Economics For Everybody Part2

354 V111 PRODUCING: THE ROLE OF BUSINESS

Understandin: Economics
SPECULATORS AND THE STOCK MARKET

Marjorie Morris, Clarence Berens, panies in the electronics industry, and
selling them after they had gone up in
Harry Wong, and Sylvia Finn do not know value. Each made their buy on March 24,
one another, but they have a number of 2000, and held on to their stock for about
things in common. Each thought that they a year.
could profit by buying the stock of corn-

DATE: March 24, 2000

Buyer Stock Number of Price Per Total
Morris Microsoft Shares Purchased Share Cost
Berens Cisco Systems
Finn Intel 70 111.69 $7,818.30
Wong Yahoo
100 79.38 7,938.00

100 69.53 6,953.00
40 194.00 7,760.00

On March 29, 2001, each of the made because early on in 2001 the long
speculators sold their shares at a substan- predicted collapse of the electronics and
tial loss. Here is how it happened. dot-com stocks began. In the course of
that decline, the four speculators saw their
Starting in January of 1997, stocks is- potential profits disappear. Meanwhile,
the collapse of electronics stocks came
sued by electronics and Internet-related as a terrible blow to investors across the
companies (popularly described as the
"dot-corns") began a run-up in prices that United States and overseas. As the value
of their investments fell, panicky stock-
looked to many speculators like it would holders ordered their brokers to sell. Our
four speculators did the same. On March
never end. Despite warnings that stock 29, 2001, Morris, Berens, Wong, and Finn

prices never increase forever, people like sold the stocks they had purchased only
Morris, Berens, Wong, and Finn kept buy- a year earlier. The results of their sales are
ing those securities, and prices continued summarized in the table below:
their advance. "Look at those stocks climb,"
they said. "We will make a fortune!"

Alas, there was no fortune to be

DATE: March 29, 2001

Buyer Stock Number of Price Per Total
Morris Microsoft Shares Sold Share Received
Berens Cisco Systems
Finn Intel 70 $55.38 $3,876.60
Wong Yahoo 100 1,525.00
15.25
100 28.56 2,856.00
40 15.00 600.00

Buying and Selling Stocks and Bonds VV1 355

In less than one month's time, Mor- for those who thought it possible for stock
ris had lost $3,941.70; Berens, $6,413; prices to rise indefinitely. The fact is that
Finn, $4,097; and Wong, a whopping the only thing certain about stock prices
$7,160! Millions of other investors also lost is that they will fluctuate. Sometimes they
money in the stock market that month. will rise, and sometimes they will fall. For
that reason, investors and speculators
The reasons why the electronics in- alike need to be prepared for the unex-
dustry stocks collapsed when they did pected, which may occur at any time.
may never be known. Whatever the rea-
sons, the events stand as a stark reminder

© The New Yorker Collection 1997 Roz Chast from cartoonbank.com.
Optimistic bulls expect stock prices to rise, while pessimistic bears expect them to fall.

WHAT ARE MUTUAL FUNDS?

Although the advice given above about investing is good, few
people have the knowledge, time, or money to follow the advice.
But there is a method for people of average means to invest in
stocks and bonds while limiting their risks. For millions of inves-
tors, the method is to invest in mutual funds.

356 PRODUCING: THE ROLE OF BUSINESS

A mutual fund is a company that invests on behalf of its share-
holders. People purchase shares of the mutual fund, and the com-

pany pools the money of all these people. The company invests the

pooled money in a variety of securities, including stocks, corporate
bonds, and government bonds. Income earned by a fund is distrib-
uted to the shareholders in accordance with the number of shares
they own.

Advantages of Mutual Funds

1. Professional Management. The employees of a mutual
fund are trained to study financial information, economic trends,
and political developments. Few investors have the time or exper-
tise to do this.

2. Diversification. To reduce the risks of ownership, mutual
funds invest in a wide variety of stocks and bonds.

3. Liquidity. A mutual fund investment can be turned into
cash quickly and easily.

Figure 23.4 Household Ownership of Mutual Funds Since 1980
(Percent and Number of U.S. Households)

60

50
Percent of U.S. Households

Millions of U.S. Households
40

30

20

10

1980 1 984 1 992 1 996 2001 2013

Year

Buying and Selling Stocks and Bonds 357

Personal Economics
SOME ADVICE TO WOULD-BE INVESTORS

Are you thinking about investing in diversifying (investing your money in a
corporate stocks or bonds? Then consider number of companies rather than in just
the following advice: one or two). You can further diversify by
putting your money in different kinds of
1. Investigate before you invest. stocks or in both stocks and bonds.
Know something about the business in
which you plan to invest: its finances, his- 3. Keep checking your investments.
tory, and future outlook. Get the advice of Nothing is forever! Even the best of cor-
an expert. porations will at times perform poorly.
Keep an eye on your investments, and
2. Do not "put all your eggs in one switch to new ones when necessary.
basket." You can reduce your risks by

Disadvantages of Mutual Funds

Mutual funds are not free from risk, however. If stocks in gen-
eral are doing poorly, so too will most mutual funds. Generally,
funds that invest in government securities carry less risk than
ones that invest in corporate stocks. In addition, many different
companies sell mutual funds. Some of these companies are better
managed than others. So, even when investing in mutual funds,
investigate before you invest.

HOW IS THE PUBLIC PROTECTED IN THE
SALE OF SECURITIES?

The federal government has taken steps to protect those who
invest in corporate stocks and bonds. In the 1930s, it established
the Securities and Exchange Commission (SEC) to regulate the
sale of securities. The SEC also tries to make it easier for the pub-
lic to get the information that it needs to make intelligent deci-
sions about investments. The SEC does not, however, offer advice

on the worth of any particular stock or bond. The decision to buy

or sell is left to each individual investor.
In 1970, Congress took another step to protect investors by cre-

ating the Securities Investor Protection Corporation (SIPC). Like

N358 PRODUCING: THE ROLE OF BUSINESS

the Federal Deposit Insurance Corporation (FDIC), which insures
bank accounts, the SIPC insures the cash and securities in cus-
tomer accounts in the event that a brokerage firm were to fail.

State governments also regulate securities, specifically those
that are not subject to federal regulation.

Each of the major exchanges also acts as a self-regulator. An
exchange establishes rules for trading and will penalize or ex-
pel a member who fails to follow its rules. An exchange does not
guarantee the safety of any investment traded. Nor does it take
responsibility for the advice given to an investor by any of its
members.

What does this mean for you, your family, and your friends?
It means that if you are thinking of buying securities or mutual
funds, you would be wise to be careful. Remember, you can easily
lose part, or all, of your investment.

SUMMARY

Corporations pay for their operations from their earnings or from
money raised from outside sources. Outside sources include loans and
the sale of stocks and bonds. Lenders are paid interest for the use of their
money. Stockholders receive a share of the company's profits in the form
of dividends. Stock exchanges make it possible for millions of shares of
stocks and bonds to change hands daily.

People invest in corporate stocks to receive dividends, to acquire cap-
ital gains, and to speculate.

Mutual fund companies pool large sums of money that they invest
on behalf of their customers. In this way, the mutual funds offer the ad-
vantages of professional management and diversification to investors of
modest means.

The federal Securities and Exchange Commission regulates the pur-
chase and sale of stocks and bonds. The primary function of the SEC is to
see to it that the public is given accurate and honest information about
the corporations whose securities are offered for sale. Another federal
agency, the Securities Investor Protection Corporation, protects the in-
vesting public by insuring the contents of their brokerage accounts.

LOOKING AHEAD

The following chapter looks at one of the major reasons for the size
and wealth of the U.S. economy: mass production. This term refers to the
ability of businesses to manufacture large quantities of goods at low cost
and to sell them at a profit.

NBuying and Selling Stocks and Bonds 359

EXERCISES

Matching Match each term in Column A with its definition in
Column B.

Column A Column B
a. the agency that regulates the sale of stocks and
1. investment
bank bonds
b. any investment based on one's hope to profit
2. stock
3. stock exchange from its short-term rise or fall in value
4. bond c. a business that sells new issues of stocks and
5. capital gain
6. dividend bonds to brokers
7. speculation d. one who buys and sells stocks for investors
8. bull e. a place where publicly traded securities are
9. bear
10. mutual fund bought and sold
11. stockbroker
12. Securities and 1. one who expects the price of stock to rise

Exchange g. an increase in the value of a share of stock
Commission h. one who expects the price of stock to fall
i. a pool of funds invested in a variety of stocks

j. a share of ownership in a corporation
k. a debt of the company that issues it
1. a payment by a company to its stockholders

I/Multiple Choice Choose the letter of the item that best completes
the statement or answers the question.

1. Recently, XYZ Corporation, one of the nation's largest corporations,
sold several million shares of its stock to the public. How was the
stock sold? (a) by mail-order catalog (b) by one or more investment
banks (c) over the counter at the corporation's many stores and of-
fices (d) all of the above.

2. A year after all its stock was sold, investors are still busily buy-
ing and selling shares of XYZ stock. Who receives the money from
these sales? (a) the individual owners of XYZ who choose to sell
their stock (b) the XYZ Corporation (c) the managers of the XYZ
Corporation (d) the stock exchange that handles the sales.

3. Alvin Atwell is buying shares of stock in a retailing corporation be-
cause he is convinced that the price of its stock is going to rise very
soon. Alvin is a (a) "bear" (b) pessimist (c) careful investor (d) "bull."

4. Millicent Marcus owns 100 shares of the Blue Sea Fishing Company
of Portland, Maine. At the end of the year, Blue Sea declares a
$1.50 dividend. How will this declaration affect Millicent? (a) Each
hare of stock will increase in value by $1.50. (b) She will receive
heck for $150. (c) She will receive a check for $1.50. (d) It will
no effect at all on Millicent because she lives in Oregon.

360 PRODUCING: THE ROLE OF BUSINESS

5. The Securities and Exchange Commission (a) regulates the amount
of money and credit in circulation (b) supervises the coining of
money (c) regulates the sale of stocks and bonds (d) guarantees
home mortgages.

6. Stock dividends (a) must be paid to stockholders every year (b) are
paid to those who lend the corporation money (c) represent shares
of profits and are paid to stockholders (d) are not taxable.

7. Which of the following is true of corporate bonds? (a) They repre-
sent a debt of the corporation. (b) They pay bondholders a fixed
rate of interest. (c) They promise to repay bondholders a specified
amount after a fixed period of time. (d) All of the above.

Developing Skills in Economics Study the graphs on pages 352
and 356 and then answer the questions below.

1. How many people owned shares of corporate stock in 1975? in
1987? in 2002?

2. What has been the trend in corporate stock ownership over the
period shown? (Trend refers to the general course or direction in
which something is moving.)

3. What reasons can you suggest for this trend in corporate stock
ownership?

4. How many households owned shares in mutual funds in 1980? in
1992? in 2001?

5. What was the trend in mutual fund share ownership in the period
shown?

6. What reasons can you suggest for the trend in mutual fund
ownership?

V Using the Internet

The following Websites will provide further information about in-
vesting. The Stock Market Game at smgww.org is sponsored by the se-
curities industry. The game enables participants to discover the risks
and rewards involved in decision-making, the sources and uses of capital,
and other related economic concepts. The SEC's Office of Investor Edu-
cation and Advocacy Website at sec.gov can take you to many valuable
resources on the Internet.

24

Mass
Production

Key Terms

technology division of labor productivity
interchangeable automation input
computer-assisted
parts overhead
mass production design (CAD) hazardous
assembly line computer-assisted technological
specialization
machining (CAM) unemployment

Back in George Washington's day, in the 1700s, muskets were

manufactured one at a time by gunsmiths. Each trigger, hammer,

and gun barrel had to be made by hand. Thus, each musket had
parts that were slightly different from other muskets. The hand-

crafted method of making muskets came to an end in the early
1800s.

Inventor Eli Whitney (1765-1825) was under contract to make
10,000 muskets for the U.S. Army. But Whitney spent so much of

his time designing machines and tools to produce the gun parts
that for several years he delivered nothing. Finally, the day came
when he was able to pack a box with enough parts to make ten

muskets and go to Washington, D.C. There Whitney invited a

group of government officials to assemble the parts into ten fin-
ished weapons. The officials were puzzled.

"How will we know which trigger fits into which barrel?" one
asked.

"It doesn't matter," Whitney explained. "You see, all the parts
are interchangeable. Each trigger, for example, is exactly the same

as every other one. Try it. You will see that all ten guns will go

together very easily."
Sure enough, the government officials soon discovered that it

did not matter which gun part they started with. All the different

361

362 PRODUCING: THE ROLE OF BUSINESS

parts went together quite easily. In a short time, the ten guns were
assembled.

In this chapter, you will learn how Whitney's methods and
other advances in technology, the use of science and new machin-
ery to improve production, increased industrial output. You will
also find out the answers to the following questions:

• What is mass production?
• Why does mass production depend upon specialization, the

division of labor, and automation?
• How has mass production affected all Americans?

WHAT IS MASS PRODUCTION?

There were two very important advantages to Eli Whitney's
method of production of muskets. First, if a musket part, such as
a trigger, were to fail, it could easily be replaced with an identi-
cal part. Each part was interchangeable—it could be used in any
musket. But if the trigger of a handmade musket were to break,
a new trigger would have to be made to order so that it would
fit that particular musket. A second advantage of Whitney's pro-
duction method was that the muskets with interchangeable parts
could be produced faster and at lower cost than those produced by
hand.

The idea of interchangeable parts that Whitney developed is
one of the underlying principles of mass production.

Mass production is the manufacture of large quantities of
identical products in large quantities using interchangeable parts,
specialized labor, and machinery.

When goods are made by hand, no two can be exactly alike.
Machinery, however, can be designed to produce goods that are
identical to one another. In other words, machinery made the pro-
duction of interchangeable parts and tools possible.

Assembly Line

The next big step in the history of mass production was taken
about 100 years after Eli Whitney developed interchangeable
parts for muskets. In the early 1900s, Henry Ford first used the
assembly line to produce the Model T automobile.

Ford's basic idea for an automobile assembly line was this. In-
stead of moving from one automobile to another during the day,
workers stood at stations on a "line." The work came to them.

Mass Production 363

Early 20th-Century Mass Produc-
tion: (right) Assembly-line workers
perform the steps to put together
automobile generators; (top) fin-

ished Model T Fords roll off the
conveyor belt.

364 PRODUCING: THE ROLE OF BUSINESS
Before Ford's system was put into practice, it took one worker

about 20 minutes to put together a flywheel magneto for the Model
T. (The magneto supplied the car's electricity. In today's cars, this
is done by the battery.)

When the assembly line was introduced, the assembly of the
magneto was broken down into 29 steps. These steps were per-
formed by 29 workers spaced along a moving belt. The belt was
timed so that each worker was able to complete one small task
before the magneto moved on to the next worker. Within a year,
the average time needed to assemble one flywheel magneto had
been reduced from 20 minutes to 5. Eventually, all the steps in
the manufacture of Model Ts were put on assembly lines. The re-
sults were dramatic. Whereas fewer than 11,000 Model Ts were
made in 1908, that figure exploded to more than 730,000 in 1917.
Meanwhile, in that period the price of a Model T dropped over 60
percent, reflecting the efficiency of the company's assembly-line
production methods.

Ford's success made the Ford Motor Company the world's lead-
ing producer of automobiles. Ford became one of the richest people
in the world.

Late 20th-Century Mass Produc-
tion: Workers assemble computer
circuit boards. How does this
scene differ from the one of early
mass-production assembly, on
page 363?

Mass Production 365

WHY DOES MASS PRODUCTION DEPEND UPON
SPECIALIZATION, THE DIVISION OF LABOR,
AND AUTOMATION?

The assembly line applied two principles of economics to pro-
duction: specialization and the division of labor. It also served to
increase productivity by using automated machinery.

Specialization and Division of Labor

In manufacturing automobiles, no one worker assembles an en-
tire car. Instead, each worker does only one small part of the total
job. Similarly, one worker in a refrigerator factory may install ther-
mostats while another puts on doors. This is called specialization.

What is true for automobiles and refrigerators also holds for
manufacturing computers, television sets, airplanes, and thou-
sands of other items. That is, production is broken down into many
tasks. Each one is performed by a number of workers. When work-
ers specialize in the production of only part of a good or service, we
have a situation called the division of labor.

There are two important advantages to the division of labor.
First, workers are more easily trained when the job they perform
is limited. It is much easier to teach a group of workers how to op-
erate one machine in a factory than to teach all the workers how
to operate every machine there. If one group of workers assembles
only carburetors and another group assembles only gear boxes,
then only one set of skills need be taught to each group.

The second advantage to the division of labor is that each
worker needs fewer skills. If one person had to produce an entire
television set, he or she would need the abilities of an engineer, a
cabinet maker, a mechanic, and a technician. But when these tasks
are divided, a worker needs only one set of skills to perform the job.

Automation

The efforts to find more efficient methods of production have con-
tinued since the development of the assembly line in 1913. In the
1950s and 1960s, people began to speak of a revolutionary new con-
cept in production called automation. This term refers to production
in which machines are operated by other machines rather than by
humans. A thermostat, a device that turns a machine on or off when
a certain temperature is reached, is a simple example of automation.

In recent decades, the addition of computers to automated
equipment has enabled machinery to perform even more tasks

366 PRODUCING: THE ROLE OF BUSINESS

Computer-Assisted Design: An engineer studies a computer display of his ideas. What
economies (savings) are offered by CAD?

formerly done by humans. Computer-assisted design (CAD) re-
fers to the use of computers and special software to assist them in
the designing of products. Before the development of CAD, draft-
ers and engineers had to spend many hours at the drafting ta-
ble, drawing their designs by hand. Now, computers can prepare
a perfect picture of the most complex product or any of its parts.
Still another feature of computer-assisted design is that computer
models can be tested even before they exist in the real world. For
example, the computer can calculate how outside forces (such as
wind, rain, and speed) might affect a structure.

Computer-assisted machining (CAM) refers to computer con-
trol of production machines. A printing press operating under in-
structions from a computer tape is one example of CAM. So too
is a computer-directed robot used to weld automobile frames. You
can see how CAD and CAM together could help to speed produc-
tion of next year's model of your favorite automobile. Now if only
someone could find a way to get a robot to do homework.

HOW HAS MASS PRODUCTION AFFECTED ALL AMERICANS?

The quality of life today—the way Americans live their lives—is
far different from what it was a hundred years ago. People today
are generally healthier and live longer, have more of the necessities

Mass Production 367

Understandin: Economics
MASS PRODUCTION IN A BICYCLE COMPANY

Suppose you are the manager of a selling price was $90, the company made
bicycle-manufacturing company. Your a profit of $50 on each bike ($90 — $40 =
small factory is able to manufacture 100 $50), and a total monthly profit of $5,000
bicycles every month and sell them at
$90 each. It costs the firm $4,000 a ($50 x 100 = $5,000).
month to turn out these bikes. The own- Now let us see how the plant would
ers are interested in increasing their profits.
So you are asked to look into the possi- do if it were to expand. With production
bility of expanding the plant and bringing at 800 bicycles a month and expenses
in modern machinery and equipment. You at $16,000, each bicycle would cost the
investigate and learn the following: company $20 to produce ($16,000 ± 800
= $20). This would yield a profit of $70
1. Expansion and modernization on each bicycle ($90 — $20 = $70), and a
would increase montl-ily expenses total profit for the month of $56,000 ($70
to $16,000. x 800 = $56,000).

2. Output of bicycles would increase To summarize: Although enlarging
from 100 to 800 a month. the bicycle company's operations would
increase its monthly costs (from $4,000
3. The company could sell all 800 bi- to $16,000), it would also increase its
cycles at the old price of $90. monthly production (from 100 to 800 bi-
cycles). As a result, the production cost
Would you recommend that the bicy- of each bicycle would be reduced from
cle company expand its production? You $40 to $20, and profits would rise from
probably would, because an increase in $5,000 to $56,000.
production would considerably increase
the company's profits. Let us see why. In The high profits gained by the intro-
the small plant, it costs $4,000 to manu- duction of mass-production techniques
facture 100 bikes each month. Therefore, serve to explain why most businesses
every bike may be said to have cost $40 will adopt them if they can. While costly,
because $4,000 ± 100 = $40. Since the large-scale production enables producers
to turn out many more goods at a lower
cost for each item.

Figure 24.1 Mass Production in a Bicycle Factory

1. 2. Management Survey 3.

1Output 100 III Output 800
Price $90 Price $90
Costs $4,000 ida Costs $16,000

What will happen to the factory's profits when it increases its output of bicycles?

368 PRODUCING: THE ROLE OF BUSINESS

and luxuries of life, and enjoy more leisure time than most Amer-
icans did in the early 1900s. Many of the reasons why our lives
are different and mostly better than those of people a century ago
can be credited to the advantages that followed the development
of mass production.

Advantages of Mass Production

I. Productivity Gains. It costs money to produce goods. If it
costs Company A $100 to produce two bicycles, each bicycle costs
the firm $50 (because $100 ± 2 = $50). But suppose another firm,
Company B, uses the latest machinery to manufacture its bicy-
cles. Company B is able to produce four bicycles, identical to A's,
for $100. That is, each bicycle costs Company B only $25 to pro-
duce ($100 ± 4).

When we compare the number of units of a product that are
produced to the cost of producing these units, we are speaking of
productivity. Some economists define productivity as the quantity
of output for every unit of input. In our bicycle example, the input
is $100. Company A's output is two bicycles, while Company B's
output is four bicycles.

The principal advantage of mass-production methods is that
they increase productivity. And productivity gains can benefit
everyone. Productivity gains make companies more competitive.
When productivity is increasing, it costs a firm less to produce each
of its products. That being the case, it is possible for a company
both to lower its selling prices and increase its profits. Lower prices
mean that more consumers will be able to afford the product.

Sales should increase. When people buy more, their living
standards rise. Workers, too, might benefit from increasing pro-
ductivity, if their employers choose to share the gains with them.

2. Lower Cost of Materials, Services, and Capital. Big
businesses buy in large quantities. It is an advantage to them.
Suppliers usually offer discounts to businesses that place large
orders. The cost of borrowing is usually lower for big businesses
than it is for small ones. Banks and private investors are more
willing to lend money to big companies than to little ones. And
they often charge big companies lower interest rates.

3. Use of Modern Machinery and Equipment. It takes vast
amounts of capital to pay for modern factories and machinery. For
that reason, not all firms can afford them. But modern machines in-
crease productivity. So those firms that can afford them are often at
an advantage. They can increase their output and reduce their costs.

Mass Production 369

4. Opportunities for Research and Development. Busi-
nesses use scientific research to find and develop new products
and production methods. But scientific research is costly. Labo-
ratories must be built and maintained, and scientists and techni-
cians must be paid. Only the largest firms can afford the expense
of maintaining research staffs. Research can, however, bring great
rewards after important discoveries are made and developed into
new products or production methods.

Disadvantages of Mass Production

We have, however, paid a price for the gains made through
mass production. Here are some of the disadvantages of mass pro-
duction. You may be able to think of others.

1. Enormous Capital Investment. Mass production is very
costly. The factory buildings, machinery, and other equipment of
mass production must be paid for and maintained even when the
demand for products declines.

Expenses that must be paid regardless of how much or how
little the company earns are called overhead (fixed expenses). In
order to pay for their overhead, companies involved in mass pro-
duction must constantly seek better ways of selling their output.

2. Threats to Personal Health and the Environment. Fac-
tories can produce a great deal of waste. Some of this waste is re-
leased into the atmosphere in the form of smoke and gases. Liquid
wastes are sometimes released intentionally or unintentionally
into waterways or are allowed to seep into the soil, where they
may enter the drinking water. Solid wastes are often deposited in
dumps or landfills, where they may cause pollution problems un-
derground. Sometimes solid wastes are burned, thereby contribut-
ing to air pollution.

The manner in which industries dispose of their wastes can be
extremely hazardous (dangerous) to the environment and the public.
Many chemical wastes have been linked to human cancers and chro-
mosome damage. For that reason, the federal government now reg-
ulates the disposal of industrial wastes. Both industry and govern-
ment have been studying the problem and searching for solutions.

The oil tanker Exxon Valdez went aground in Alaska's Prince
William Sound in 1989. The tragedy resulted in the biggest oil
spill in U.S. history and the destruction of vast quantities of fish,
birds, and wetlands. After ten years, Exxon had paid over $2 bil-
lion just to clean up the oil spill and over $6 billion in fines and
damages for that environmental disaster.

370 4,/, PRODUCING: THE ROLE OF BUSINESS

Understanding Economics
SAWMILLS ARE BUZZING AND THE
ECONOMY IS HUMMING

Sawmills cut timber into boards and computers enable Willamette to produce
planks. In the past, logs were fed into lumber with 20 percent fewer workers
huge circular saws that sliced them into and 12 percent fewer trees than it needed
lumber. Sawmills wasted a lot of wood to generate the same amount of boards
because the trees they worked on were ten years ago.
less than straight. There is not much that
can be done about gently curved trees, The introduction of new computers
because trees turn themselves toward the and machines increased productivity at
sun as they grow. But there is something Willamette. Similar productivity increases
now that can be done to get the most have been taking place in thousands of
lumber with the least amount of waste companies and hundreds of industries
out of curved logs. around the country. Economists tell us
that the increase in productivity is helping
At Willamette Industries one of the economy and the stock market and
the nation's largest forest products com- is raising employment levels and living
panies—lasers scan incoming logs. The standards. It also helps keep prices down.
results are fed into a computer that cal-
culates the most efficient way to cut up Questions for Thought and Discussion
the logs. Then, as logs roll into the mill,
24 paired saw blades swivel and pivot to 1. What do economists mean by "in-
follow the curve of the tree. In no time at creases in productivity"?
all, each long, not-entirely-straight log is
converted to a neat stack of 2X 12, 2 X10, 2. How did the introduction of new
and 2 x8 boards, along with a 2 X 6 that machines and computers affect pro-
the saws scavenge from the narrower ductivity at Willamette?
sides of the log. The new machines and
3. Explain what effects increasing pro-
ductivity can have on the economy.

3. Dependence on Large-Scale Industries. Because they
operate on such a large scale, mass-production industries employ
large numbers of workers. The failure of a single company can re-
sult in unemployment for hundreds, thousands, or even tens of
thousands of workers.

4. Many Lost Jobs. The introduction of automated production
techniques sometimes means that fewer workers are needed. In
1811, British newspapers carried the story of weavers who were
rampaging through textile factories. The weavers (called Luddites)
were smashing the new weaving machines that had cost many of

Mass Production 371

them their jobs. In more recent times, automated harvesting ma-
chines have replaced many farm workers. Robots have replaced
workers on many factory assembly lines.

When people lose their jobs to machines (or "technology"), the
problem is described as technological unemployment. While some
workers who have lost a job can be retrained, losing one's job is
painful. For that reason, technological unemployment is listed
as one of the high costs that society must pay for the advances it
makes. Because technologies keep changing, technological unem-
ployment will continue to be a problem for workers. Perhaps every
worker will have to be retrained two, three, or four times during
his or her working life.

SUMMARY

Mass production is the manufacture of large quantities of identical
products, using interchangeable parts, machinery, and the division of la-
bor. Mass production enables manufacturers to produce more goods at a
lower cost per unit. These gains in productivity enable many consumers
and workers to live better.

Mass production has its disadvantages. The failure of an industry,
or even an individual, large firm, can lead to widespread unemployment.
The development of new machinery can result in technological unem-
ployment. Industrial wastes may threaten the environment and, in turn,
everyone's health.

LOOKING AHEAD

Despite the problems associated with mass production, most busi-
nesses would prefer to grow in size. One way for a business to accomplish
this goal is to combine with other firms to form a larger company. In the
next chapter, we will see how businesses combine. And we will learn of
the problems that these combinations have created.

EXERCISES

VMultiple Choice Choose the letter of the item that best completes
the statement or answers the question.

1. The assembly line changed automobile production methods because
(a) workers decided what tasks they would perform during the
workday (b) the parts to be worked on were brought to the workers

372 PRODUCING: THE ROLE OF BUSINESS

on a moving belt (c) workers moved from one car to the next and
performed a small task on each one (d) it enabled each worker to
assemble a larger portion of an entire car.

2. If a product is made with mass-production methods, it (a) will cost
more to produce than if it had been produced by hand (b) is likely
to cost less to set up the factory than it would to set up a shop to
produce the goods by hand (c) should cost less to produce than if it
had been produced by hand (d) will always be of better quality than
one produced on an individual basis.

3. One advantage of the division of labor is that (a) workers can be
more easily trained to perform a small number of tasks than a
large number of tasks (b) workers find it more interesting to do
the same small job over and over again than to complete an entire
product (c) workers can do much of the production at home (d) it
encourages the establishment of many small businesses rather
than a few very large ones.

4. One advantage of producing goods on a very large scale is that
(a) the large-scale manufacturer can come to know the workers bet-
ter than a small producer can (b) overhead expenses are lower than
those of small producers (c) large-scale producers do not have to
borrow money, but small producers do (d) large-scale producers
can usually obtain their raw materials at lower rates than small
producers.

5. In 1910, the price of a Model T Ford was $950. By 1917, the aver-
age price for the same car was $360. In 1910, fewer than 19,000
Model Ts were sold. In 1917, over 730,000 were sold. What con-
clusion can you draw from this information? (a) The cost of living
must have gone down between 1910 and 1917. (b) Henry Ford was
making less money in 1917 than he was in 1910. (c) It cost the Ford
Motor Company less to produce a Model T in 1917 than it did in
1910. (d) There is no relationship between the price of the Model Ts
and the number sold.

6. Which of the following items is an example of an overhead ex-
pense? (a) rent on a factory (b) electricity, most of which is used to
power a plant's machinery (c) raw materials used in manufacturing
(d) shipping costs on goods sold. ( Hint: Remember that overhead
expenses are fixed costs, which must be paid regardless of the
amount of business done.)

7. Which of the following is the best example of the use of automa-
tion? (a) a garment sewn by an operator at a sewing machine (b)
a letter written by a secretary using a computer (c) an automobile
painted by a computer-directed robot on an assembly line (d) a
medical assistant drawing blood from a patient's arm.

Mass Production 373

i/Matching Match each term in Column A with its definition in
Column B.

Column A Column B
a. an expense of doing business that must be paid
1. assembly line
2. division of labor regardless of earnings
3. mass production b. a process that involves division of labor,
4. overhead
5. technological specialization, and machinery
c. a method of production that brings the work to
unemployment
6. automation the worker, rather than the worker to the work
7. interchangeable
d. the breaking down of production into a number
parts of tasks so that each worker performs only one
8. specialization
e. production of a narrow range of goods
f. the concept of manufacturing using many

identical units
g. a method of production in which machines op-

erate other machines

h. the loss of jobs because machines now perform

the tasks once done by workers

V Which Would You Choose?

A large-scale manufacturer of kitchen appliances (refrigerators,
stoves, and dishwashers) is planning to open a new factory. Three possi-
ble locations for the factory are being considered. The first of these sites
is located in a rural area, the second is in a suburb, and the third is in a
city. At a conference attended by the top executives of the company, the
advantages and disadvantages of each site were discussed.

Ms. Backus liked the 25-acre site located in the middle of a 500-acre
farm some 30 miles from the nearest town. Mrs. Martinez preferred the
suburban location five miles from the city. This site was between the
railroad line and the main highway leading to the city. Mr. Mott spoke
in favor of the city location. This site was in the heart of the industrial
district of one of the nation's largest cities.

1. List the three locations (rural, suburban, city) in the order in
which you would recommend them for the site of the new appliance
factory.

2. Give two reasons why you selected your first choice.

3. Explain one drawback of each of the other two sites.

374 PRODUCING: THE ROLE OF BUSINESS

INQUIRY INTO ECONOMICS

Does automation equal progress?

S/Focus on a Question Increases in productivity through mass
production has made goods, such as cars, available to masses of
people. It has greatly increased standards of living, but it does
have disadvantages. Write a tightly focused question related to one
aspect of mass production. Example: Should government retrain
workers when new machinery takes their jobs?

Apply Concepts About Economics Analyze how incentives
influence the development of modern means of production.
Consider all you have learned about mass production, then do
research in three different sources to answer your question.

VEvaluate the Evidence People from bloggers to government

economists have written about mass production. Gather multiple
sources on the same topic and analyze the reliability and relevance
of the sources. Personal stories may have relevance and interest,
but they should be balanced by broader information from
researchers and scholars

I/Share Your Conclusions Write a report to answer your
question. Use sound reasoning, examples, and significant details to
support your conclusions. Cite the author for each fact, quotation,
or opinion in your report that is not common knowledge or
undisputed information. If no individual author is listed, indicate
the source by naming the organization or title of the work.

• In the text, include the author or source and page number.
• At the end of your report, include a list of works cited that

provides the full title and publication information about each
source.
For example, in a report on Henry Ford, you might quote
from page 187 of The Perils of Prosperity, 1914-32, by William
Leuchtenburg. This book was published in Chicago, by the
University of Chicago Press, in 1958.
In your text, you might write:

According to one historian, people worshiped Ford as a
"miracle-maker" (Leuchtenburg, 187).
On page 187, Leuchtenburg declares, "Ford was worshiped
as miracle-maker."
In the Works Cited list at the end of your report, you would
provide this information:
Leuchtenburg, William E. The Perils of Prosperity, 1914-32.
Chicago, University of Chicago Press, 1958.

25

Business
Combinations

merger Key Terms target company
business takeover
vertical merger insider trading
combination conglomerate
monopoly insider
horizontal merger merger information
acquiring

company

Question: What do Time Magazine, Fortune Magazine, Life
Magazine, Sports Illustrated, Time-Life Books, People
Magazine, Warner Brothers Motion Pictures, Warner
Brothers Records, TBS, TNT, Looney Tunes, Cartoon

Network, CNN, HBO, Cinemax, America Online,

CompuServe, and Netscape have in common?
Answer: (1) All were independent companies at one time.

(2) Over the years, all the companies were acquired by
either AOL or Time Warner, Inc.

(3) In 2000, AOL purchased Time Warner for $165

billion and changed its name to AOL Time Warner,
Inc.

When two or more companies combine into a single company,
the action is called a merger. When AOL purchased Time Warner to
form AOL Time Warner, Inc., the merger created the world's larg-

est and most powerful company in the communications industry.
Why should an online services company such as AOL want

to acquire record companies, TV stations, book publishing firms,

magazines, and other media companies? Should the public be con-

cerned about these kinds of combinations? As you read this chap-
ter, you will learn more about business combinations. You will

also learn the answers to the following questions:

375

vv376 PRODUCING: THE ROLE OF BUSINESS

• Why do some business firms combine?
• How do business firms combine?
• Why are some people concerned about mergers?

WHY DO SOME BUSINESS FIRMS COMBINE?

Business firms combine because they expect that the move will
enable them to increase profits. Profits may be increased if the
business combinations allow businesses to produce more goods at
lower costs and reduce or eliminate competition.

Produce More Goods at Lower Costs

In the previous chapter, we discussed how mass-production
methods enable large firms to produce goods at lower costs than
small firms can. Companies that produce goods at lower cost than
others in the industry can afford to lower prices and thereby take
business away from their competitors.

As you know, economists use the term productivity to describe
the efficiency with which something is produced. Productivity can
be likened to the skill of a baseball player whose batting average
is .350 as compared to one whose average is .200. The .350 bat-
ter may be expected to get 350 hits for every 1,000 times at bat.
The .200 hitter will get only 200 hits for every 1,000 times at bat.
Thus, the .350 hitter may be said to have greater productivity.

The same principle applies to industry. Workers at Company
A can produce an average of 25 pocket combs per hour. Company
B, which also manufactures combs, is considerably larger than
Company A. Workers at Company B can produce an average of
50 pocket combs per hour. We can say that worker productivity at
Company B is twice as great as productivity at Company A.

There are a number of reasons why large businesses are often
more efficient than small ones.

1. Workers Assigned More Efficiently. When a retail store
has branches all over town, it can transfer its experienced sales-
people from one location to another as they are needed. A single
store often has to keep salespeople on the payroll during slow
business times so that they will be available during busy ones.

As businesses grow in size, they can afford to hire full-time spe-
cialized workers, such as accountants, advertising managers, and
computer operators. The tasks that these people perform are likely
to be carried out more efficiently than they would be in small busi-
nesses where most jobs are done by people who are not specialists.

Business Combinations 377

2. Shared Risks. You have heard the saying, "Never put all
your eggs in one basket." Why is this good advice? Because if you
were to drop the basket, all the eggs might break. When a retail
business opens in several locations and when a manufacturer
makes a variety of products, they are "putting their eggs in sev-
eral baskets." That is, they are spreading risks.

Thus, a grocery chain might find that the loss of business in
one part of town has not hurt its profits because sales have picked
up in another location. A manufacturer of toys, sporting goods,
and tools might have a similar experience. If the demand for its
tools falls off, for example, the loss may be offset by an increased
demand for its toys.

3. Reduced Expenses. It is often too costly for a single store
to place an ad in a local newspaper. This is not so for a firm that
owns ten stores in an area. All can share the cost of the ad, and all
can share in bringing the firm's name before the public.

A large chain of stores might find it profitable to buy out a man-
ufacturer and produce its own line of goods. In this way, the goods
sold by the chain could cost the chain less. For this reason, huge
producers such as automobile companies have bought out firms
that produce car batteries. Steel manufacturers have acquired coal
mines. In these instances, the purpose was to acquire companies
that produce goods that go into the making of the firm's products.

Reduce or Eliminate Competition

Normally, a restaurant will not charge for a glass of water. But
just imagine what it could charge if it owned the only well in the
middle of a large desert! Or imagine two small towns identical in
every way. In one, there is one plumber to service the needs of the
community. In the other town, there are 12 plumbers. In which
town could a plumber charge more for his or her services?

In both of these examples, there was only one supplier of a prod-
uct or service. In the first, there was only one seller of water; in the
second, there was but one plumber. Economists describe the situa-
tion in which there is only one seller of an item or service as a mo-
nopoly. In both instances, the sole sellers would be able to charge a
much higher price for their product or service than they could have
had there been competitors. Competition may be defined as a state
of rivalry between sellers, each of whom tries to outsell the other.

The greater the rivalry, the stiffer the competition.
Because firms that have no competition are able to charge

higher prices than those that must compete, some companies try
to become as much like monopolies as they can. By growing ever

378 PRODUCING: THE ROLE OF BUSINESS

larger in size, a business improves its chance of capturing a larger
share of the market. (The "market" in this case refers to the total
demand for a product or service.) Few companies ever gain control
of an entire market. Indeed, in most instances monopolies are ille-
gal in the United States. It is possible, however, for a company to
control such a large share of the market that it can fix (set) prices
and, in that way, increase its profits.

Many industries have monopolistic competition, a condition of
many producers, varied products, and diverse prices. Restaurants
are competitive, but they do not all converge on the same menu.

HOW DO BUSINESS FIRMS COMBINE?

Nowadays, most people refer to business combinations as
mergers. When one corporation combines or merges with another,
it does so by buying enough shares of the other corporation's stock
to gain control of it. There are three types of mergers: horizontal,
vertical, and conglomerate.

Horizontal Mergers

When a company acquires another firm that makes or sells
similar products or services, we call the combination a horizontal
merger. The acquisition of one newspaper company by another is
an example of a horizontal merger.

The most important reasons why companies seek horizontal
mergers are to reduce competition, acquire a larger share of the mar-
ket for their goods and services, and lower certain business costs.

A horizontal merger reduces competition because the busi-
nesses that merge formerly competed against one another. For
example, Sneakers Unlimited is a store located at one end of a
town's business section. At the other end is Sneakers Unlimited's
fiercest competitor: Soft Shoes, Inc. Sneakers Unlimited recently
purchased a large percentage of the stock of Soft Shoes, Inc. The
purchase enabled Sneakers Unlimited to elect its own people to
Soft Shoes's board of directors and control its policies.

Since the two companies are in the same business, Sneakers's
acquisition eliminated its strongest competition. From that point
on, the two companies have been run by the same management.
Sneakers now has retail stores in two areas of the business sec-
tion. The company thus is in a position to attract more customers
and increase its earnings.

The merger lowered certain business costs. Before the merger,
both Sneakers Unlimited and Soft Shoes regularly placed a full-

Business Combinations 379

Horizontal Merger: The Limited stores are part of a. clothing and personal care
conglomerate that includes Lane Bryant, Lerner, and Bath and Body Works.

page ad in the county newspaper every Sunday. Now, instead of
two pages of ads in an issue, both stores can get the same ad cov-
erage with only one page. Advertising costs per store were cut in
half. In the same way, the merged stores can now share bookkeep-
ers, sales managers, and other personnel.

Vertical Mergers

A vertical merger is a merger between a company and one of its
suppliers. For example, the Monster Cookie Company has become
enormously successful. One of the reasons for its success is that its
cookies have more chocolate in them than any of its competitors'
cookies. Indeed, business has been so good that Monster Cookie
recently purchased controlling interest in Chuck's Chocolate, Inc.,
which manufactures baking chocolate. Since chocolate is used in
the production of Monster cookies, the combination of Monster
Cookie with Chuck's Chocolate is a vertical merger.

The principal reason for creating a vertical merger is to reduce
the costs of doing business. When USX, the nation's largest steel
company, acquired an iron mine, a vertical merger was formed.
Why was it called a vertical merger? Because iron ore is used in
the manufacture of steel.

380 Ail PRODUCING: THE ROLE OF BUSINESS
Figure 25.1 Types of Business Mergers

Horizontal
Merger

SNEAKERS
UNLIMITED

Vertical Conglom-
Merger erate

Merger

Conglomerate Mergers

A conglomerate merger combines companies that sell vastly
different products, services, or both.

With $14.5 billion in assets, Cendant Corporation was a large
conglomerate before it was broken apart in 2006. Among the well-
known companies combined under the Cendant logo were hotel
and motel chains such as Days Inn, Ramada, Super 8, and Howard
Johnson; real estate franchises like Coldwell Banker and Century
21, and financial services such as Jackson Hewitt Tax Services,
as well as Long Term Preferred Care (a health-related insurance
company) and Avis Rent-a-Car.

Because hotels, health insurance, real estate, financial services,
and auto rental companies are hardly related, Cendant was a clas-
sic example of a conglomerate merger.

Business Combinations 381
WHY ARE SOME PEOPLE CONCERNED ABOUT MERGERS?

Many people today are concerned about mergers because merg-

ers may lead to monopolies. When only a few firms produce similar
products, economic power may be concentrated in the hands of a
few people. Americans fear concentration of power in the business
world. They feel that it is unfair when the opportunity for others

to enter a field is reduced or eliminated.
Americans believe in competition as a way of life. They also

believe that competition is more efficient than monopoly. In a com-
petitive market, a company succeeds by making better products at
lower costs than its competitors and then selling its products to

more customers.
In many industries, bigger has not always meant better. In

steelmaking, new low-overhead "mini-mills" run by small, aggres-
sive U.S. companies have been more successful than the large,
multibillion-dollar steel mills built in the 1950s and 1960s. And in
recent years, smaller Japanese and Korean automakers have been
more efficient than the huge American auto producers.

Number of Corporate Mergers per Year

Year Number

1970 1,351
1980 1,560
1985 1,719
1990 4,239
1994 4,383
1998 9,634
2003 7,743
2012 10,882

Mergers are costly. There are usually two companies involved
in a merger: the acquiring company and the target company (the
one that is being acquired). Sometimes, the company being taken

over does not want to merge and will fight back. A costly struggle
may result. Both companies will spend enormous sums of money
to buy up the stock of the company being targeted for takeover. A
problem caused by mergers is that those who take over companies
usually pay for their purchases with borrowed funds. Often the

loans are guaranteed by the parent company. This borrowing has
created a mountain of debt for many companies which, sooner or
later, will have to be repaid.

Some mergers involve billions of dollars. This is shown in the
following table.

382 PRODUCING: THE ROLE OF BUSINESS
Recent Billion-Dollar-Plus Mergers

Acquiring Target Company Purchase Price
Company (in billions)
Time Warner
America On Line SmithKline $181.6
Glaxo Wellcome GTE 75.7
Verizon (Bell Atlantic) Texaco 65.0
Chevron Chrysler 43.0
Daimler-Benz Union Carbide 40.5
Dow Chemical Ralston Purina 11.6
Nestle Reynolds 10.3
Alcoa 4.8

Problems of Mergers and "Insider Trading"

Some mergers have received bad publicity because they have
been associated with the illegal activity known as insider trad-
ing. Experts have warned that insiders can profit unfairly from
advance information about corporate mergers. Those wanting to
take over a company have to buy up large blocks of its stock. The
increased demand pushes up the price of the shares. Then, as
other investors learn of the takeover attempt, they too rush out to
buy the shares of the target company, and prices rise even further.

Insiders, such as those working for the brokerage house han-
dling the deal or for the company doing the acquiring, stand to
make an easy profit from their knowledge. Such a person would
simply buy shares of the target company's stock while the infor-
mation was still private, and sell when the news became public
and prices were rising. Profiting in this way from inside informa-
tion is a violation of federal law.

Ivan F. Boesky, one of Wall Street's most successful stock
traders, made nearly a billion dollars in profits in the 1980s by
correctly predicting which companies were about to be taken over
by others. Government investigators found that Boesky was cor-
rect so often because he had illegally obtained insider information
about the acquisitions from people in the companies that were be-
ing acquired or those doing the buying. In 1986, Boesky was fined
$100 million and sent to prison for his crime.

Despite such huge fines and prison sentences, the problem of
insider trading continues. In 2000, an employee of Salomon Smith
Barney—one of the nation's largest investment firms—pleaded
guilty to criminal charges of insider trading. According to the Se-
curities and Exchange Commission (SEC), the employee used in-
formation about upcoming mergers that he had gotten on the job
to reap profits of nearly $2 million.

Business Combinations 383

In 2001, the SEC charged insiders with having illegally used
advance knowledge of the Nestle buyout of Ralston Purina to turn
a $500,000 profit. Similarly, that same year, another group of de-
fendants were fined $581,000 for profiting from insider informa-
tion about IBM's takeover of the Lotus Corporation.

SUMMARY

The acquisition, or takeover, of one corporation by another is known
as a merger. One business combines with another in order to increase
its productivity and profits, reduce competition, and add new products
and diversify its holdings. Mergers that combine companies in the same
business are horizontal mergers. Combinations of companies that could
be each other's suppliers or customers are vertical mergers. Mergers that
combine two or more companies in businesses that are not related to one
another are called conglomerate mergers.

There are differing viewpoints about the worth of mergers. Oppo-
nents of mergers feel that the money spent to create giant new compa-
nies does not help either the U.S. economy or the public. There is also the
concern that too much economic power is gained by the corporations and
individuals behind the takeovers. Others disagree. They say that merg-
ers make business more efficient and competitive.

LOOKING AHEAD

As many U.S. companies have grown in size, some lawmakers have
become fearful that these companies might use their economic power to
exploit the public. In the following chapter, we will learn how the govern-
ment seeks to protect the public from unfair business practices.

EXERCISES

Multiple Choice Choose the letter of the item that best completes
the statement or answers the question.

1. Which one of the following is not a form of business combination?
(a) acquisition (b) S corporation (c) conglomerate (d) merger.

2. When a business increases its productivity, the cost of producing
each item will be (a) higher than before (b) lower than before
(c) the same as before (d) determined by its competitors.

3. In order to avoid "putting all its eggs in one basket," a business is
most likely to (a) concentrate on the production of its best product

384 PRODUCING: THE ROLE OF BUSINESS

(b) avoid growing too large (c) produce or supply a variety of goods
and services (d) spend more money to improve its product.

4. A monopoly exists when (a) a company is larger than all the other
companies in the industry combined (b) a company produces
greater quantities of an item than any other firm (c) a company
charges higher prices than anyone else for a product (d) there is
only one supplier of a particular good or service.

5. Which one of the following is the best example of a conglomerate
merger? (a) Five neighborhood appliance stores combine to form a
chain. (b) A manufacturer of steel combines with an owner of iron
mines. (c) A theater chain combines with a hotel company and a
tire manufacturer. (d) A bakery merges with a flour mill.

6. Jose's Pizza Parlor, Inc., recently acquired controlling interest
in Mariana's Pizza Parlor, Inc. This acquisition is called a
(a) monopoly (b) vertical merger (c) conglomerate merger
(d) horizontal merger.

7. Jose's Pizza Parlor, Inc., acquired the Eastern Pizza Cheese Corpo-
ration (EPCC). EPCC is a wholesale distributor of the cheese used
in the making of pizza pies. The acquisition created a (a) monopoly
(b) vertical merger (c) conglomerate merger (d) horizontal merger.

8. Last January, Cecilia Pye, president of the Pye Plate Company,
announced that the company had acquired Young's Bicycle Rental.
The Pye Plate Company manufactures dinnerware. Young's is a
chain of bicycle rental stores. The acquisition of Young's Bicycles
by Pye Plate is an example of a (a) monopoly (b) vertical merger
(c) conglomerate merger (d) horizontal merger.

i/Matching Match each term in Column A with its definition in
Column B.

Column A Column B

1. productivity a. the joining together of two or more busi-
2. monopoly ness firms in the same business
3. competition
4. horizontal merger b. the joining together of two or more busi-
5. conglomerate merger ness firms in unrelated fields
6. vertical merger
7. insider trading c. the joining together of two or more busi-
ness firms, at least one of which is a

supplier of another
d. the effort of two or more firms to outsell

one another in the same market

e. a situation in which there is only one seller
1. a measure of efficiency in turning out

goods and services
g. the buying or selling of a company's stock

using private information

Business Combinations 385

V Critical-Thinking Questions

The table on page 382 lists a number of recent mergers. With refer-
ence to any one of those mergers:

1. Identify and explain two reasons why the companies might have
chosen to merge.

2. What effect might the merger have on: (a) competing firms in the in-
dustry, and (b) consumers? Consider whether it created a monopoly.

VReading for Enrichment Read the selection below and then answer

the questions that follow.

Frankiedogs

Upon graduation from high school, Frankie Russo took all
the money he had saved out of the bank and bought a rolling hot
dog stand. He attached a colorful umbrella overhead and painted
Frankiedogs in bright orange letters along the sides of the wagon.
Frankie set his stand up in front of the local high school.

Perhaps it was the sauerkraut, maybe the spicy onions, or it
may even have been the crisp French fried potatoes you got with
every frankfurter—whatever it was, business was terrific. Busi-
ness was so good, in fact, that whenever Frankie heard about other
stand owners who were having difficulty earning a living, he would
offer to buy them out. As a result, he soon owned 25 rolling hot dog
carts. These, too, were fitted out with a colorful umbrella and had
the trademark Frankiedogs painted on the sides.

Perhaps it was the sauerkraut, maybe the spicy onions, or it
may even have been the crisp French fried potatoes you got with
every frankfurter—whatever it was, business continued to be ter-
rific. By the end of the next year, he owned 159 carts!

Business was so good, in fact, that Frankie went across the
river into the next city and set up carts. "Why stop here?" he
thought, and soon Frankiedogs and Frankiecarts were seen all
over the state.

Perhaps it was the sauerkraut, maybe the spicy onions, or it may
even have been the crisp French fried potatoes you got with every
frankfurter—whatever it was, business continued to be terrific.

"Why stop here?" thought Frankie. He hired a personnel man-
ager and set up a program to train people to operate his carts. He
hired an advertising manager to plan his sales campaigns. "You'll
be top clog, frankly, with a Frankiedog!" became a slogan known in
every household.

"Why stop here?" thought Frankie. He bought out a large
sausage factory, which he converted to full-time frankfurter
production.

386 PRODUCING: THE ROLE OF BUSINESS

Perhaps it was the sauerkraut, maybe the spicy onions, or
it may even have been the crisp French fried potatoes you got
with every frankfurter—whatever it was, business continued to
be terrific. Frankiedogs were the hottest selling hot dogs in the
50 states and in 17 other countries.

One day, PDQ, the nation's largest conglomerate and owners
of a world championship football team, a television network, sev-
eral steel mills and aircraft factories, and a host of other indus-
trial plants, sent representatives to talk to Frankie. "We want to
buy you out," they said. "We will give you $400 million for your
Frankiedog business."

"I think I will retire," thought Frankie.

1. As Frankie's business grew, so did profits. Frankiedog wagons
earned more for Frankie than they did for their former owners.
(a) What three reasons can you think of that would explain why
profits grew as Frankie added hot dog wagons? (b) Explain each of
these reasons.

2. Why did Frankie buy a sausage factory?

3. (a) What kind of company bought Frankie's business? (b) Explain
your answer. (c) Why do you suppose this company wanted to buy
out Frankie? (d) Why did Frankie sell out?

INQUIRY INTO ECONOMICS

Are business combinations good for the economy?

Focus on a Question Mergers are an enduring part of a
market economy, and they have both costs and benefits. Develop a
focused question about a business combination. Example: Would a
combination of two large airlines be good for consumers?

VApply Concepts About Economics Consider the benefits
and costs of government policies to improve competition in specific
markets. Do research in three different sources to answer your
question. Examine legal issues related to business combinations, so
government policy institutes and business associations can be good
sources.

VEvaluate the Evidence In commenting on a business
combination, many people are biased by whether the change will
help or hurt them personally. Use sources valued by experts.

Share Your Conclusions Make a chart in which you list
various costs and benefits associated with your question. Include
significant examples and details to clarify your points. Draw a
conclusion based on the evidence in your chart.

26

The Government
Promotes and
Regulates
Competition

Key Terms

oligopoly public utility regulatory agency
patent natural monopoly deregulation
copyright antitrust law

Item: When Staples announced plans to acquire Office Depot, the
Justice Department of the federal government stepped in
to block the merger. Staples and Office Depot are two of
the nation's three largest office supply companies. Were
the merger allowed to proceed, the government explained,
consumers might have to pay millions of dollars more for
their office supplies.

Item: Microsoft, the world's largest software company, was found
guilty of violating the nation's antitrust laws. After a long
trial, a federal judge ruled that Microsoft was a monopoly.
Worse yet, said the court, the company had used its "power
and immense profits to harm any firm" that seriously com-
peted with it.

Item: Two major automobile manufacturers and five St. Louis
area dealerships signed agreements with the Federal Trade

Commission, a government agency, to end certain advertis-
ing practices. The companies said that they would no longer
omit or bury key cost information in small and sometimes

unreadable print in their lease advertisements.

387

4388 PRODUCING: THE ROLE OF BUSINESS

What do the items just mentioned have in common? In each, the
government took steps to regulate or influence the way in which
a company did business. First, Staples was barred from acquiring
Office Depot, because doing so would have given Staples too much
power in the market for office supplies. Second, the federal court
ruled against Microsoft after finding that the company was trying to
prevent other software companies from competing with it. Third, the
Federal Trade Commission moved to make it easier for consumers
to understand the terms of the automobile leases they were signing.

"But," you say, "this is supposed to be a free country. Why does the
government interfere with the ways in which corporations choose to
compete?" As you read this chapter, you will learn the answer to this
question. You will also be able to answer these questions:

• Why is monopoly power harmful?
• Why are some monopolies legal?
• How does government promote competition?

WHY IS MONOPOLY POWER HARMFUL?

In earlier chapters, we described how the U.S. economic system
is based upon competition. It is competition with other companies,
we said, that leads businesspeople to try to please their customers.
By pleasing the public, by giving it the best products at the lowest
prices, a company stands to earn the greatest profits. Thus, compe-
tition encourages firms to work hard to improve their products and
methods of doing business. In turn, the public benefits by having
better goods and services at the lowest possible prices.

Suppose, however, that only one company sells a certain product
or service. As you know, economists describe a situation in which
there is but one seller as a monopoly. A monopolist can provide its
products or services at whatever prices it wants to charge.

The same might also be true if there are just a handful of firms
in an industry. A market in which there are but a few sellers is
called an oligopoly. As in a monopoly, sellers in an oligopoly have
been known to agree among themselves to set prices. Examples of
oligopolies include the cell phone industry, the breakfast cereal in-
dustry, and the music recording industry.

Harmful Effects of Monopoly Power

Monopolies and oligopolies wield a great deal of power over the
markets for their goods and services. Sometimes, this power is
harmful to the public.

The Government Promotes and Regulates Competition 389

HELP NAITO

AtitSPAY _2 Pt 4'

Business Competition: Two fast-
food restaurants on a crowded
road compete for travelers'
business.

1. Destroys Competition. Wealthy monopolies and oligopo-
lies have in the past used their market power to prevent other
firms from entering the field. During the early years of the 20th
century, for example, the Standard Oil Company controlled about
90 percent of the gasoline industry. One reason for the company's
success was its ability to destroy its competition. For example, if a
competitor opened a gas station, Standard Oil responded by low-
ering prices at its stations in the area. Those station owners who
had no financial backer could not survive. Once its competition
was forced into bankruptcy, Standard Oil made up for its losses
simply by raising prices.

2. Wastes Resources. When firms compete, each tries to oper-
ate with the lowest possible costs. Each wants to be able to sell its
goods at the lowest possible price. Every company, large or small,
will strive to get the most out of its resources. Businesspeople
know that to waste scarce raw materials or fuels simply adds to
the costs of doing business. So competition encourages businesses
to conserve our valuable natural resources.

Monopolies are not under the same kind of pressure to conserve
resources and operate efficiently. Unlike other businesses, monopo-

390 PRODUCING: THE ROLE OF BUSINESS

lies can pass on increased costs to their customers without having
to worry about being undersold by their competitors.

3. Creates Higher Prices. Prices are usually lower when

there is competition. If you have ever bought food and soft drinks
at a theater or stadium, you probably noticed that their prices

were higher there than those in grocery stores and supermarkets.
The theater and stadium vendors had a monopoly on the sale of
their goods and thus charged higher prices.

4. May Not Satisfy Consumer Wants. Consumer wants are
much more likely to be satisfied when there is competition. If you

and a dozen friends march into the local post office and ask to buy

triangle-shaped stamps, you might get a smile from the clerk. But
you will not get triangular stamps. The Postal Service determines
what stamps look like. On the other hand, think what would hap-

pen if you and a dozen friends asked your local pizza parlor for
slices topped with bacon. You can be sure that with that kind of
demand, the pizza parlor would not be long in finding a way to
provide everyone who wanted them with bacon pizzas!

5. May Threaten Democratic Values. When companies be-
come wealthy and powerful because they have little or no com-
petition, they can use their wealth to influence government offi-
cials to favor them. Running for political office costs a great deal
of money. Television and radio commercials and newspaper ad-
vertising are very expensive. Like other special interest groups,
powerful monopolies have used their wealth to buy the support of
elected officials. In this way, monopolies have been able to secure
the enactment of laws that benefit and protect their interests.

WHY ARE SOME MONOPOLIES LEGAL?

In some instances, monopolies are considered desirable, and,
therefore, have been legalized.

Patents and Copyrights

Let us pretend that you have just invented a device that will en-
able automobiles to run on flashlight batteries instead of gasoline.
You have decided to call your invention a "Battgo." Instead of having
to refill a car's tank with, say, 15 gallons of gas, a driver whose car
is equipped with a Battgo will simply say to the filling station atten-
dant, "I'll have four D-cells, please." There is not an automobile driver
anywhere in the world who will not want to own such a device.

The Government Promotes and Regulates Competition 391

What is more, as the inventor of Battgo, you will be entitled
to receive a patent on it. A patent is a grant issued by the federal
government that gives inventors the sole right to manufacture, use,
and sell their inventions. In other words, the inventor of a patented
device has a legal monopoly on its manufacture and sale. After a
limited number of years (usually 17), the patent will expire and ev-
eryone else will have the right to copy the invention.

Why are patents granted to inventors? The government wants
to encourage new inventions and discoveries. It might have taken
you years of research to invent your Battgo. And yet you continued
in your efforts because you knew that if you were successful, you
alone would be entitled to the rewards. Without a patent to protect
you, however, it would only be a matter of time before others copied
and marketed your invention.

The government also grants copyrights to owners of intellectual
and cultural works. They give exclusive rights to authors, artists, and
composers to reproduce, perform, and sell their works. Copyrights
thus encourage the creation of artistic, musical, and literary works.
The publishers or producers of books, magazines, newspapers, news-
letters, movies, recordings, television programs, computer software,
and electronic (video) games may also copyright these works.

Video game software are inventions that are copyrighted by their creators.

392 V111 PRODUCING: THE ROLE OF BUSINESS
Natural Monopolies/Public Utilities
Most communities receive things like electricity, water, and nat-
ural gas from the public utilities servicing the area. Public utilities
provide essential public services, and for reasons that we will soon
explain, are granted a monopoly in the market that they serve.
Imagine what it would be like if say, five electric power compa-
nies served your neighborhood. In areas where the wires ran above
ground, five sets of poles (one for each company) would be needed
to carry them. Where the wires ran underground, five companies
would have to service them. Imagine too, what things would be like
if the streets had to be dug up five times as often as they are now
just to maintain electric power service. Similarly, think about what
might happen if water and gas service were delivered under local
streets by numbers of competing companies.
It takes a huge investment to build, operate, and maintain pub-
lic utilities. Nevertheless, these companies can operate at a profit if
they have a monopoly because large-scale production lowers costs
per unit. If there were competing companies, however, the cost to
service individual households would be greater than it was when
there was but one supplier. Economists describe these public utili-
ties as natural monopolies. Natural monopolies occur in industries
in which a single firm is more efficient and therefore more desir-
able than two or more competing companies.
Since competition among public utilities does not make eco-
nomic sense, antitrust laws do not apply to them. Nonetheless, fed-

Legal Monopolies—Utilities: For years, power companies like this one had a monopoly
on providing power in a region.

The Government Promotes and Regulates Competition Vv1 393

eral, state, and/or local governments regulate public utilities to a
greater extent than other kinds of enterprises.

HOW DOES THE GOVERNMENT PROMOTE COMPETITION?

Because of the many possible threats to our economy that are
posed by some monopolies, government often uses its powers to (1)
encourage competition in the marketplace and (2) regulate business
activities. It does this through the enforcement of antitrust laws
and the work of regulatory agencies.

Antitrust Laws

Laws designed to promote competition and prevent business
firms from gaining monopolies are known as antitrust laws. The
most important of the federal antitrust laws are summarized in the
following table.

Federal Antitrust Laws, 1887-1950

Law Date
Enacted Provisions

Interstate Commerce 1887 First federal law regulating the abuse of
Act monopoly power. Banned certain unfair
practices in the railroad industry
Sherman Antitrust Act 1890
Outlawed combinations that were "in
Clayton Antitrust Act 1914 restraint of trade"

Federal Trade 1914 Sought to prevent the creation of monopolies
Commission Act by defining specific illegal practices
Created the Federal Trade Commission
Robinson-Patman Act 1936 (FTC), which has responsibility to carry out
provisions of the Clayton Act
Celler-Kefauver Act 1950
Protects small retailers from unfair competi-

tion by chain stores and other large-scale
competitors
Outlawed mergers or acquisitions that
would lessen competition or create a
monopoly

As the table above shows, in the past 115 years U.S. antitrust
laws have outlawed monopolies, banned certain monopolistic prac-
tices, and created a federal government agency to enforce the laws.

Antimonopoly laws are called antitrust laws because in the 19th
century big businesses were called "trusts."

In the 1880s, Americans became aware that powerful monop-
olies existed in the oil, sugar, tobacco, and railroad industries. As

N394 PRODUCING: THE ROLE OF BUSINESS

knowledge spread of how these huge corporations had abused their

power, a demand went up for the federal government to "do some-
thing about the monopolies."

Finally, in 1887, the first of the antitrust laws was passed—
the Interstate Commerce Act. It was designed to regulate the na-
tion's railroads. Three years later, in 1890, the first law affecting
every business in the country was passed. This was the Sherman
Antitrust Act, which declared monopolies to be illegal. The Sher-
man Antitrust Act was followed by the Clayton Antitrust Act in
1914. The latter closed some of the loopholes in the Sherman Act
by spelling out some of the things businesses would not be allowed
to do. The Federal Trade Commission Act (1914) created the Fed-

eral Trade Commission (FTC). The FTC has the responsibility of
enforcing the antitrust laws. It conducts investigations and brings
offending companies to court.

Still later acts have strengthened the antitrust laws. In 1936,
the Robinson-Patman Act was passed. It was designed to pro-
tect small retail stores from the competition of large stores. The
Celler-Kefauver Act of 1950 is also known as the Antimerger Act.
It says that mergers would be illegal if it could be shown that they
would "lessen competition, or . . . create a monopoly."

Is the government doing enough today to curb the power of mo-
nopolies? Some critics say it is not. If it had, there would not have
been over 60,000 mergers during the last ten years. Critics also
claim that the federal courts have been too "soft on monopolies."
They point to a case in which Owens-Illinois purchased Brockway,
Inc. Each of the companies was a major producer of glass containers.
The FTC objected to the merger because it would have increased
Owens's share of the market from 24 percent to 40 percent. The fed-
eral courts, however, overruled the FTC. They said that the merger
would not lead to increased prices or reduced competition.

Another point that critics make is that the present laws do not
cover conglomerate mergers. Conglomerates threaten competition
because of their size. They can afford to take losses with low prices
until they have forced their competitors out of business. Once free
of competition, the conglomerates can then raise their prices to
whatever level they choose. Conglomerates may also stifle compe-
tition because of their buying power. For example, a conglomerate
that owns hotels, automobile rental companies, and bakeries can
demand that the company from which it buys grain use its services
for business travel and entertainment.

Others say that the government should keep its hands off busi-
nesses. They argue that it is contrary to the spirit of freedom and
liberty for the government to tell business firms what they can

The Government Promotes and Regulates Competition 395

Antitrust Fervor: Public fury at the
greed of the trusts was expressed
in cartoons such as this one from
the late 1880s. Justice "extracts"
the gold (the people's money)
from the dragon (Standard Oil
Trust).

and cannot do. Furthermore, they say, many of the antitrust laws
cost consumers money. Protecting the small, less efficient producer
means that the public has to pay more for the things that it buys,
claim the critics of antitrust laws.

There are, however, those who speak well of our antitrust
laws. They point out that free competition still exists in the U.S.
economy. Had there been no Sherman Act or Clayton Act or FTC,
they argue, the likelihood is that our economy would now be in the
hands of monopolies.

An Antitrust Case Study

Can you imagine a company intentionally delaying the loading
of iron ore ships operated by competitors? That is what the Fed-
eral Trade Commission in 1990 charged a railroad with doing.

This railroad was owned by USX, the nation's largest steel and

energy corporation. Competing steelmakers said that their ships
were affected. The government contended that this was a deliber-
ate effort to restrain trade and a violation of the antitrust laws.

396 PRODUCING: THE ROLE OF BUSINESS

The courts agreed. In 1994, the U.S. Supreme Court said that USX
would be required to pay a total of $660 million in damages and
fines to the affected firms and the government. National Steel Cor-
poration received $110 million as its share of an antitrust judgment
against the USX Corporation.

Regulatory Agencies

Government agencies that oversee the way companies in some
industries do business are known as regulatory agencies. All public
utilities and certain industries are supervised by these agencies.

I. State Public Service Commissions. Although public util-
ities are legal monopolies, they do not have the same freedoms en-
joyed by other kinds of businesses. They cannot by themselves de-
cide what goods or services they will provide and how much they
will charge for them. Instead, the public utilities are regulated by
state-run agencies known as public service commissions. These
commissions issue licenses granting publicly and privately owned
utilities the right to operate. They also determine the kinds of ser-
vices that the utilities must provide and how much they will be
permitted to charge for these services.

Why do public service commissions tell the electric power, gas,
and other utilities how much they may charge for their services? Is
it unfair to require that a water or telephone company get permis-
sion from the government to change its service or increase its rates
when other businesses are free to take these actions on their own?

The reason utilities are regulated is that they have a monopoly
over the services they provide. Other companies, such as your neigh-
borhood appliance center, hardware store, and gasoline station,
must compete in order to stay in business. Competition prevents
them from taking advantage of the public. If your supermarket's
prices become too high, you can take your business elsewhere. But
you cannot go elsewhere if you do not like the prices charged by your
electric company. Public service commissions were set up to see that
public utilities use their monopoly power fairly.

2. Federal Government Agencies. Industries that have been
regulated and are being regulated by federal government agen-
cies include radio and television broadcasting, railroads, airlines,
trucking, and banking. On a local basis, taxicabs, buses, and even
tow trucks have been supervised by regulatory agencies.

Several of the best-known federal regulatory agencies and their
functions are listed in the following table.

The Government Promotes and Regulates Competition Vv1 397

Some Federal Regulatory Agencies

Agency Date Function
Created

Interstate Commerce 1887 Originally created to regulate the rail-
Commission (ICC)— roads, in the 1930s its power was
terminated in 1995; 1934 extended to all surface transportation.
remaining functions 1974
picked up by Dept. of Regulates radio, television, phone, tele-
Transportation graph, and satellite industries.
Federal Communications
Commission (FCC) Licenses and regulates civilian uses of
Nuclear Regulatory nuclear energy in order to protect public
Commission health and safety, as well as the
environment.

The Deregulation Movement

In the late 1970s, the U.S. economy appeared to be in trouble. For
many, the source of the difficulties lay in competition from abroad.
Japanese and other foreign businesses were selling their goods for
less than U.S. firms. U.S. companies had difficulty competing, it was
said, because of government restrictions that added to their produc-
tion costs and the price at which they sold their products. The solu-
tion, it was argued, could be found in deregulation.

Deregulation is the dismantling of some or all the governmental
restrictions on the operation of certain businesses. In the mid-1970s,
airlines, cable television, natural gas, and electric power industries
were still regulated by government agencies. Since then, there has
been some deregulation in each of those industries.

Experts expected that the lifting of government restraints
would result in increased competition and lower prices. As the mil-
lennium drew to a close, however, it was apparent that deregula-
tion did not necessarily have these outcomes. We will look at three
attempts at deregulation.

1. Telephone Deregulation. The Telecommunications
Act of 1996 deregulated the telephone industry. As stated in its
preamble, the goal of the law was: "To promote competition and
reduce regulation in order to secure lower prices and higher quality
services. . . ." In particular, it was expected that the new law would

introduce real competition in local telephone service. After five

years, few of those goals had been achieved. In 2001, 90 percent of
consumers had only one choice in local telephone service. Prices
of local service had not declined. Indeed, families were paying an

398 V111 PRODUCING: THE ROLE OF BUSINESS

average of 20 percent more for their telephone services than they had
been paying in 1996. Meanwhile, telephone customer complaints in
some regions of the country were higher than ever.

Competition for local telephone service had all but disappeared in
most parts of the country because the law did not prevent some of the
larger telephone companies from merging. As a result, the eight re-
gional phone companies that existed in 1996 had been reduced to four
regional carriers by 2001. Meanwhile, smaller companies that tried to
enter the local telephone market could not afford to compete with their
multibillion-dollar competitors.

2. Airline Deregulation. Airlines were deregulated in 1978. At
the time, it was expected that deregulation would bring an increase
in competition. Quite the opposite occurred. In the following decades,
competition among airlines all but disappeared. Critics blamed unreg-
ulated mergers and cutthroat business practices in the airline industry
for having forced over 100 carriers to close their doors. This, in turn,
left large areas of the country with little or no air service. In the mean-
time, as the number of air carriers declined, complaints about the
quality of service seemed to be on the increase.

As promised by those who fought for airline deregulation, average
airfares have decreased. This has made it possible for more people
than ever before to be flying to their destinations. But many travelers
have to pay fares that are much higher than the average. For exam-
ple, in 2001 a business traveler from Washington, D.C., to San Fran-
cisco leaving on a Saturday and returning the following Monday paid
$543 for the flight. Were he or she to choose to spend Saturday with
the family and fly out on Sunday, the fare would have been $2,248.
Nonbusiness travelers flying from Washington, D.C., to San Francisco
could do so for far less simply by buying their tickets weeks in advance
of departure. Thus, it was possible that seated next to one another on
the return flight from San Francisco to Washington, D.C., were three
people, one of whom had spent $2,200, another $540, and another $250
for the same trip.

Increasing complaints about fares, delays, and the quality of ser-
vice in air travel (as well as security concerns in light of 9/11) have
led to calls for the return to regulation of the airline industry.

3. Energy Deregulation.

. . . With only minutes of warning, sections of San Fran-
cisco, Silicon Valley, the state capital of Sacramento and a few
other smaller cities went dark. . . . Traffic lights and television
broadcasts blinked off, assembly lines stopped. . . . Passen-
gers were trapped in elevators, businesses closed early, and
schools dismissed students for the day. . . .

The Government Promotes and Regulates Competition 399

In January 2001, Californians experienced their first "rolling
blackout." These were periods of an hour or two in which the power
was turned off for a half million homes at a time. The blackouts
were necessary because there simply was not enough electricity to go
around. Something had gone terribly wrong with the deregulation of
the power industry in the nation's most populous state.

In 1996, California had deregulated its electric industry. At the
time, it was thought that by allowing private generating plants (both
in and out of California) to compete, it would lead to lower prices. By
2000, it was obvious that deregulation was a failure. Wholesale prices
of electricity increased dramatically because there were so few whole-
sale suppliers. But California had ordered the retailers to freeze the
rates they charged their customers. With these utilities paying more
for electricity than they were charging, one of the state's largest, Pacific
Gas and Electric, was forced into bankruptcy.

To make matters worse, there was not enough power to go
around. Consequently, in January 2001, the state introduced the
first of its "rolling blackouts." Meanwhile, other states (including
New York, Nevada, and Arkansas) that were planning to deregulate
their power industries (or were in the process) began having second
thoughts about the process.

SUMMARY

Competition in the marketplace benefits us all. It discourages waste
and provides rewards for those who can sell their goods and services at the
lowest prices. By contrast, monopolies often waste resources, stifle compe-
tition, raise prices, and threaten our democratic institutions.

Certain types of monopolies are thought to be in the public interest,
and for that reason are legal. These include inventions (protected by pat-
ents), creative works (protected by copyright), and public utilities (regu-
lated by public service commissions).

Government encourages competition through its antitrust laws and its
regulatory agencies. The nation's antitrust laws have made the creation
of monopolies and activities that interfere with competition illegal. The
regulatory agencies limit the actions of certain industries and public utili-
ties. Since the 1970s, a number of industries supervised by the regulatory
agencies have been deregulated.

LOOKING AHEAD

Unit V takes us further into the government's economic role. In Chap-
ter 27, you will learn why, as the chapter says, "We are all taxpayers."

400 V111 PRODUCING: THE ROLE OF BUSINESS

EXERCISES

II/Matching Match each term in Column A with its definition in
Column B.

Column A Column B

1. oligopoly a. the monopoly given to inventors to be the
2. public utility only persons permitted to make, use, or sell
3. regulatory agency their inventions
4. patent
5. antitrust law b. an exclusive right granted to authors, artists,
6. copyright
and composers to reproduce, perform, and
sell their works
c. an industry that performs a vital public ser-

vice and is regulated by the government
d. a market in which there are few sellers
e. an act of government that outlaws monopolies
f. a government organization that oversees the

way companies in some industries do business

Just Suppose

Imagine that you are the inventor of a new kind of running shoe. The
unusual thing about this shoe is that it enables those who wear a pair to
run 20 percent faster than they can wearing any other type of shoe. For
example, if you can run a mile in ten minutes in your present shoes, you
can run a mile in just eight minutes in these new shoes.

Your company is the only business firm permitted to make and sell
the shoes because you hold the patent. You are now trying to decide what
price to charge for the shoes. You have called a meeting of your top exec-
utives to consider the question. They have made a study and have found
that the factory will be able to produce up to 50,000 pairs of running
shoes a year and that each pair will cost the company about $60 to turn
out. You have also invited Professor O.L. Arbiter, one of the nation's fore-
most authorities on business matters, to attend the meeting as adviser.

In the discussion that followed, many suggestions were made. One
person said, "Let's charge $65 for each pair of shoes. At that price, we
know we will sell them all and make a profit."

Another said, "That's ridiculous. We ought to charge $1,000 for each
pair. There are plenty of rich people in the world who will be willing to
pay that price."

Still another said, "Wait a minute. We're the only company selling these
running shoes. Let's charge $5,000 a pair for them. We'll make a fortune."

The discussion went on for some time. Everyone had a different price
to suggest, ranging from $65 to $5,000. Finally, it was Professor Arbiter's
turn to speak. The wise professor rose and addressed the group as follows:

"I have been listening to your discussion with great interest. I do be-
lieve, however, that before you arrive at a decision on the price to charge,
you ought first to conduct a study to find out how many pairs of shoes

The Government Promotes and Regulates Competition Vv1 401

you would sell at $5,000 or $1,000 or at any other price you might think
of, all the way down to $65. Remember, your objective is profit, not price."

Professor Arbiter had intended to remain after the meeting to an-
swer a few questions. But the professor suddenly remembered a previous
engagement and had to leave in a hurry. Here are the questions that did
come up. Perhaps you can answer them for the professor.

1. What, if anything, is likely to happen to the number of pairs of
running shoes sold as the price charged for them is reduced from
$5,000 to $65?

2. What did Professor Arbiter mean by the statement that the compa-
ny's objective was "profit, not price"?

3. What determines which price the company should choose for its
running shoes?

4. Suppose that, as a result of the study recommended by Professor
Arbiter, the following information is obtained:

At a price of Number sold would be

$5,000 10
1,000 100
500 1,000
200 10,000
150 50,000
100 50,000
65 50,000

Which price would you recommend charging for the running shoes?

6/ Questions for Thought and Discussion

1. Explain the quotation, "Monopoly is usually good for monopolists,
but bad for consumers."

2. Explain whether the clothing industry has monopolistic
competition.

3. Evaluate one example of regulations on the establishment of a
business and one example of the operation of businesses, explain-
ing whether you think each regulation is useful.

I/ Using the Internet

Visit the Internet to investigate and report on the status of a recent
antitrust investigation. Note that the Federal Trade Commission and the
Antitrust Division of the Department of Justice enforce the federal anti-
trust laws. You can learn more about the activities of those agencies at:
ftc.gov/ftc/antitrust.htm and usdoj.gov/atr.

THE ROLE OF
GOVERNMENT

Taxes pay for a necessary government expense: laying new sewage lines.

Chapter 27 We Are All Taxpayers
Chapter 28 Government Spending and Budgeting
Chapter 29 Business Cycles:

The Ups and Downs of the Economy
Chapter 30 Economic Goals of Government

The U.S. economy relies largely on private markets to provide us
with our goods and services. We have seen how the desire for profits
leads privately owned firms to produce the goods and services wanted
by consumers, at a price they are willing to pay. The market system has
given Americans one of the world's highest living standards. However,
business firms and private consumers are but two of the three compo-
nents of the market system. Government, or the public sector as it is
also described, plays an important role in the U.S. system.

The Economic Role of Government

Government plays a large role in our economic system. It (1)
provides a legal system, (2) promotes competition, (3) provides
public goods and services, and (4) steps in when the market sys-
tem breaks down.

1. Our Legal System. Government can be helpful to our eco-
nomic system. Members of government write and enforce laws,
without which the economy could not function. Features like con-
tracts, the monetary system, property rights, and the relationship
between buyers and sellers—essential ingredients in every econ-
omy—are described and protected by government.

2. Promoting Competition. Competition is an essential in-
gredient in the market system. Without competition there is less
incentive to improve goods and services and reduce costs. For that
reason, government has enacted antitrust laws and other mea-
sures to protect competition.

3, Public Goods and Services. Those goods and services that

might not be produced were it not for the government are called
public goods and services. Parks, roads, lighthouses, and national
defense are examples of public goods and services.

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