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firm_theory_1 - Firm Theory production functions cost...

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1 Firm Theory: production functions, cost curves and profit maximization
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2 Remarks Switching gears: “Theory of the Firm” Embarking on an analysis of the firm. Note: There are lots of different types of firms. There are lots of ways to organize entrepreneurial activity. There are lots of firm objectives.
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3 What We Assume For our analysis we assume that: we have an owner manager, who has a business, with the primary and only objective to maximize economic profit.
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4 What’s a Business? A business is an organization producing goods or services, also called a firm. A business, or firm, is assumed to maximize its profits. Examples of businesses: Microsoft, Kinko’s, the Campus Store (a business within Cornell University). Examples of organizations that are not businesses in this sense: Cornell University as a whole, US Department of Defense. Organizations that produce goods and services but are legally prohibited from using the profit motive are excluded from our formal model of a firm.
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5 What’s a Market? A collection of buyers and sellers organized for the purpose of exchanging goods and services for money. Markets can be global, national, regional, or local depending upon the item being bought and sold.
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6 Profit Maximization profit = total revenue - total cost total revenue: determined by the level and nature of competition in your market total cost: costs are determined by factor market prices and the firm’s technology or production function
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7 Economic Profits Economic profits are the difference between total revenue and total costs. Economic total costs include the opportunity costs of all inputs to the production process–in particular, the opportunity costs of the owner’s time and physical capital (equipment and space). Whenever we talk about profit we mean economic profit.
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8 Accounting Profits Accounting profits are defined as total sales revenue (the same as total revenue in the economic profits definition) minus operating costs (costs of goods sold + administrative and sales costs for those who know some accounting). Accounting Profits = Sales Revenue - Accounting Costs
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9 Production & Cost Structures There are lots of ways to describe production and costs. You need to understand them all. For example: total, fixed and variable concepts average and marginal concepts long run and short run concepts all related to each other
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10 Jonathan’s New York State Apple Farm The farm is a business organized to grow and sell apples. The owner/proprietor, Jonathan, tries to maximize his profits from the business.
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11 The U.S. Apple Market Americans consume 19 lbs. of apples per person annually, for a total consumption of 5 billion lbs.
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