Ch09 - Chapter 9: Organizing Production I. The Firm and Its...

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C h a p t e r   9 :   O r g a n i z i n g   P r o d u c t i o n I. The Firm and Its Economic Problem A. A firm is an institution that hires factors of production and organizes them to produce and sell goods and services. B. The Firm’s Goal 1. A firm’s goal   is to maximize profit . 2. If the firm fails to maximize its profit, it is either eliminated or bought out by other firms seeking to maximize profit. C. Opportunity Cost 1. A firm’s decisions respond to opportunity cost and economic profit . 2. A firm’s opportunity cost of producing a good is the best, forgone alternative use of its factors of production, usually measured in dollars. Opportunity cost includes both: a) Explicit costs that are paid directly in money, and b) Implicit costs that are incurred when a firm uses its capital, or its owners’ time in production for which it does not make a direct money payment. 3. The firm can rent capital and pay an explicit rental cost reflecting the opportunity cost of using the capital. 4. The firm can also buy capital and incur an implicit opportunity cost of using its own capital, called the implicit rental rate  of capital. The implicit rental rate of capital is made up of two components: a) Economic depreciation —the change in the market value of capital over a given period. b) Interest forgone, which is the return on the funds used to acquire the capital. 5. There also is a cost for the resources the owner uses to operate the business: a) The return to entrepreneurship is profit, and the return that an entrepreneur can expect to receive on the average is called normal profit . b) The opportunity cost of the owner’s labor spent running the business is the wage income forgone by not working in the next best alternative job . E. Economic Profit 1. Economic profit equals a firm’s total revenue minus its opportunity cost of production. 2. A firm’s opportunity cost of production is the sum of its explicit costs and implicit costs. 3. Normal profit is part of the firm’s opportunity costs, so economic profit is profit over and above normal profit. 4. Table 9.1 illustrates the economic accounting concepts. F. Economic Accounting: A Summary To achieve its objective of profit maximization, the firm must make five basic decisions: 1. What goods and services to produce and in what quantities 2. How to produce—the production technology to use 3. How to organize and compensate its managers and workers 4. How to market and price its products 5. What to produce itself and what to buy from other firms
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G. The Firm’s Constraints The five basic decisions of a firm are limited by the constraints it faces. There are three constraints a firm faces: 1. Technology Constraints a) Technology is any method of producing a good or service. b)
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This note was uploaded on 04/03/2009 for the course ECON 2102 taught by Professor Bill during the Fall '08 term at Temple.

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Ch09 - Chapter 9: Organizing Production I. The Firm and Its...

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