- Slides: 23
Types of Businesses
Free Enterprise gives businesses the right to choose what, how, and for whom to produce. Often businesses make similar production choices, leading to competition. Competition is the economic rivalry that exists among businesses selling the same or similar products. Competition is important because it encourages producers to lower prices improve their products or develop new ones.
Adam Smith Economist Adam Smith lived in the late 1700 s. He firmly believed in free enterprise and allowing self interest to direct individuals and businesses. Smith’s book The Wealth of Nations stresses Laissez Faire economics, or keeping government regulations out of economic decisions. Instead, Adam Smith says the “invisible hand” of self interest should guide the economy.
The Invisible Hand
Business startups Businesses are created by entrepreneurs. An entrepreneur is someone who seeks profits but accepts the risks and uncertainties when they combine the factors of production.
Types of business In the free market (free enterprise) system we see many different types of businesses. The majority of businesses are Sole Proprietorships, followed by Corporations and finally Partnerships.
Entrepreneurs are people who start new businesses. They must be aware of the laws, be willing to assume risk, and have capital to start. Most Entrepreneurs start sole proprietorships which gives them great control over the business, but also places them at risk for liability if the business fails, is sued, or has other issues.
Sole Proprietorship This is the oldest, simplest and most common form of business. These businesses are owned and operated by one person. Examples: usually small businesses, local or family owned In NY, you don’t have to file any special legal paperwork to establish a Sole Proprietorship. All you have to do is file what’s called a DBA (Doing Business As) and obtain an EIN (Employer Identification Number) from the IRS.
Sole Proprietorship Advantages • • • Easy to start and end Full control over business operations- can make changes quickly and easily Exclusive profits Pride of ownership Lower taxes (pays no corporate income taxes) Disadvantages • • • Unlimited liability- may have to use personal wealth to pay off debts if business fails or is sued Difficulty in raising funds- may have to borrow money from friends and family Sole responsibility for all losses Limited growth/life span Management knowledge may be limited
Partnerships Business is owned and controlled by two or more people who receive all profits and bear all the losses. Often times, partnerships exist between family members. Examples: Professional businesses- Cellino and Barnes Attorneys at Law, Crowley & Halloran CPAs, P. C.
Partnership Advantages • • • Increase in start-up financial capital Decrease in costs Easy to start Job specialization Shared losses and decisions Lower taxes (pays no corporate income taxes) Disadvantages • • • Liability for firm and other partner Conflict with partner Different views of how business should be run Lack of longevity Shared profits
Corporations Commonly referred to as Big Business, a corporation is a legal entity that is owned by stockholders. In corporations, the owners and business operators are separate from each other. Owners are shareholders, earning dividends, or a portion of the profits. Legally, corporations are treated as individuals and can own property, enter into contracts, pay taxes and take loans. Examples: Large companies- Kodak, Xerox, GM
Corporations Advantages • • Limited liability for stockholderslosses are limited to what they paid for their shares More financial capital- can raise funds by selling shares or corporate bonds Longevity Separate management from owners, allows for specialization Disadvantages • • • Difficult and costly to obtain corporate status Delayed decision making because of large, bureaucratic structure Easy to anger shareholders Increased government control/reporting requirements Profit is taxed twice (once by the business and again by the shareholders).
Investing in a Corporations are considered separate from the shareholders who own and invest in the company. This means that the corporation itself is held legally liable for the actions and debts the business incurs. Some corporations are publically traded, meaning anyone can buy a share of the company. The more shares you own the more say you have. Each company only has so many shares which are bought and sold at stock exchanges, like Wall Street. Many people invest in stocks to make money. As a corporation makes money, the price of their stock goes up, and the stockholder makes money (by selling their shares)
Corporate organization There are several forms of corporate organization: -Horizontal combination- a merger between two or more companies producing the same good or service (Walgreens and Rite Aid, Dollar Tree and Family Dollar) -Vertical combination- a merger between two or more companies involved in different production phases of the same good or service (steel companies owns the mines and the steel mills) -Conglomerate- a merger of companies producing unrelated products (examples on the next slide) -Franchise- an enterprise that uses the original company’s name to sell goods and services (Subway, 7 -11, All. State, Hilton Hotels)
Unequal competition While many economists follow Adam Smith’s advice for free enterprise there are challenges. When competition is no longer equal the consumer will be hurt. Oligopolies and Monopolies can hurt economic systems because they restrict competition among businesses.
Oligopolies are market structures with only a few large sellers controlling most production of goods and services. An Oligopoly exists when there are certain conditions: -only a few large sellers -sellers offer identical or similar products -other sellers cannot enter the market easily
Oligopoly problem The lack of competition means the oligopoly can keep their prices similar. There are times of price wars where the oligopoly members try to lower prices to gain market share. Often these price wars are followed by a return to higher prices. It is illegal for the oligopoly companies to work together to set prices. However, simply aligning prices of the similar products is legal. For instance: Wendy’s, Mc. Donalds and Burger King all have a dollar menu
Monopolies are market structures with only a single seller controlling the prices of a good or service. A Monopoly exists when there are certain conditions: -only a single large seller -no close substitute goods available -other sellers cannot enter the market easily
Monopoly problem The lack of competition means the monopoly could raise prices and consumers would have no other options. However, the government monitors monopolies to ensure they are not taking advantage of the consumers. Some monopolies develop naturally, as a result of having a large economy of scale. That is, the seller’s large size allows them to use their resources more efficiently. Utility (gas and electric) companies are examples of natural utilities because competitors cannot easily enter the market.
Costs of Business Remember, businesses mostly operate for profit. Profit is the amount of money remaining after producers have paid all of their costs. There are two types of business costs: Fixed and variable Fixed Costs- an expense that does not vary from month to month regardless of the individual's or business’s output (ex: rent, salaries, interest on loans) Variable Costs- Costs that change directly with a change in the output, typically rising and dropping as production increases or decreases (ex: hourly wages, utility bills, raw materials)
Review: Opportunity Cost Remember, economics is all about the efficient use of scarce resources. The Production Possibilities Frontier shows all the possible combinations of making two goods. If we choose to use resources to make rubber ducks, we wont be able to use those same resources to make tires. When we sacrifice one good to make something else we call it a trade off. Opportunity cost is the cost of the trade off, or the value of the next best alternative given up. Let’s say you go to the mall with $50 and you need to decide between a 2 shirts or a pair of sneakers. You choose to purchase the sneakers, your opportunity cost would be 2 shirts.