M11_PARK_1243_09_CH10 - Chapter 10 ORGANIZING PRODUCTION...

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Page 230 1. What is a firm’s fundamental goal and what happens if the firm that doesn’t pursue this goal? A firm’s fundamental goal is to maximize its profit. If the firm fails to maximize profit it is either eliminated or bought out by other firms maximizing profit. 2. Why do accountants and economists calculate a firm’s cost and profit in different ways? Accountants and economists have different reasons for computing a firm’s costs. An accountant calculates a firm’s cost and profit to ensure that the firm pays the correct amount of income tax and to show its investors how their funds are being used. An economist calculates a firm’s cost and profit in a way that enables him or her to predict the firm's decisions. 3. What are the items that make opportunity cost differ from the accountant’s measure of cost? A firm’s opportunity cost includes the cost of using resources bought in the market, owned by the firm and supplied by the firm's owner. For instance, use of a building the owner has already purchased has an opportunity cost that accountants do not include. Additionally the normal profit the entrepreneur earns is another opportunity cost not recorded by an accountant. 4. Why is normal profit an opportunity cost? Normal profit is the return to a firm’s owner for the owner’s supply of entrepreneurial ability and labor to the firm’s production process. Using the owner’s ability to run the business implies that the owner could have received a return for using it in another capacity, such as running another firm. This cost is an opportunity cost for the firm because it is the cost of a forgone alternative, which is running another firm, and must be included in calculating the firm’s opportunity cost of production. 5. What are the constraints that a firm faces? How does each constraint limit the firm’s profit? The three types of constraints a firm faces are technology constraints, information constraints, and market constraints. Technology is any specific method of producing a good or service and it advances over time. Using the available technology, the firm can produce more only if it hires more resources, which will increase its costs and limit the profit of additional output. Information is never complete, for the future or the present. A firm is constrained by limited information about the quality and effort of its work force, current and future buying plans of its customers, and the plans of its competitors. The cost of coping with limited information itself limits profit. Market constraints mean that what each firm can sell and the price it can obtain are constrained by its customers’ willingness to pay and by the prices and marketing efforts of other firms. The resources that a firm can buy and the prices it must pay for them are limited by the willingness of people to work for and invest in the firm. The expenditures a firm incurs to overcome these market constraints will limit the profit the firm can make. 10
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This note was uploaded on 03/02/2011 for the course ECON 001 taught by Professor Stein during the Fall '07 term at UPenn.

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M11_PARK_1243_09_CH10 - Chapter 10 ORGANIZING PRODUCTION...

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