capitalism

capitalism

• A broad economic system where competition in a free market determines the price, production and consumption of goods and services through the “invisible hand” of supply and demand

socialism

• Broad economic system in which the major enterprises are either owned or controlled by the state

What companies are going to flourish in the future?

The role of profits… and losses

2010 Chile mine disaster

• In August 2010, 33 miners were trapped 2,300 feet underground in a copper/gold mine in Chile

• They were trapped three miles from the entrance • It was presumed they were killed in collapse• 17 days after the accident, a bore hole drilled

came back with a note: "Estamos bien en el refugio, los 33" (English: "We are well in the shelter, the 33“)

‘Capitalism Saved the Miners’

Wall Street Journal, October 14, 2010

“If those miners had been trapped a half-mile down like this 25 years ago anywhere on earth, they would be dead. What happened over the past 25 years that meant the difference between life and death for those men? Short answer: the Center Rock drill bit.”

“The Center Rock drill… is in fact a piece of tough technology developed by a small company in it for the money, for profit. That's why they innovated down-the-hole hammer drilling. If they make money, they can do more innovation.”

“The profit=innovation dynamic was everywhere at that Chilean mine... In an open economy you will never know what is out there on the leading developmental edge of this or that industry...”

“The miners’ rescue is a thrilling moment for Chile... But I’m thinking of that 74-person outfit in Berlin, Pa., whose high-tech drill bit opened the earth to free them...”

So, what did we learn from Chapter 6?

Profits and Losses

• Remember: P&L play equally important roles in maintaining and advancing the standards of living of the country

Profits and Losses

• Remember: P&L play equally important roles in maintaining and advancing the standards of living of the country

• Both P&L force efficiencies on companies

Profits and Losses

Remember: P&L play equally important roles in maintaining and advancing the standards of living of the country

Both P&L force efficiencies on companiesNo accident that people in free markets have

higher standards of living than those in controlled economies

Profits and losses

• When one business in a market economy – aka capitalism – finds a way to lower costs, competitors usually have to do the same

Profits and losses


• Wal*Mart lowers food prices by 6-12% when it rolls into town

Profits and losses


• Wal*Mart lowers food prices by 6-12% when it rolls into town

• How city of Sarasota responds: $5 million subsidy for Whole Foods, refuses to allow Wal*Mart to build on Ringling Avenue

Mystery: why aren’t prices lower in socialist nations even through profits are eliminated?

Profits, take 2

• Hope for profits and threat of losses force capitalists to produce at the lowest cost and sell what customers are willing to buy… i.e., an incentive to be as efficient as possible with scarce resources that have alterative uses

Profits, take 2

• Hope for profits and threat of losses force capitalists to produce at the lowest cost and sell what customers are willing to buy… i.e., an incentive to be as efficient as possible with scarce resources that have alterative uses

• Consumers gain when companies fight to earn profits and avoid losses through lower prices and innovation

More about ProfitsProfits are the price paid for efficiency

More about ProfitsProfits are the price paid for efficiencyIf the cost of the profits exceeded the value

of the efficiency they promoted, then non-profits like governments and schools could get the same things done cheaper or better than for-profit companies

More about ProfitsProfits are the price paid for efficiencyIf the cost of the profits exceeded the value

of the efficiency they promoted, then non-profits like governments and schools could get the same things done cheaper or better than for-profit companies

Fat chance… governments outsourcing of garbage, janitorial services, payrolls, security, prisons to private businesses

Even more about profits

• While capitalism has a visible cost – profits – that does not exist under socialism, socialism has an invisible cost: inefficiency



• Profit is the price paid for efficiency



• Profit is the price paid for efficiency• History shows that capitalism has had far

more people living well than socialism

Greedy capitalists

Myths about profits

• “Greed” drives profits, resulting in higher prices for consumers

Myths about profits

• “Greed” drives profits, resulting in higher prices for consumers

• Fact: most fortunes have been made by companies making things cheaper for consumers… Wal*Mart, Facebook, Henry Ford, Dell, Google

Myths about profits

• Profit margins for American business are obscene

Myths about profits

• Profit margins for American business are obscene

• Average rate of return on investments ranged from 2.2-7.8% from 1960-2005

Profits redux

• In private business, the owner is an “unmonitored monitor” rather than having layers of authorities

Profits redux

• In private business, the owner is an “unmonitored monitor” rather than having layers of authorities

• Self-interest takes the place of external monitors and forces attention to detail… driving efficiency

Profit Rates

• Gross profit on sales: buy something for $10 and sell it for $15

Profit Rates


• Net profits: profits after overhead such as employees, electricity, inventories, taxes, etc. are accounted for

Profit Rates


• Net profits: profits after overhead such as employees, electricity, inventories, taxes, etc. are accounted for

• Profit on investment: most important measure, because it’s what causes $ to flow to various sectors

Costs of Production

• Crucial factor in determining prices and profits

Costs of Production

• Crucial factor in determining prices and profits• No fixed cost for producing anything

Costs of Production

• Crucial factor in determining prices and profits• No fixed cost for producing anything• Economies of scale: up to a certain point, it’s

cheaper to make more of the same thing because you spread fixed costs over larger units of output, whether cars or pizzas

• “Lower costs/unit of output as numbers increase is economy of scale”

Costs of Production

• Advertising can actually improve sales and profits if it causes more units to be sold

Costs of production

• Disenconomy of scale: there is a point where the enterprise gets so large, it’s difficult to coordinate and monitor

Costs of production


• J&J is a $65 billion company broken up into 250 subsidiaries

Costs of production



• Many big companies become stagnant and inefficient: GM, Microsoft

Costs of production



• Many big companies become stagnant and inefficient: GM, Microsoft

• McDonald’s grows through franchises

Costs and Capacity

• Costs not only vary with the volume of output, they also vary according to the extent to which capacity is being used

Costs and Capacity


• In many industries, capacity must be built to handle peak volume, i.e., electricity companies, computer networks, phone companies

Costs and Capacity


• In many industries, capacity must be built to handle peak volume, i.e., electricity companies, computer networks, phone companies

• Priceline and Travelocity responded to excess capacity in travel industry

‘Passing on’ costs/savings

Passing on of costs depends on competition


Passing on of costs depends on competitionMyth that companies can charge whatever

they want


Passing on of costs depends on competitionMyth that companies can charge whatever

they wantIf you develop a new technology that lowers

your production costs, you can either keep the extra profit or lower your price and sell more


Passing on of costs depends on competitionMyth that companies can charge whatever they

wantIf you develop a new technology that lowers

your production costs, you can either keep the extra profit or lower your price and sell more

Over time, competitors will match your advantage… thus constant innovation is essential

Specialization and Distribution

• A businesses is limited in the range of functions it can perform efficiently



• Car companies buy tires, stereos, many other parts




• Computer makers buy chips, screens, sometimes most of their machines




• Computer makers buy chips, screens, sometimes most of their machines

• Many companies buy janitorial, security, payroll, accounting, ‘back office’ services

No, ‘middlemen’ are not baddiesGoods tend to flow to their most valued uses

in a free market and are more valuable to those who can handle them more efficiently at a given stage



Furniture makers don’t own stores, many farmers don’t have transportation services



Furniture makers don’t own stores, many farmers don’t have transportation services

What connects the self-interest of a company with the efficiency of the economy as a whole are prices

Distribution

• Middlemen can typically distribute products more efficiently, whether in a developed or developing nation

Distribution

• Middlemen can typically distribute products more efficiently, whether in a developed or developing nation

• Socialist countries often eliminate middlemen and specialists at great sacrifices of efficiency

Final bit on miners… and profits

“You know there are tens of thousands of stories like this in the U.S., as big as Google and small as Center Rock. I'm glad one of them helped save the Chileans. What's needed now is a new American economic model that lets our innovators rescue the rest of us.”

Assignment February 19

• Chapter 6: “Big Business and Government”

capitalism

Documents

Transcript of capitalism