Ch09 - Chapter 9: Organizing Production Objectives: Explain...

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Chapter 9: Organizing Production Objectives: Explain what a firm is and describe the economic problems that all firms face Distinguish between technological efficiency and economic efficiency Define and explain the principal-agent problem and describe how different types of business organizations cope with this problem Describe and distinguish between different types of markets in which firms operate Explain why markets coordinate some economic activities and firms coordinate others
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The Firm and Its Economic Problem A firm is an institution that hires factors of production and organizes them to produce and sell goods and services. The Firm’s Goal A firm’s goal is to maximize profit. If the firm fails to maximize profits it is either eliminated or bought out by other firms seeking to maximize profit.
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The Firm and Its Economic Problem Measuring a Firm’s Profit Accountants measure a firm’s profit using Internal Revenue Service rules based on standards established by the Financial Accounting Standards Board (FASB). Economists measure profit based on an opportunity cost measure of cost.
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The Firm and Its Economic Problem Opportunity Cost A firm’s decisions respond to opportunity cost and economic profit. 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 Explicit costs Implicit costs
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The Firm and Its Economic Problem Explicit costs are costs paid directly in money. Implicit costs are costs incurred when a firm 1. Uses its own capital. 2. Uses its owners’ time or financial resources. The firm can rent capital and pay an explicit rental cost. Or the firm can buy capital and incur an implicit opportunity cost of using its own capital, called the implicit rental rate of capital.
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The Firm and Its Economic Problem The implicit rental rate of capital is made up of 1. Economic depreciation 2. Interest forgone Economic depreciation is the change in the market value of capital over a given period. Interest forgone is the return on the funds used to acquire the capital.
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The Firm and Its Economic Problem Cost of Owner’s Resources The owner often supplies entrepreneurial ability and labor. The return to entrepreneurship is profit and the return that an entrepreneur can expect to receive on the average is called normal profit . The opportunity cost of the owner’s labor spent running the business is the wage income that the owner forgoes by not working in the best alternative job.
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Economic Profit Economic profit equals a firm’s total revenue minus its total cost. A firm’s total cost of production is the sum of the explicit costs and implicit costs. Normal profit
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This note was uploaded on 04/03/2009 for the course ECON 2102 taught by Professor Bill during the Spring '08 term at Temple.

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Ch09 - Chapter 9: Organizing Production Objectives: Explain...

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