’s take a closer look at each of these goals, both to find out what they mean and to show how we determine whether they’re being met.

Economic GrowthEconomic Growth

One purpose of an economy is to provide people with goods and services—cars, computers, video games, houses, rock concerts, fast food, amusement parks. One way in which economists measure the performance of an economy is by looking at a widely used measure of total output called gross domestic product (GDP). GDP is defined as the market value of all goods and services produced by the economy in a given year. In the United States, it’s calculated by the Department of Commerce. GDP includes only those goods and services produced domestically; goods produced outside the country are excluded. GDP also includes only those goods and services that are

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produced for the final user; intermediate products are excluded. For example, the silicon chip that goes into a computer (an intermediate product) would not count, even though the finished computer would.

By itself, GDP doesn’t necessarily tell us much about the state of the economy. But change in GDP does. If GDP (after adjusting for inflation) goes up, the economy is growing. If it goes down, the economy is contracting.

The Business CycleThe Business Cycle

The economic ups and downs resulting from expansion and contraction constitute the business cycle. A typical cycle runs from three to five years but could last much longer. Though typically irregular, a cycle can be divided into four general phases of prosperity, recession, depression (which the cycle generally skips), and recovery:

• During prosperity, the economy expands, unemployment is low, incomes rise, and consumers buy more products. Businesses respond by increasing production and offering new and better products.

• Eventually, however, things slow down. GDP decreases, unemployment rises, and because people have less money to spend, business revenues decline. This slowdown in economic activity is called a recession. Economists often say that we’re entering a recession when GDP goes down for two consecutive quarters.

Figure 1.9

Ian Lamont – Local and national newspapers – CC BY 2.0.

• Generally, a recession is followed by a recovery in which the economy starts growing again.

• If, however, a recession lasts a long time (perhaps a decade or so), while unemployment remains very high and production is severely curtailed, the economy could sink into a depression. Though not impossible, it’s

1.6 MEASURING THE HEALTH OF THE ECONOMY • 25

unlikely that the United States will experience another severe depression like that of the 1930s. The federal government has a number of economic tools (some of which we’ll discuss shortly) with which to fight any threat of a depression.

Full EmploymentFull Employment

To keep the economy going strong, people must spend money on goods and services. A reduction in personal expenditures for things like food, clothing, appliances, automobiles, housing, and medical care could severely reduce GDP and weaken the economy. Because most people earn their spending money by working, an important goal of all economies is making jobs available to everyone who wants one. In principle, full employment occurs when everyone who wants to work has a job. In practice, we say that we have “full employment” when about 95 percent of those wanting to work are employed.

The Unemployment RateThe Unemployment Rate

The U.S. Department of Labor tracks unemployment and reports the unemployment rate: the percentage of the labor force that’s unemployed and actively seeking work. The unemployment rate is an important measure of economic health. It goes up during recessionary periods because companies are reluctant to hire workers when demand for goods and services is low. Conversely, it goes down when the economy is expanding and there is high demand for products and workers to supply them.

Figure 1.10 “The U.S. Unemployment Rate, 1970–2010” traces the U.S. unemployment rate between 1970 and 2010. If you want to know the current unemployment rate, go to the CNNMoney Web site (CNNMoney.com) and click on “Economy” and then on “Job Growth.”

Figure 1.10 The U.S. Unemployment Rate, 1970–2010

Price StabilityPrice Stability

A third major goal of all economies is maintaining price stability. Price stability occurs when the average of the

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prices for goods and services either doesn’t change or changes very little. Rising prices are troublesome for both individuals and businesses. For individuals, rising prices mean you have to pay more for the things you need. For businesses, rising prices mean higher costs, and, at least in the short run, businesses might have trouble passing on higher costs to consumers. When the overall price level goes up, we have inflation. Figure 1.11 “The U.S. Inflation Rate, 1960–2010” shows inflationary trends in the U.S. economy since 1960. When the price level goes down (which rarely happens), we have deflation.

Figure 1.11 The U.S. Inflation Rate, 1960–2010

The Consumer Price IndexThe Consumer Price Index

The most widely publicized measure of inflation is the consumer price index (CPI), which is reported monthly by the Bureau of Labor Statistics. The CPI measures the rate of inflation by determining price changes of a hypothetical basket of goods, such as food, housing, clothing, medical care, appliances, automobiles, and so forth, bought by a typical household.

The CPI base period is 1982 to 1984, which has been given an average value of 100. Table 1.1 “Selected CPI Values, 1950–2010” gives CPI values computed for selected years. The CPI value for 1950, for instance, is 24. This means that $1 of typical purchases in 1982 through 1984 would have cost $0.24 in 1950. Conversely, you would have needed $2.18 to purchase the same $1 worth of typical goods in 2010. The difference registers the effect of inflation. In fact, that’s what an inflation rate is—the percentage change in a price index.

You can find out the current CPI by going to the CNNMoney Web site (CNNMoney.com) and click on “Economy” and then on “Inflation (CPI).”

Table 1.1 Selected CPI Values, 1950–2010

Year 1950 1960 1970 1980 1990 2000 2001 2002

CPI 24.1 29.1 38.8 82.4 130.7 172.2 177.1 179.9

Year 2003 2004 2005 2006 2007 2008 2009 2010

CPI 184.0 188.9 195.3 201.6 207.3 215.3 214.15 218.1

1.6 MEASURING THE HEALTH OF THE ECONOMY • 27

Economic ForecastingEconomic Forecasting

In the previous section, we introduced several measures that economists use to assess the performance of the economy at a given time. By looking at changes in GDP, for instance, we can see whether the economy is growing. The CPI allows us to gauge inflation. These measures help us understand where the economy stands today. But what if we want to get a sense of where it’s headed in the future? To a certain extent, we can forecast future economic trends by analyzing several leading economic indicators.

Economic IndicatorsEconomic Indicators

An economic indicator is a statistic that provides valuable information about the economy. There’s no shortage of economic indicators, and trying to follow them all would be an overwhelming task. Thus, economists and businesspeople track only a select few, including those that we’ll now discuss.

Lagging and Leading IndicatorsLagging and Leading Indicators

Statistics that report the status of the economy a few months in the past are called lagging economic indicators. One such indicator is 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 three to twelve months in the future are called leading economic indicators. If such an indicator rises, the economy is likely to expand in the coming year. If it falls, the economy is likely to contract.

To predict where the economy is headed, we obviously must examine several leading indicators. It’s also helpful to look at indicators from various sectors of the economy—labor, manufacturing, and housing. One useful indicator of the outlook for future jobs is the number of new claims for unemployment insurance. This measure tells us how many people recently lost their jobs. If it’s rising, it signals trouble ahead because unemployed consumers can’t buy as many goods and services as they could if they had paychecks.

To gauge the level of goods to be produced in the future (which will translate into future sales), economists look at a statistic called average weekly manufacturing hours. This measure tells us the average number of hours worked per week by production workers in manufacturing industries. If it’s on the rise, the economy will probably improve. For assessing the strength of the housing market, building permits is often a good indicator. An increase in this statistic—which tells us how many new housing units are being built—indicates that the economy is improving. Why? Because increased building brings money into the economy not only through new home sales but also through sales of furniture and appliances to furnish them.

Finally, if you want a measure that combines all these economic indicators, as well as others, a private research firm called the Conference Board publishes a U.S. leading index. To get an idea of what leading economic indicators are telling us about the state of the economy today, go to the Conference Board site at http://www.conference-board.org and click on “U.S. Indicators” and then “leading economic index.”

Consumer Confidence IndexConsumer Confidence Index

The Conference Board also publishes a consumer confidence index based on results of a monthly survey of

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five thousand U.S. households. The survey gathers consumers’ opinions on the health of the economy and their plans for future purchases. It’s often a good indicator of consumers’ future buying intent. For information on current consumer confidence, go to the Conference Board site at http://www.conference-board.org and click on “consumer confidence.”

Key Takeaways

• All economies share three goals: growth, high employment, and price stability.

• Growth. An economy provides people with goods and services, and economists measure its performance by studying the gross domestic product (GDP)—the market value of all goods and services produced by the economy in a given year.

• If GDP goes up, the economy is growing; if it goes down, the economy is contracting.

• High employment. Because most people earn their money by working, a goal of all economies is making jobs available to everyone who wants one.

• The U.S. government reports an unemployment rate—the percentage of the labor force that’s unemployed and actively seeking work.

• The unemployment rate goes up during recessionary periods and down when the economy is expanding.

• Price stability. When the average prices of products either don’t change or change very little, price stability occurs.

• When overall prices go up, we have inflation; when they go down, we have deflation.

• The consumer price index (CPI) measures inflation by determining the change in prices of a hypothetical basket of goods bought by a typical household.

• To get a sense of where the economy is headed in the future, we use statistics called economic indicators.

• Indicators that, like average length of unemployment, report the status of the economy a few months in the past are lagging economic indicators.

• Those, like new claims for unemployment insurance, that predict the status of the economy three to twelve months in the future are leading economic indicators.

Exercises

1. (AACSB) Analysis

Congratulations! You entered a sweepstakes and won a fantastic prize: a trip around the world. There’s only one catch: you have to study the economy of each country (from the list below) that you visit, and identify the current phase of its business cycle. Be sure to explain your responses.

• Country 1. While the landscape is beautiful and the weather is superb, a lot of people seem unhappy. Business is slow, and production has dropped steadily for the past six months. Revenues are down,

1.6 MEASURING THE HEALTH OF THE ECONOMY • 29

companies are laying off workers, and there’s less money around to spend.

• Country 2. Here, people are happily busy. Almost everyone has a job and makes a good income. They spend freely, and businesses respond by offering a steady outflow of new products.

• Country 3. Citizens of this country report that, for a while, life had been tough; lots of people were jobless, and money was tight. But things are getting much better. Workers are being called back to their jobs, production is improving, and people are spending again.

• Country 4. This place makes you so depressed that you can’t wait to get back home. People seem defeated, mostly because many have been without jobs for a long time. Lots of businesses have closed down, and those that have managed to stay open are operating at reduced capacity.

2. What are the three main economic goals of most economies, including the economy of the United States? What economic measures do we examine to determine whether or how well these goals are being met?

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1.7 Government’s Role in Managing the Economy

Learning Objective

1. Discuss the government’s role in managing the economy.

In every country, the government takes steps to help the economy achieve the goals of growth, full employment, and price stability. In the United States, the government influences economic activity through two approaches: monetary policy and fiscal policy. Through monetary policy, the government exerts its power to regulate the money supply and level of interest rates. Through fiscal policy, it uses its power to tax and to spend.

Monetary PolicyMonetary Policy

Monetary policy is exercised by the Federal Reserve System (“the Fed”), which is empowered to take various actions that decrease or increase the money supply and raise or lower short-term interest rates, making it harder or easier to borrow money. When the Fed believes that inflation is a problem, it will use contractionary policy to decrease the money supply and raise interest rates. When rates are higher, borrowers have to pay more for the money they borrow, and banks are more selective in making loans. Because money is “tighter”—more expensive to borrow—demand for goods and services will go down, and so will prices. In any case, that’s the theory.

Figure 1.12

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The Fed will typically tighten or decrease the money supply during inflationary periods, making it harder

to borrow money.

frankieleon – tight budget – CC BY 2.0.

To counter a recession, the Fed uses expansionary policy to increase the money supply and reduce interest rates. With lower interest rates, it’s cheaper to borrow money, and banks are more willing to lend it. We then say that money is “easy.” Attractive interest rates encourage businesses to borrow money to expand production and encourage consumers to buy more goods and services. In theory, both sets of actions will help the economy escape or come out of a recession.

Fiscal PolicyFiscal Policy

Fiscal policy relies on the government’s powers of spending and taxation. Both taxation and government spending can be used to reduce or increase the total supply of money in the economy—the total amount, in other words, that businesses and consumers have to spend. When the country is in a recession, the appropriate policy is to increase spending, reduce taxes, or both. Such expansionary actions will put more money in the hands of businesses and consumers, encouraging businesses to expand and consumers to buy more goods and services. When the economy is experiencing inflation, the opposite policy is adopted: the government will decrease spending or increase taxes, or both. Because such contractionary measures reduce spending by businesses and consumers, prices come down and inflation eases.

The National DebtThe National Debt

If, in any given year, the government takes in more money (through taxes) than it spends on goods and services

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(for things such as defense, transportation, and social services), the result is a budget surplus. If, on the other hand, the government spends more than it takes in, we have a budget deficit (which the government pays off by borrowing through the issuance of Treasury bonds). Historically, deficits have occurred much more often than surpluses; typically, the government spends more than it takes in. Consequently, the U.S. government now has a total national debt of more than $14 trillion.

As you can see in Figure 1.13 “The U.S. National Debt, 1940–2010”, this number has risen dramatically in the last sixty-five years. The significant jump that starts in the 1980s reflects several factors: a big increase in government spending (especially on defense), a substantial rise in interest payments on the debt, and lower tax rates. As of this writing, your share is $46,146.21. If you want to see what the national debt is today—and what your current share is—go on the Web to the U.S. National Debt Clock (http://www.brillig.com/debt_clock).

Figure 1.13 The U.S. National Debt, 1940–2010

Macroeconomics and MicroeconomicsMacroeconomics and Microeconomics

In the preceding discussion, we’ve touched on two main areas in the field of economics: (1) macroeconomics, or the study of the economy as a whole, and (2) microeconomics, or the study of the economic choices made by individual consumers or businesses. Macroeconomics examines the economy-wide effect of inflation, while microeconomics considers such decisions as the price you’re willing to pay to go to college. Macroeconomics investigates overall trends in imports and exports, while microeconomics explains the price that teenagers are willing to pay for concert tickets. Though they are often regarded as separate branches of economics, we can gain a richer understanding of the economy by studying issues from both perspectives. As we’ve seen in this chapter, for instance, you can better understand the overall level of activity in an economy (a macro issue) through an understanding of supply and demand (a micro issue).

Key Takeaways

• The U.S. government uses two types of policies—monetary policy and fiscal policy—to influence economic performance. Both have the same purpose: to help the economy achieve growth, full employment, and price stability.

1.7 GOVERNMENT’S ROLE IN MANAGING THE ECONOMY • 33

• Monetary policy is used to control the money supply and interest rates.

• It’s exercised through an independent government agency called the Federal Reserve System (“the Fed”), which has the power to control the money supply and interest rates.

• When the Fed believes that inflation is a problem, it will use contractionary policy to decrease the money supply and raise interest rates. To counter a recession, it will use expansionary policy to increase the money supply and reduce interest rates.

• Fiscal policy uses the government’s power to spend and tax.

• When the country is in a recession, the government will increase spending, reduce taxes, or do both to expand the economy.

• When we’re experiencing inflation, the government will decrease spending or increase taxes, or both.

• When the government takes in more money in a given year (through taxes) than it spends, the result is a surplus.

• When the opposite happens—government spends more money than it takes in—we have a deficit.

• The cumulative sum of deficits is the national debt—the total amount of money owed by the federal government.

Exercises

1. Let’s say that you’re the Fed chairperson and that the country is in a recession. What actions should the Fed take to pull the country out of the recession? What would you advise government officials to do to improve the economy? Justify your recommendations.

2. Browsing through your college’s catalog, you notice that all business majors must take two economics courses: macroeconomics and microeconomics. Explain what’s covered in each of these courses. In what ways will the things you learn in each course help you in the future?

34 • EXPLORING BUSINESS

1.8 Cases and Problems

Learning on the Web (AACSB)

The “Economy” section of the CNNMoney Web site provides current information on a number of economic indicators. Go to http://money.cnn.com and click on “Economy” and then on “Jobs,” and find answers to the following questions:

1. You read in the chapter that an important goal of all economies is to make jobs available to everyone who wants one. Review the CNNMoney discussion on job growth and then answer the following questions:

a. Is the current level of unemployment rising or falling? b. What do economists expect will happen to unemployment rates in the near future? c. Is the current level of unemployment a burden or an asset to the economy? In what ways?

2. Do you remember the first dollar you earned? Maybe you earned it delivering newspapers, shoveling snow, mowing lawns, or babysitting. How much do you think that dollar is worth today? Go to the WestEgg site at http://www.westegg.com/inflation and find the answer to this question. After determining the current value of your first dollar, explain how the calculator was created. (Hint: Apply what you know about CPI.)

Career Opportunities

Is a Career in Economics for You?

Are you wondering what a career in economics would be like? Go to the U.S. Department of Labor Web site (http://www.bls.gov/oco/ocos055.htm) and review the occupational outlook for economists. Look for answers to the following questions:

1. What issues interest economists?

2. What kinds of jobs do government economists perform? What about those who work in private industry? In education?

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3. What educational background and training is needed for these jobs?

4. What is the current job outlook for economists?

5. What is the entry-level salary for an economist with a bachelor’s degree? With a master’s degree?

Ethics Angle (AACSB)

How Much Is That CD in the Window?

The early 1990s were a good time to buy CDs, mainly because discounters such as Wal-Mart and Best Buy were accumulating customers by dropping prices from $15 to $10. They were losing money, but they figured that the policy still made good business sense. Why? They reasoned that while customers were in the store to shop for CDs, they’d find other, more profitable products.

The policy was a windfall for CD buyers, but a real problem for traditional music retailers such as Tower Records. With discounters slashing prices, CD buyers were no longer willing to pay the prices asked by traditional music retailers. Sales plummeted and companies went out of business.

Ultimately, the discounters’ strategy worked: stores such as Wal-Mart and Best Buy gained customers who once bought CDs at stores like Tower Records.

Let’s pause at this point to answer the following questions:

1. Does selling a product at below cost make business sense?

2. Whom does it hurt? Whom does it help?

3. Is it ethical?

Let’s continue and find out how traditional music retailers responded to this situation.

They weren’t happy, and neither were the record companies. Both parties worried that traditional retailers would put pressure on them to reduce the price that they charged for CDs so that retailers could lower their prices and compete with discounters. The record companies didn’t want to lower prices. They just wanted things to return to “normal”—to the world in which CDs sold for $15 each.

Most of the big record companies and several traditional music retailers got together and made a deal affecting every store that sold CDs. The record companies agreed with retail chains and other CD outlets to charge a minimum advertised price for CDs. Any retailer who broke ranks by advertising below-price CDs would incur substantial financial penalties. Naturally, CD prices went up.

Now, think about the following:

1. Does the deal made between the record companies and traditional retailers make business sense?

2. Whom does it hurt? Whom does it help?

3. Is it ethical?

4. Is it legal?

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Team-Building Skills (AACSB)

Get together in groups of four selected by your instructor and pick any three items from the following list:

• Pint of milk

• Gallon of gas

• Roundtrip airline ticket between Boston and San Francisco

• Large pizza

• Monthly cost of an Internet connection

• CD by a particular musician

• Two-day DVD rental

• Particular brand of DVD player

• Quarter-pound burger

Outside of class, each member of the team should check the prices of the three items, using his or her own sources. At the next class meeting, get together and compare the prices found by team members. Based on your findings, answer the following questions as a group:

1. Are the prices of given products similar, or do they vary?

2. Why do the prices of some products vary while those of others are similar?

3. Can any price differences be explained by applying the concepts of supply and demand or types of competition?

The Global View (AACSB)

Life Is Good in France (if You Have Le Job)

A strong economy requires that people have money to spend on goods and services. Because most people earn their money by working, an important goal of all economies is making jobs available to everyone who wants one. A country has “full employment” when 95 percent of those wanting work are employed. Unfortunately, not all countries achieve this goal of full employment. France, for example, often has a 10 percent unemployment rate overall and a 20 percent unemployment rate among young people.

Does this mean that France isn’t trying as hard as the United States to achieve full employment? A lot of people in France would say yes.

Let’s take a quick trip to France to see what’s going on economically. The day is March 19, 2006, and more than a million people are marching through the streets to protest a proposed new employment law that would make it easier for companies to lay off workers under the age of twenty-six during their first two years of employment. Granted, the plan doesn’t sound terribly youth-friendly, but, as usual, economic issues are never as clear-cut as they seem (or as we’d like them to be).

To gain some further insight into what’s going on in France, go to a BusinessWeek Web site

1.8 CASES AND PROBLEMS • 37

(http://www.businessweek.com/globalbiz/content/mar2006/gb20060321_896473.htm) and read the article “Job Security Ignites Debate in France.” Then answer the following questions:

1. Why does the French government support the so-called First Employment Contract? Who’s supposed to be helped by the law?

2. Which two groups are most vocal in protesting the law? Why?

3. If you were a long-time worker at a French company, would you support the new law? Why, or why not?

4. If you were a young French person who had just graduated from college and were looking for your first job, would you support the law? Why, or why not?

5. What do you think of France’s focus on job security? Does the current system help or hurt French workers? Does it help or hurt recent college graduates?

6. Does the French government’s focus on job security help or hinder its economy? Should the government be so heavily involved in employment matters?

38 • EXPLORING BUSINESS

Chapter 2: Business Ethics and Social Responsibility

2.1 Misgoverning Corporations: An Overview 2.2 The Individual Approach to Ethics 2.3 Identifying Ethical Issues 2.4 The Organizational Approach to Ethics 2.5 Corporate Social Responsibility 2.6 Environmentalism 2.7 Stages of Corporate Responsibility 2.8 Cases and Problems

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2.1 Misgoverning Corporations: An Overview

Learning Objectives

1. Define business ethics and explain what it means to act ethically in business.

2. Explain how you can recognize an ethical organization.

The WorldCom situation is not an isolated incident. The boom years of the 1990s were followed by revelations of massive corporate corruption, including criminal schemes at companies such as Enron, Adelphia, and Tyco. In fall 2001, executives at Enron, an energy supplier, admitted to accounting practices concocted to overstate the company’s income over a period of four years. In the wake of the company’s collapse, stock prices plummeted from $90 to $1 a share, inflicting massive financial losses on the investment community. Thousands of employees lost not only their jobs but their retirement funds, as well (Kadlec, 2002). Before the Enron story was off the front pages, officials at Adelphia, the nation’s sixth-largest cable company, disclosed that founder and CEO John Rigas had treated the publicly owned firm as a personal piggy bank, siphoning off billions of dollars to support his family’s extravagant lifestyle and bankrupting the company in the process (Lieberman, 2004). Likewise, CEO Dennis Koslowzki of conglomerate Tyco International was apparently confused about what was his and what belonged to the company. Besides treating himself to a $30 million estate in Florida and a $7 million Park Avenue apartment, Koslowzki indulged in a taste for expensive office accessories—such as a $15,000 umbrella stand, a $17,000 traveling toilette box, and a $2,200 wastebasket—that eventually drained $600 million from company coffers1.

As crooked as these CEOs were, Bernie Madoff, founder of Bernard L. Madoff Investment Securities and former chairman of the NASDAQ stock exchange, makes them seem like dime-store shoplifters2. Madoff is alleged to have run a giant Ponzi scheme (Langan, 2008) that cheated investors of up to $65 billion. His wrongdoings won him a spot at the top of Time Magazine’s Top 10 Crooked CEOs. According to the SEC charges, Madoff convinced investors to give him large sums of money. In return, he gave them an impressive 8 percent to 12 percent return a year. But Madoff never really invested their money. Instead, he kept it for himself. He got funds to pay the first investors their return (or their money back if they asked for it) by bringing in new investors. Everything was going smoothly until the fall of 2008, when the stock market plummeted and many of his investors asked for their money back. As he no longer had their money, the game was over and he had to admit that the whole thing was just one big lie. Thousands of investors, including many of his wealthy friends, not-so-rich retirees who trusted him with

40

their life savings, and charitable foundations, were financially ruined. All those harmed by Madoff either directly or indirectly were pleased when he was sentenced to jail for one-hundred and fifty years.

Are these cases merely aberrations? A Time/CNN poll conducted in the midst of all these revelations found that 72 percent of those surveyed don’t think so. They believe that breach of investor and employee trust represents an ongoing, long-standing pattern of deceptive behavior by officials at a large number of companies (Gibbs, et. al., 2002). If they’re right, then a lot of questions need to be answered. Why do such incidents happen (and with such apparent regularity)? Who are the usual suspects? How long until the next corporate bankruptcy record is set? What action can be taken—by individuals, organizations, and the government—to discourage such behavior?

The Idea of Business EthicsThe Idea of Business Ethics

It’s in the best interest of a company to operate ethically. Trustworthy companies are better at attracting and keeping customers, talented employees, and capital. Those tainted by questionable ethics suffer from dwindling customer bases, employee turnover, and investor mistrust.

Let’s begin this section by addressing one of the questions that we posed previously: What can individuals, organizations, and government agencies do to foster an environment of ethical and socially responsible behavior in business? First, of course, we need to define two terms: business ethics and social responsibility. They’re often used interchangeably, but they don’t mean the same thing.

What Is Ethics?What Is Ethics?

You probably already know what it means to be ethical: to know right from wrong and to know when you’re practicing one instead of the other. At the risk of oversimplifying, then, we can say that business ethics is the application of ethical behavior in a business context. Acting ethically in business means more than simply obeying applicable laws and regulations: It also means being honest, doing no harm to others, competing fairly, and declining to put your own interests above those of your company, its owners, and its workers. If you’re in business you obviously need a strong sense of what’s right and what’s wrong (not always an easy task). You need the personal conviction to do what’s right, even if it means doing something that’s difficult or personally disadvantageous.

What Is Social Responsibility?What Is Social Responsibility?

Corporate social responsibility deals with actions that affect a variety of parties in a company’s environment. A socially responsible company shows concern for its stakeholders—anyone who, like owners, employees, customers, and the communities in which it does business, has a “stake” or interest in it. We’ll discuss corporate responsibility later in the chapter. At this point, we’ll focus on ethics.

How Can You Recognize an Ethical Organization?How Can You Recognize an Ethical Organization?

One goal of anyone engaged in business should be to foster ethical behavior in the organizational environment.

2.1 MISGOVERNING CORPORATIONS: AN OVERVIEW • 41

How do we know when an organization is behaving ethically? Most lists of ethical organizational activities include the following criteria:

• Treating employees, customers, investors, and the public fairly

• Making fairness a top priority

• Holding every member personally accountable for his or her action

• Communicating core values and principles to all members

• Demanding and rewarding integrity from all members in all situations (Axelrod, 2004)

Whether you work for a business or for a nonprofit organization, you probably have a sense of whether your employer is ethical or unethical. Employees at companies that consistently make Business Ethics magazine’s list of the “100 Best Corporate Citizens” regard the items on the previous list as business as usual in the workplace. Companies that routinely win good-citizenship awards include Procter & Gamble, Hewlett-Packard, Intel, Avon Products, Cisco Systems, and Merck3.

By contrast, employees with the following attitudes tend to suspect that their employers aren’t as ethical as they should be:

• They consistently feel uneasy about the work they do.

• They object to the way they’re treated.

• They’re uncomfortable about the way coworkers are treated.

• They question the appropriateness of management directives and policies (Axelrod, 2004).

Figure 2.1

42 • EXPLORING BUSINESS

In the early 1990s, many Sears automotive customers were surprised by hefty repair bills. Their complaints

raised red flags with law-enforcement officials and forced Sears to refund $60 million.

Kevin McShane – The Receipt For My New Socks Is Longer Than My New Socks – CC BY-NC 2.0.

In the early 1990s, many workers in Sears automotive service centers shared suspicions about certain policies, including the ways in which they were supposed to deal with customers. In particular, they felt uncomfortable with a new compensation plan that rewarded them for selling alignments, brake jobs, shock absorbers, and other parts and services. Those who met quotas got bonuses; those who didn’t were often fired. The results shouldn’t be surprising: In their zeal to meet quotas and keep their jobs, some employees misled customers into believing they needed parts and services when, in fact, they were not needed. Before long, Sears was flooded with complaints from customers—as were law-enforcement officials—in more than forty states. Sears denied any intent to deceive customers but was forced not only to eliminate sales commissions but also to pay out $60 million in refunds.

Why Study Ethics?Why Study Ethics?

Ideally, prison terms, heavy fines, and civil suits should put a damper on corporate misconduct, but, unfortunately, many experts suspect that this assumption may be a bit optimistic. Whatever the condition of the ethical environment in the near future, one thing seems clear: The next generation entering business—which includes most of you—will find a world much different than the one that waited for the previous generation. Recent history tells us in no uncertain terms that today’s business students, many of whom are tomorrow’s business leaders, need a much sharper understanding of the difference between what is and isn’t ethically acceptable. As a business student, one of your key tasks is learning how to recognize and deal with the ethical challenges that will confront you.

Moreover, knowing right from wrong will make you more marketable as a job candidate. Asked what he looked for in a new hire, Warren Buffet, the world’s most successful investor, replied: “I look for three things. The first is personal integrity, the second is intelligence, and the third is a high energy level.” He paused and then added: “But if you don’t have the first, the second two don’t matter.”4

Key Takeaways

• It’s in a company’s best interest to act ethically. Trustworthy companies are better able to attract and keep customers, talented employees, and capital.

• Business ethics is the application of ethical behavior in a business context.

• Acting ethically in business means more than just obeying laws and regulations. It also means being honest, doing no harm to others, competing fairly, and declining to put your own interests above those of your employer and coworkers.

• To act ethically in business situations, you need a good idea of what’s right and wrong (not always an easy task).

• You also need the personal conviction to do what’s right even if it means doing something that’s difficult or personally disadvantageous.

2.1 MISGOVERNING CORPORATIONS: AN OVERVIEW • 43

• Ethical organizations treat employees, customers, investors, and the public fairly. They make fairness a top priority, communicate core values to those in the organization, and demand and reward integrity from all members while holding them accountable for their actions.

Exercise

(AACSB) Analysis

Is Honesty Academic?

Just as businesses have codes of conduct for directing employee behavior in job-related activities, so, too, do colleges and universities have codes of conduct to guide students’ academic behavior. They’re called various things—honor codes, academic integrity policies, policies on academic honesty, student codes of conduct—but they all have the same purpose: to promote academic integrity and to create a fair and ethical environment for all students.

At most schools, information on academic integrity is available from one of the following sources:

• The school Web site (probably under the tab “Dean of Students” or “Student Life”)

• The student handbook

• Printed materials available through the Dean of Students’ office

Assignment

Locate information on your school’s academic integrity policies and answer the following questions:

1. What behaviors violate academic integrity?

2. What happens if you’re accused of academic dishonesty?

3. What should you do if you witness an incident of academic dishonesty?

1“Tyco Wants Its Money Back,” CNNMoney, September 17, 2002, http://money.cnn.com/2002/09/17/news/ companies/tyco/index.htm (accessed January 22, 2012).

2“Top 10 Crooked CEOs,” Time Specials, Time.com, http://www.time.com/time/specials/packages/article/ 0,28804,1903155_1903156_1903160,00.html (accessed July 25, 2011).

3“100 Best Corporate Citizens for 2010,” Corporate Responsibility Magazine, no. 11, Spring 2011, http://thecro.com/content/100-best-corporate-citizens (accessed September 5, 2011).

4Quoted by Adrian Gostick and Dana Telford, The Integrity Advantage (Salt Lake City: Gibbs Smith, 2003), 3–4.

ReferencesReferences

Axelrod, A., My First Book of Business Ethics (Philadelphia: Quirk Books, 2004), 7.

44 • EXPLORING BUSINESS

Gibbs, N., et al., “Summer of Mistrust,” Time, July 22, 2002, 20.

Kadlec, D., “Enron: Who’s Accountable?” Time, January 21, 2002, 31.

Langan, F., “The $50-billion BMIS Debacle: How a Ponzi Scheme Works,” CBSNews, December 15, 2008, http://www.cbc.ca/news/business/story/2008/12/15/f-langan-bmis.html (accessed January 26, 2009).

Lieberman, D., “Prosecutors Wrap Up $3.2B Adelphia Case,” USA Today, June 25, 2004, http://www.usatoday.com/money/industries/telecom/2004-06-25-adelphia_x.htm (accessed January 22, 2012).

2.1 MISGOVERNING CORPORATIONS: AN OVERVIEW • 45

2.2 The Individual Approach to Ethics

Learning Objective

1. Specify the steps that you would take to solve an ethical dilemma and make an ethical decision.

Betty Vinson didn’t start out at WorldCom with the intention of going to jail. She undoubtedly knew what the right behavior was, but the bottom line is that she didn’t do it. How can you make sure that you do the right thing in the business world? How should you respond to the kinds of challenges that you’ll be facing? Because your actions in the business world will be strongly influenced by your moral character, let’s begin by assessing your current moral condition. Which of the following best applies to you (select one)?

1. I’m always ethical.

2. I’m mostly ethical.

3. I’m somewhat ethical.

4. I’m seldom ethical.

5. I’m never ethical.

Now that you’ve placed yourself in one of these categories, here are some general observations. Few people put themselves below the second category. Most of us are ethical most of the time, and most people assign themselves to category number two—“I’m mostly ethical.” Why don’t more people claim that they’re always ethical? Apparently, most people realize that being ethical all the time takes a great deal of moral energy. If you placed yourself in category number two, ask yourself this question: How can I change my behavior so that I can move up a notch? The answer to this question may be simple. Just ask yourself an easier question: How would I like to be treated in a given situation (Maxwell, 2003)?

Unfortunately, practicing this philosophy might be easier in your personal life than in the business world. Ethical challenges arise in business because business organizations, especially large ones, have multiple stakeholders and because stakeholders make conflicting demands. Making decisions that affect multiple stakeholders isn’t easy even for seasoned managers; and for new entrants to the business world, the task can be extremely daunting. Many managers need years of experience in an organization before they feel comfortable making decisions that affect

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various stakeholders. You can, however, get a head start in learning how to make ethical decisions by looking at two types of challenges that you’ll encounter in the business world: ethical dilemmas and ethical decisions.

Addressing Ethical DilemmasAddressing Ethical Dilemmas

An ethical dilemma is a morally problematic situation: You have to pick between two or more acceptable but often opposing alternatives that are important to different groups. Experts often frame this type of situation as a “right-versus-right” decision. It’s the sort of decision that Johnson & Johnson (known as J&J) CEO James Burke had to make in 1982 (Kaplan, 2012). On September 30, twelve-year-old Mary Kellerman of Chicago died after her parents gave her Extra-Strength Tylenol. That same morning, twenty-seven-year-old Adam Janus, also of Chicago, died after taking Tylenol for minor chest pain. That night, when family members came to console his parents, Adam’s brother and his wife took Tylenol from the same bottle and died within forty-eight hours. Over the next two weeks, four more people in Chicago died after taking Tylenol. The actual connection between Tylenol and the series of deaths wasn’t made until an off-duty fireman realized from news reports that every victim had taken Tylenol. As consumers panicked, J&J pulled Tylenol off Chicago-area retail shelves. Researchers discovered Tylenol capsules containing large amounts of deadly cyanide. Because the poisoned bottles came from batches originating at different J&J plants, investigators determined that the tampering had occurred after the product had been shipped.

So J&J wasn’t at fault. But CEO Burke was still faced with an extremely serious dilemma: Was it possible to respond to the tampering cases without destroying the reputation of a highly profitable brand? Burke had two options:

• He could recall only the lots of Extra-Strength Tylenol that were found to be tainted with cyanide. This was the path followed by Perrier executives in 1991 when they discovered that cases of bottled water had been poisoned with benzine. This option favored J&J financially but possibly put more people at risk.

• Burke could order a nationwide recall—of all bottles of Extra-Strength Tylenol. This option would reverse the priority of the stakeholders, putting the safety of the public above stakeholders’ financial interests.

Burke opted to recall all 31 million bottles of Extra-Strength Tylenol on the market. The cost to J&J was $100 million, but public reaction was quite positive. Less than six weeks after the crisis began, Tylenol capsules were reintroduced in new tamper-resistant bottles, and by responding quickly and appropriately, J&J was eventually able to restore the Tylenol brand to its previous market position. When Burke was applauded for moral courage, he replied that he’d simply adhered to the long-standing J&J credo that put the interests of customers above those of other stakeholders. His only regret was that the tamperer was never caught (Weber, 1999).

If you’re wondering what your thought process should be if you’re confronted with an ethical dilemma, you could do worse than remember the mental steps listed in Figure 2.2 “How to Face an Ethical Dilemma”—which happen to be the steps that James Burke took in addressing the Tylenol crisis:

1. Define the problem: How to respond to the tampering case without destroying the reputation of the Tylenol brand.

2. Identify feasible options: (1) Recall only the lots of Tylenol that were found to be tainted with cyanide or (2) order a nationwide recall of all bottles of Extra-Strength Tylenol.

2.2 THE INDIVIDUAL APPROACH TO ETHICS • 47

3. Assess the effect of each option on stakeholders: Option 1 (recalling only the tainted lots of Tylenol) is cheaper but puts more people at risk. Option 2 (recalling all bottles of Extra-Strength Tylenol) puts the safety of the public above stakeholders’ financial interests.

4. Establish criteria for determining the most appropriate action: Adhere to the J&J credo, which puts the interests of customers above those of other stakeholders.

5. Select the best option based on the established criteria: In 1982, Option 2 was selected, and a nationwide recall of all bottles of Extra-Strength Tylenol was conducted.

Figure 2.2 How to Face an Ethical Dilemma

Making Ethical DecisionsMaking Ethical Decisions

In contrast to the “right-versus-right” problem posed by an ethical dilemma, an ethical decision entails a “right- versus-wrong” decision—one in which there is a right (ethical) choice and a wrong (unethical or illegal) choice. When you make a decision that’s unmistakably unethical or illegal, you’ve committed an ethical lapse. Betty Vinson, for example, had an ethical lapse when she caved in to her bosses’ pressure to cook the WorldCom books.

48 • EXPLORING BUSINESS

If you’re presented with what appears to be this type of choice, asking yourself the questions in Figure 2.3 “How to Avoid an Ethical Lapse” will increase your odds of making an ethical decision.

Figure 2.3 How to Avoid an Ethical Lapse

To test the validity of this approach, let’s take a point-by-point look at Betty Vinson’s decisions:

1. Her actions were clearly illegal.

2. They were unfair to the workers who lost their jobs and to the investors who suffered financial losses (and also to her family, who shared her public embarrassment).

3. She definitely felt bad about what she’d done.

4. She was embarrassed to tell other people what she had done.

5. Reports of her actions appeared in her local newspaper (and just about every other newspaper in the country).

2.2 THE INDIVIDUAL APPROACH TO ETHICS • 49

So Vinson could have answered our five test questions with five yeses. To simplify matters, remember the following rule of thumb: If you answer yes to any one of these five questions, odds are that you’re about to do something you shouldn’t.

Revisiting Johnson & JohnsonRevisiting Johnson & Johnson

As discussed earlier in this section, Johnson & Johnson received tremendous praise for the actions taken by its CEO, James Burke, in response to the 1982 Tylenol catastrophe. But things change. To learn how a company can destroy its good reputation, let’s fast forward to 2008 and revisit J&J and its credo, which states, “We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality” (Credo, Johnson & Johnson, 2011). How could a company whose employees believed so strongly in its credo find itself under criminal and congressional investigation for a series of recalls due to defective products? (Kimes, 2010) In a three-year period, the company recalled twenty-four products, including Children’s, Infants’ and Adults’ Tylenol, Motrin, and Benadryl (McNeil Product Recall Informations, 2011); 1-Day Acuvue TruEye contact lenses sold outside the U.S. (Berkrot, 2010); and hip replacements (New York Times, 2010).

Unlike the 1982 J&J Tylenol recall, no one died from the defective products, but customers were certainly upset to find they had purchased over-the-counter medicines for themselves and their children that were potentially contaminated with dark particles or tiny specks of metal (Kimes, 2010); contact lenses that contained a type of acid that caused stinging or pain when inserted in the eye (Rockoff & Kamp, 2010); and defective hip implants that required patients to undergo a second hip replacement (Singer, 2010).

Who bears the responsibility for these image-damaging blunders? We’ll identify two individuals who were at least partially responsible for the decline of J&J’s reputation: The first is the current CEO—William Weldon—who has been criticized for being largely invisible and publicly absent during the recalls (Kimes, 2010). Additionally, he admitted that he did not understand the consumer division where many of the quality control problems originated (Kimes, 2010). Some members of the board of directors were not pleased with his actions (or inactions) and were upset at the revenue declines from the high-profile recalls. Consequently, Weldon was given only a 3 percent raise for 2011, and his end-of-year bonus was cut by 45 percent. But don’t cry for him: His annual compensation for the year (including salary, bonus, and stock options) was $23 million—down from $26 million in the previous year (Perrone, 2011).

The second individual who was at least partially responsible for the decline of J&J’s reputation is Colleen Goggins, Worldwide Chairman of J&J’s Consumer Group, who was in charge of the factories that produced many of the recalled products. She was heavily criticized by fellow employees for her excessive cost-cutting measures and her propensity to replace experienced scientists with new hires (Kimes, 2010). In addition, she was implicated in an unbelievably foolish and extremely unethical behavior to avoid publically disclosing another J&J recall of a defective product.

Here is the story behind the unethical scheme: After learning that J&J had released packets of Motrin that did not dissolve correctly, the company hired contractors to go into convenience stores and secretly buy up every pack of Motrin on the shelves. The instructions given to the contractors were the following: “You should simply ‘act’ like a regular customer while making these purchases. THERE MUST BE NO MENTION OF THIS BEING A RECALL OF THE PRODUCT!” (Kimes, 2010) In May 2010, when Goggins appeared before a

50 • EXPLORING BUSINESS

congressional committee investigating the “phantom recall,” she testified that she was not aware of the behavior of the contractors (Silverman, 2010) and that she had “no knowledge of instructions to contractors involved in the phantom recall to not tell store employees what they were doing.” In her September 2010 testimony to the House Committee on Oversight and Government Reform, she acknowledged that the company wrote those instructions. She also told the committee she was retiring. This had to be a major disappointment for her. Before J&J started falling apart, she was a contender to take over as CEO when Weldon retired. But, as is true with Weldon, don’t shed too many tears for her. Goggins departed from J&J a wealthy woman after cashing in one-third of her shares of company stock for $3 million1.

From a right-versus-wrong point of view, both Weldon and Goggins acted inappropriately. Their actions caused harm to others, including consumers, employees, and investors. They most likely felt badly about what happened, were embarrassed to discuss the situation with others, and regretted the fact that almost every newspaper in the country carried the story of J&J’s downfall.

Regardless of whom is to blame, the bottom line is this: What was once an admired company is tarnished. J&J went from a most admired company to a struggling company that will require more than a Band-Aid to heal its business wounds (Kimes, 2010). Whether J&J can regain the public’s trust is a question that no one can answer at this time. At this point, consumers have a right to ask the questions: Should I pay a premium for J&J products given the company’s recent track record of poor quality control?

What to Do When the Light Turns YellowWhat to Do When the Light Turns Yellow

Like our five questions, some ethical problems are fairly straightforward. Others, unfortunately, are more complicated, but it will help to think of our five-question test as a set of signals that will warn you that you’re facing a particularly tough decision—that you should think carefully about it and perhaps consult someone else. The situation is like approaching a traffic light. Red and green lights are easy; you know what they mean and exactly what to do. Yellow lights are trickier. Before you decide which pedal to hit, try posing our five questions. If you get a single yes, you’ll be much better off hitting the brake (Online Ethics Center for Engineering and Science, 2006).

Key Takeaways

• Businesspeople face two types of ethical challenges: ethical dilemmas and ethical decisions.

• An ethical dilemma is a morally problematic situation in which you must choose between two or more alternatives that aren’t equally acceptable to different groups.

• Such a dilemma is often characterized as a “right-versus-right” decision and is usually solved in a series of five steps:

1. Define the problem and collect the relevant facts.

2. Identify feasible options.

3. Assess the effect of each option on stakeholders (owners, employees, customers, communities).

2.2 THE INDIVIDUAL APPROACH TO ETHICS • 51

4. Establish criteria for determining the most appropriate option.

5. Select the best option, based on the established criteria.

• An ethical decision entails a “right-versus-wrong” decision—one in which there’s a right (ethical) choice and a wrong (unethical or downright illegal) choice.

• When you make a decision that’s unmistakably unethical or illegal, you’ve committed an ethical lapse.

• If you’re presented with what appears to be an ethical decision, asking yourself the following questions will improve your odds of making an ethical choice:

1. Is the action illegal?

2. Is it unfair to some parties?

3. If I take it, will I feel bad about it?

4. Will I be ashamed to tell my family, friends, coworkers, or boss about my action?

5. Would I want my decision written up in the local newspaper?

If you answer yes to any one of these five questions, you’re probably about to do something that you shouldn’t.

Exercise

Explain the difference between an ethical dilemma and an ethical decision. Then provide an example of each. Describe an ethical lapse and provide an example.

1“J&J’s Colleen Goggins Sells Nearly $3M in Stock,” Citibizlist, September 14, 2010 (accessed August 16, 2011).

ReferencesReferences

Berkrot, B., “J&J Confirms Widely Expanded Contact Lens Recall,” December 1, 2010, http://www.reuters.com/ article/2010/12/01/us-jandj-recall-idUSTRE6B05G620101201 (accessed August 12, 2011).

Credo, Johnson & Johnson company Web site, http://www.jnj.com/connect/about-jnj/jnj-credo (accessed August 15, 2011).

Kaplan, T., “The Tylenol Crisis: How Effective Public Relations Saved Johnson & Johnson,” http://www.aerobiologicalengineering.com/wxk116/TylenolMurders/crisis.html (accessed January 22, 2012).

Kimes, M., “Why J&J’s Headache Won’t Go Away,” Fortune (CNNMoney), August 19, 2010, http://money.cnn.com/2010/08/18/news/companies/jnj_drug_recalls.fortune/index.htm (accessed August 12, 2011).

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Maxwell, J. C., There’s No Such Thing as “Business Ethics”: There’s Only One Rule for Making Decisions (New York: Warner Books, 2003), 19–21.

McNeil Product Recall Information, http://www.mcneilproductrecall.com/ (accessed August 12, 2011).

New York Times, Business Day, August 20, 2010, http://www.nytimes.com/2010/08/27/business/27hip.html (accessed August 12, 2011).

Online Ethics Center for Engineering and Science, “Advice from the Texas Instruments Ethics Office: What Do You Do When the Light Turns Yellow?” Onlineethics.org, http://onlineethics.org/corp/help.html#yellow (accessed April 24, 2006).