Chapter 9 Reading Notes

Chapter 9 Reading Notes - Chapter Nine Organizing...

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February 26, 2008 Chapter Nine: Organizing Production The Firm and Its Economic Problem Firm – 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 Accountant of a firm measures cost and profit to ensure that the firm pays the correct amount of income tax and to show the bank how its loan has been used A firm’s opportunity cost includes explicit and implicit costs o Explicit costs – paid in money (i.e. for Sidney’s Sweaters, its expenditure on wool, utilities, wages, and interest are explicit costs) o Implicit costs – a firm incurs implicit costs when it forgoes an alternative action but does not make a payment o A firm incurs implicit costs when it uses its own capital or uses its owner’s time or financial resources Implicit rental rate of capital – cost of using capital owned by the firm is an implicit cost —and an opportunity cost—because the firm could have rented the capital to another firm. The rental income forgone is the firm’s opportunity cost of using the capital it owns. This opportunity cost is called the implicit rental rate of capital. o Includes normal profit If a firm uses the capital it owns, it incurs an implicit cost, which is made up of economic depreciation and interest forgone Economic depreciation – the change in the market value of capital over a given period Normal profit – the return that an entrepreneur can expect to receive The entrepreneur’s normal profit is part of a firm’s opportunity cost because it is the cost of a forgone alternative—running another firm Economic profit – is equal to firm’s total revenue minus its total cost A firm’s total costs is equal to the sum of its explicit and implicit costs To achieve the objective of maximum profit—maximum economic profit—a firm must make five basic decisions: o 1) What goods and services to produce and in what quantities.
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February 26, 2008 o 2) How to produce—the techniques of production to use o 3) How to organize and compensate its managers and workers o 4) How to market and price its products o 5) What to produce itself and what to buy from other firms Three features of its environment limit the maximum profit a firm can make o Technology, information, market Technology constraints o Technology - any method of producing a good or service o Technology also includes detailed designs of machines, layout of the workplace, organization of the firm o At each point in time, to produce more output and gain more revenue, a firm must hire more resources and incur greater costs o The increase in profit that the firm can achieve is limited by the technology available Information constraints– we never possess all the information we would like to have to make decisions o We lack information about both the future and the present o A firm is also constrained by limited information about the quality and effort of its
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This note was uploaded on 12/05/2009 for the course ECON 988099 taught by Professor Carollfoster during the Winter '08 term at UCSD.

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Chapter 9 Reading Notes - Chapter Nine Organizing...

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