BJU Economics Unit 3

Sole Proprietorship

A business firm that has one owner - Most popular form of business ownership in the U.S. - gives the owner the most freedom of any type of business

Advantages of Sole Proprietorship

Freedom to enter and exit the market easily

Freedom from outside control

Freedom to retain information

Freedom from paying excessive taxes

Freedom from being an employee

Disadvantages of Sole Proprietorship

Unlimited personal financial liability

Limited management and employee skills

Limited life

Limited availability of money

Creditor

The lender of a loan - someone to whom a debt is owed

Partnership (or General Partnership)

A business enterprise with two or more persons as the owners

Advantages of Partnership

Greater management skills

Greater retention of competent employees

Greater sources of financing

Ease of formation and freedom to manage

Disadvantages of Partnership

Unlimited personal financial liability (both partners)

Uncertain life

Conflicts between partners

Has the shortest lifespan of all business types

Surety

The act of becoming security for or pledging to undertake another's debt

Two Forms of Partnership*

General Partnership (all partners are fully responsible for the financial decisions of each other) and Limited Partnership (limited partners avoid full financial liability in exchange for less input in the management and decision-making)

Corporation

A separate entity created and recognized by law - business is its own organization separate from the owners - type of business that is most subject to government regulation

Private Corporations

Corporations that private citizens own i.e. Coca Cola

Public Corporations

Corporations owned by the general public and managed by the government i.e. Amtrak

Stock

Pieces of a company that can be bought

Advantages of Incorporation

-*Limited personal financial liability

-Experienced management and specialized employees

-Continuous life

-Ease in raising financial capital - more likely to get a low-interest loan (lower risk) and can sell more stock to raise money

Disadvantages of Incorporation

-Higher taxes & double taxation of earnings

-Greater governmental regulation

-Impersonality - due to large size

-Rigidity - the organizational structure makes it difficult to respond quickly to the market

Limited Liability Company (LLC)

A form of business organization that combines the benefits of a corporation with those of a partnership. The owners of an LLC are not liable for the acts and debts of the LLC and owners avoid the double taxation of company earnings

1. May have any number of shareholders

2. governed by an operating agreement

3. not required to have a board of directors or hold regular shareholder meetings

What are the 3 basic forms of business organization, and which is the most common in the US?*

sole proprietorships, partnerships and corporations, and the most common in the US is sole proprietorships

Explain the biblical principle J.C. Penney applied in the foundation of his company. Cite the applicable reference.

To treat others as you would want others to treat you. "To love him with all your heart, with all your understanding and with all your strength, and to love your neighbor as yourself is more important than all burnt offerings and sacrifices." Mark 12:33

What is the primary advantage of being incorporated?

Limited financial liability of corporate ownership is its primary advantage.

An LLC combines the benefits of which 2 forms of business ownership?

The LLC combines the benefits of a corporation with those of a partnership

Book of Proverbs

book of the Bible that gives much advice on personal financial practices

advantage of partnership over sole proprietorship

greater financial resources - banks are more likely to lend money - risk is spread out between 2 parties

stock

portions of ownership of a company

limited partner

an investor with no liability and few or no duties in the company

CEO

Chief Executive Officer - president of a corporation

cosigner

someone who agrees to pay back a loan if the original borrower cannot

25%

the amount of new businesses that fail within their first year

Stock

Shares or portions of a corporation

Stock Certificates

Pieces of paper that were used as evidence of their ownership of the company. Although this method is not used today.

Common Stock

The most prevalent type of stock that companies offer and represents true ownership of the firm.

Dividend

A distribution of a portion of the corporation's profits.

Who are the last shareholders to be paid if a company fails?

Common shareholders

Preferred stock

Stock that companies consider more like a debt rather than other shares.

Stockbroker

A person who generally works for a brokerage company and who specializes in buying and selling stocks on behalf of his clients.

The fee that stockbrokers get paid

Commission

Floor traders

Another name for stock traders

Initial public offering (IPO)

The sale of a certain quantity of stock through an exchange at an investment bank.

The two reasons people primarily purchase stock.

1) To make a profit; 2) To receive dividend payments;

Stock exchange

Where merchants trade stock

When was the Philadelphia Stock Exchange founded? and what was it?

It was founded in 1790 and it was the first stock exchange in the US.

What is a stock market?

A stock market is a location at which people come together to buy and sell shares of stock.

What are the most well-known stock markets?

The New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ)

Stock index

A group of stocks that analysts use to help identify stock trends in specific industries.

Who developed the most well-known index?

Charles Dow, who helped found the Wall Street Journal, developed the Dow Jones Industrial Average (DJIA).

What is a commonly reported investment index?

The Standard and Poor's 500 (S&P 500).

Stock portfolio

A collection of stocks from different individual corporations.

The importance of stock markets

1) Stock markets provide a venue for the sale of stock. 2) It provides opportunities for individuals to invest. 3) The stock market indices provide information to corporate leaders, economic analysts, ad governmental policymakers.

Mutual funds

Privately managed stock portfolios

The most memorable event that proved the importance of stock exchanges.

The Great Depression in 1929

Speculation

Actively buying and selling stocks for the purpose of taking advantage of short-term price changes.

Speculative bubble

When stock prices rise in an industry or across the entire market simply because of expectations and they rise in excess of the corporations' true value.

Securities and Exchange Commission (SEC)

It was founded in 1934 to ensure that corporations provide accurate and current information to the public about their financial situations and their business dealings.

How does a person control a corporation?

By not offering any of the corporation's stock to the public and decide to hold all their company's stock and thus retain complete control

What is the primary reason for a corporation selling shares of its stock?

to raise money for their business

What do the owners of the corporations lose when they sell shares of its own stock?

A small percentage of their company since the buyer of their company stocks allows them to own a small percentage of the company

What situations are associated with common preferred stock?

shareholders receive dividends first

less risky

if the corporation fails, these shareholders receive any leftover revenue ahead of other shareholders

What situations are associated with common shares of stock?

owners have voting rights

considered true ownership

When launching an IPO, how do the original owners maintain control of their corporation?

the owners sell less than half the stock then they can raise the necessary capital but still retain majority ownership of their corporation, this is an advantage since they have the majority shares and majority votes.

How does the phrase "buy low;sell high" apply to buying stock for profit?

individuals who buy stock at what they consider to be a low price for shares that they believe are going to increase in value and then to sell those shares later at a higher price, thus making a profit, which means stock prices reflect the opinion of buyers as regards to the financial future of a company

In what two countries did stock exchanges originate?

Great Britain and North Holland

Where and when did the first U.S. stock exchange develop?

Philadelphia Stock Exchange founded in 1790 was the first stock exchange in the US

What stock index gives a broader perspective than the DJIA, and why is it important?

Standard and Poor's 500 (S&P 500) it includes 500 stocks and tracks not only corporations engaged in industrial production but also other types of businesses, like those that provide services.

What are two distinctions between gambling and stock ownership?

1. to buy stock is to purchase partial ownership in a corporation and thereby have a personal interest in its successful operation

2. the stock market need not carry the risk of a gambling game, by keeping informed of the details of the companies stock and not taking high risks in investing at strike it rich attitude.

How is a corporation's board of directors important?

A board of directors is a group of individuals selected by the shareholders of a company or organization to oversee a firm and its management. The board has a fiduciary duty to make sure the management of the firm is acting in the shareholders' best interest. The board does this through its advisory and oversight roles.

How is an individual investor important?

An individual who purchases small amounts of securities for him/herself, as opposed to an institutional investor also called retail investor or small investor.

Had the SEC existed in the 1920's, how might its regulatory policies have prevented the stock market crash of 1929?

It would have made companies to fully disclose their financial status so that potential investors could make informed investment decisions and also regulated the activities of stock exchanges and brokers in the best interest of the investor.

Market

The arrangements that people have developed for trading with one another

Competition

The struggle each firm experiences as it seeks to survive and then thrive - encourages both quality and efficiency

Industry

A group of businesses that share common concerns, sell a similar product, serve a certain group of customers, and produce products in a similar way i.e. automotive

Differentiated

Products that are visibly different from one firm to another - candy, cereal, handbags

Undifferentiated

Products that are exactly alike regardless of which firm produced it - milk, corn, wheat

Barrier to Entry

Any significant obstacle that prevents or hinders a new firm from entering an industry and competing on an equal basis with established firms - this does NOT include the normal start-up difficulties such as financing, attracting new customers, hiring, or producing a product

Natural Barriers to Entry

Occurs when firms already in the industry own all a vital natural resource that a new firm would need to enter the market or when production costs favor high-volume production over production in small quantities

Artificial Barriers to Entry

Result from governmental regulations, such as licensing requirements or patents

Perfect Competition

When there are many producers selling an identical product, no single firm controls the price, and businesses find it relatively easy to enter and exit the market - buyers base their buying decision solely on price - i.e. crops, gas stations - this is the MOST DIFFICULT market in which to make a profit

Imperfect Competition

The most prevalent form of competition in America today. There are many producers of slightly differentiated goods, each firm has some control over price, and can enter or exit the market with relative ease - i.e. perfume, clothing - the firm's ability to control its price results directly from the ability to differentiate its products from the rest of the market's

Ogliopoly

Contains only a few (3 or more) firms; their products can be either highly differentiated or undifferentiated; each firm has a great deal of control over price, and would find it very hard to enter and exit the industry - most important characteristic is mutual interdependence

Tight Oligopoly

An industry in which the top four firms account for 75 percent of the market sales

Loose Oligopoly

An industry in which the top four firms account for 50-75 percent of the industry's total sales

Duopoly

An oligopoly composed of only two business firms

Collusion

An agreement among a small number of producers to reduce output and increase prices with the intention of making more money without losing customers to competition - most workable for oligopolies - this is legal in the U.S.

Cartel

A formalized collusion - a formal organization of producers that agree to coordinate prices and production - OPEC is the most well-known of these

Monopoly

A form of market organization in which there is only one supplier in the industry. That one business is the price setter; it is impossible for new firms to enter the industry; it is very difficult for the existing firm to exit.

Natural Monopoly

When a firm owns or controls 100 percent of a resource that is essential to an industry

Legal Monopoly

A firm that has been allowed by the government to have exclusive right to provide a good or service - very common with utility (power, cable, water/sewer, natural gas) companies in an area - government realizes that having more than one company providing these services in an area would be too expensive or inconvenient - most common type of monopoly

Trust

This is created when the head of an industry's largest company persuades the other firms to combine their stock in one account. He then administrates the account, controlling the promotion, quantity, and prices of each firm's products - He would ensure that cutthroat competition would not occur and that profits would remain high - this was big businesses way of limiting competition without forming a monopoly - the Sherman Act of 1890 made this illegal

price discrimination

Firms sell the same good to different buyers at different prices - made illegal by the Clayton Act

tying contracts

Big companies require that smaller companies desiring to buy from them had to purchase their full line of products - made illegal by the Clayton Act

synergy

Occurs when the total is greater than the sum of the parts - 1 + 1 = 3 - explains how larger companies are more economically effiicient as it concentrates its resourses to increase productivity

anticompetitive takeovers

Corporations take over other firms by purchasing a controlling share of their competion's common stock - made illegal by the Clayton Act

interlocking directorates

Firms place one or more directors on the boards of competing firms - made illegal by the Clayton Act

mutual interdependence

most important characteristic of an oligopoly - because there are only a few large firms in the industry, the production decisions of one affect the profits of the others - oligopolies face unique difficulties because of this

price setters

businesses that control the fee for their product - this does not mean that the business can control the demand for the product

price takers

businesses that accept a price that is determined by the market, price is largely out of their control - business is limited to charging the price that others in the market are charging

Andrew Carnegie

A Scottish-born American industrialist and philanthropist who founded the Carnegie Steel Company in 1892. By 1901, his company dominated the American steel industry.f

OPEC - Organization of Petroleum Exporting Countries*

An international oil cartel originally formed in 1960 - the most well-known cartel today - Represents the majority of all oil produced in the world - Attempts to limit production to raise prices

Sherman Antitrust Act

1890 - the first federal law that committed the American government to opposing monopolies - it prohibited contracts, combinations, and conspiracies to "monopolize" business

Clayton Act*

Passed by Congress in 1914 to strengthen the Sherman Act and clarify the rule of reason, the act outlawed specific monopolistic behaviors including

1. interlocking behaviors - placing one or more directors on the boards of competing firms

2. tying contracts - requiring smaller companies to purchase their full line of products or refusing to sell to firms who carried the products of competitors

3. anticompetitive takeover - taking over other firms by purchasing their common stock if the effect was to limit competition significantly

4. price discrimination - selling the same good to different firms at different prices

characteristics that distinguish types of industries*

1. The number of firms in the industry

2. the diffences between products produced within the industry

3. the industry's control over prices

4. the ease or difficulty of entering or exiting the industry

4 types of competition

1. Perfect

2. Imperfect (most common in U.S.)

3. Oligopoly

4. Monopoly