Section+1.2

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. Economics economicsStudy of how scarce resources are used to produce outputs—goods and services—that are distributed among people. is the study of how resources are used to produce goods and services to be distributed among people. Resources may include any or all of the following:
 * Section 2: What is Economics? **
 * Land and other natural resources
 * Labor (physical and mental)
 * Capital, including buildings, equipment, and money
 * 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 capitalize on an idea. Because a business uses resources to // produce // things, we also call these resources __factors of production__ factors of productionResources consisting of land, labor, capital (money, buildings, equipment), and entrepreneurial skills combined to produce goods and services. . 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 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

The 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?

Economic 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 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 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, 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 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.

** Mixed 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 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 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.

=== 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, the next section begins by describing how markets establish prices in an environment of // perfect competition //. ===