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chapternine - Ch. 9 Organizing Production The Firm and Its...

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Ch. 9 Organizing Production The Firm and Its Production - Each firm is an institution that hires factors of production and organizes those factors to produce and sell goods and services. - A firm’s goal is to maximize profit. A firm that does not seek to maximize profit is either eliminated or bought out by firms that do seek to maximize profit. - For a firm, the opportunity cost of production is the value of the firm’s best alternative use of its resources. - A firm’s opportunity cost includes both explicit costs and implicit costs. o Explicit costs : Explicit costs are paid in money. The amount paid for a resource could have been spent on something else, so it is the opportunity cost of using the resource. o Implicit costs : A firm incurs implicit costs when it forgoes an alternate action but does not make a payment. Two: 1. Uses its own capital. An implicit cost and an opportunity cost because the firm could rent the capital to another firm. The rental income for gone is the firm’s opportunity cost of using its own capital. This opportunity cost is called the implicit rental rate of capital. The implicit rental rate of capital is made up of 1) economic depreciation, and 2) interest forgone. Economic depreciation : the change in the market value of capital over a given period. It is calculated as the market price of the capital at the beginning of the period minus its market price at the end of the period. The funds used to buy capital could have been used for some other purpose. And in their next best use, they would have yielded a return – an interest income. This forgone interest is part of the opportunity cost of using the capital. Ex. Sidney’s Sweaters could have bought government bonds instead of a knitting factory. The interest forgone on the government bonds is an implicit cost of operating the knitting factory. 2. Uses its owner’s time or financial resources. A firm’s owner often supplies entrepreneurial ability. The return to entrepreneurship is profit, and the return that an entrepreneur can expect to receive on the average is called normal profit . Normal profit is part of a firm’s opportunity cost, because it is the cost of a forgone alternative – running another firm. The owner of a firm also can supply labor. The return to labor is a wage. And the opportunity cost of the owner’s time spent working for the firm is the wage income forgone by not working in the best alternative job.
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o A firm’s economic profit is equal to its total revenue minus its opportunity cost. The firm’s opportunity cost is the sum of its explicit costs and implicit costs. o The implicit costs include normal profit. The return to entrepreneurial ability is greater than normal in a firm that makes a positive economic profit. And the return to entrepreneurial ability is less than normal in a firm that makes a economic profit or economic loss. o
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This note was uploaded on 02/17/2008 for the course ECON 51 taught by Professor Leachman during the Spring '08 term at Duke.

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chapternine - Ch. 9 Organizing Production The Firm and Its...

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