Business contributes significantly to social welfare. The economy in the United States and several other countries has sustained notable growth over many decades. Benefits of that growth have also been widely distributed. Suppliers of capital, labor, and other resources all receive substantial returns for their contributions. Consumers benefit from an increasing quantity and quality of goods and services available for consumption. Taxes on the business profits of firms, as well as on the payments made to suppliers of labor, materials, capital, and other inputs, provide revenues needed to increase government services. All of these contributions to social welfare stem from the efficiency of business in serving economic needs.
MANAGERIAL APPLICATION 1.3
The "Tobacco" Issue
The "tobacco" issue is charged with emotion. From the standpoint of a business manager or individual investor, there is the economic question of whether or not it is possible to earn above-normal returns by investing in a product known for killing its customers. From a philosophical standpoint, there is also the ethical question of whether or not it is desirable to earn such returns, if available. Among the well-known gloomy particulars are
• Medical studies suggest that breaking the tobacco habit may be as difficult as curing heroin addiction. This fuels the fire of those who seek to restrict smoking opportunities among children and "addicted" consumers.
• With the declining popularity of smoking, there are fewer smokers among potential jurors. This may increase the potential for adverse jury decisions in civil litigation against the tobacco industry.
• Prospects for additional "sin" and "health care" taxes on smoking appear high.
Some underappreciated positive counterpoints to consider are
• Although smoking is most common in the most price-sensitive sector of our society, profit margins remain sky high.
• Tax revenues from smokers give the government an incentive to keep smoking legal.
• High excise taxes kill price competition in the tobacco industry. Huge changes in manufacturer prices barely budge retail prices.
Although many suggest that above-average returns can be derived from investing in the tobacco business, a "greater fool" theory may be at work here. Tobacco companies and their investors only profit by finding "greater fools" to pay high prices for products that many would not buy for themselves. This is risky business, and a business plan that seldom works out in the long run.
See: Ann Zimmerman, "Wal-Mart Rejects Shareholder Call to Explain Policies on Tobacco Ads," The Wall Street Journal Online, March 1, 2002 (http://online.wsj.com).
Firms exist by public consent to serve social needs. If social welfare could be measured, business firms might be expected to operate in a manner that would maximize some index of social well-being. Maximization of social welfare requires answering the following important questions: What combination of goods and services (including negative by-products, such as pollution) should be produced? How should goods and services be provided? How should goods and services be distributed? These are the most vital questions faced in a free enterprise system, and they are key issues in managerial economics.
In a free market economy, the economic system produces and allocates goods and services according to the forces of demand and supply. Firms must determine what products customers want, bid for necessary resources, and then offer products for sale. In this process, each firm actively competes for a share of the customer's dollar. Suppliers of capital, labor, and raw materials must then be compensated out of sales proceeds. The share of revenues paid to each supplier depends on relative productivity, resource scarcity, and the degree of competition in each input market.
Although the process of market-determined production and allocation of goods and services is highly efficient, there are potential difficulties in an unconstrained market economy. Society has developed a variety of methods for alleviating these problems through the political system. One possible difficulty with an unconstrained market economy is that certain groups could gain excessive economic power. To illustrate, the economics of producing and distributing electric power are such that only one firm can efficiently serve a given community. Furthermore, there
MANAGERIAL APPLICATION 1.4
In the fifteenth century, the printing press made widespread dissemination of written information easy and inexpensive. The printing press sends information from the printer to the general public. It is a one-way method of communication. In the new millennium, we have the Internet. Not only is transmitting information via the Internet cheaper and faster than in the printed form, but it also is a two-way method of communication. The Internet is a revolutionary communications tool because it has the potential for feedback from one consumer to another, or from one company to another.
For the first time, the Internet gives firms and their customers in New York City, in Jackson Hole, Wyoming, and in the wilds of Africa the same timely access to widely publicized economic news and information. With the Internet, up-to-the-minute global news and analysis are just mouse clicks away. The Internet also gives global consumers and businesses the opportunity to communicate with one another and thereby create fresh news and information. Over the Internet, customers can communicate about pricing or product quality concerns. Businesses can communicate about the threat posed by potential competitors. The Internet makes the production of economic news and information democratic by reducing the information-gathering advantages of very large corporations and the traditional print and broadcast media.
With the Internet, the ability to communicate economic news and information around the globe is just a mouse click away. With the Internet, companies are able to keep in touch with suppliers on a continuous basis. Internet technology makes "just in time" production possible, if not mandatory. It also puts companies in touch with their customers 24 hours a day, 7 days a week. 24/7 is more than a way of doing business; it has become the battle cry of the customer-focused organization.
Internet technology is a blessing for efficient companies with products customers crave. It is a curse for the inefficient and slow to adapt.
See: Thomas E. Webber, "Political Meddling in the Internet Is on the Rise and Needs to End," The Wall Street Journal Online, March 4, 2002 (http://online.wsj.com).
are no good substitutes for electric lighting. As a result, electric companies are in a position to exploit consumers; they could charge high prices and earn excessive profits. Society's solution to this potential exploitation is regulation. Prices charged by electric companies and other utilities are held to a level that is thought to be just sufficient to provide a fair rate of return on investment. In theory, the regulatory process is simple; in practice, it is costly, difficult to implement, and in many ways arbitrary. It is a poor, but sometimes necessary, substitute for competition.
An additional problem can occur when, because of economies of scale or other barriers to entry, a limited number of firms serve a given market. If firms compete fairly with each other, no difficulty arises. However, if they conspire with one another in setting prices, they may be able to restrict output, obtain excessive profits, and reduce social welfare. Antitrust laws are designed to prevent such collusion. Like direct regulation, antitrust laws contain arbitrary elements and are costly to administer, but they too are necessary if economic justice, as defined by society, is to be served.
To avoid the potential for worker exploitation, laws have been developed to equalize bargaining power of employers and employees. These labor laws require firms to allow collective bargaining and to refrain from unfair practices. The question of whether labor's bargaining position is too strong in some instances also has been raised. For example, can powerful national unions such as the Teamsters use the threat of a strike to obtain excessive increases in wages? Those who believe this to be the case have suggested that the antitrust laws should be applied to labor unions, especially those that bargain with numerous small employers.
A market economy also faces difficulty when firms impose costs on others by dumping wastes into the air or water. If a factory pollutes the air, causing nearby residents to suffer lung ailments, a meaningful cost is imposed on these people and society in general. Failure to shift these costs back onto the firm and, ultimately, to the consumers of its products means that the firm and its customers benefit unfairly by not having to pay the full costs of production. Pollution and other externalities may result in an inefficient and inequitable allocation of resources. In both govern ment and business, considerable attention is being directed to the problem of internalizing these costs. Some of the practices used to internalize social costs include setting health and safety standards for products and work conditions, establishing emissions limits on manufacturing processes and products, and imposing fines or closing firms that do not meet established standards.
What does all this mean with respect to the value maximization theory of the firm? Is the model adequate for examining issues of social responsibility and for developing rules that reflect the role of business in society?
As seen in Figure 1.3, firms are primarily economic entities and can be expected to analyze social responsibility from within the context of the economic model of the firm. This is an important consideration when examining inducements used to channel the efforts of business in
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