Micro- and macroeconomics - Introducing supply decisions.pdf

Micro- and macroeconomics - Introducing supply...

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Introducing supply decisions Micro-and macroeconomics
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Types of firms There are three main types of firms: self- employed sole traders, partnerships, and companies. Sole traders are the most numerous but are often very small. The large firms are companies. Companies are owned by their shareholders but run by the board of directors. Shareholders of a company have limited liability. The most they can lose is the money they spent buying shares. Partners and sole traders have unlimited liability: they can be forced to sell their personal possessions if the business goes bust.
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No matter how small or large a firm is, we will assume that their main goal is to maximize their profits: π (q) = TR(q) –TC(q) Profits are the excess of revenues (TR) over costs (TC). In order to maximize their profits, firms have to make several important decisions. These include Supply decisions determining the optimal (profit-maximizing) head2right Quantity produced (Q) barb2left ‘theory of supply’ head2right (Output) price (P) barb2right Aim: maximize TR(q) if q is given (The optimal price can be determined according to the demand curve facing the firm). head2right Technology and factors of production barb2right Aim: minimize TC(q) if q is given (can be calculated from a production function and the rental/wage rates)
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Determinants of profits For each possible output level a firm needs to calculate what it costs to make this output and how much revenue is earned by selling it. At each output, production costs depend on technology; which determines the inputs needed; and on the input prices that the firm faces. Sales revenue depends on the demand curve faced by the firm. The demand curve determines the price for which any output quantity can be sold and thus the revenue the firm earns.
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Economic costs and profits Economists and accountants take different views of cost and profit. An accountant is interested in tracking the actual receipts and payments of a company. Economists identify the cost of using a resource not as the payment actually made but as its opportunity cost. Opportunity cost is the amount lost by not using a resource (labour, capital) in its best alternative use.
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Examples of opportunity costs Opportunity costs include the cost of the owner’s time and effort in running a business. For example, if you could have earned $25,000 a year working for someone else, and the accounting profit of a firm you run is $20,000, being self-employed is losing you at least $5000. Accounting profits also ignore the use of owned (as opposed to borrowed) financial capital. The money you put up to start a business could have been deposited in an interest-bearing bank account or used to buy shares in other firms.
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Economic costs and supernormal profits These opportunity costs are part of the economic costs of the business but not its accounting costs.
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