110Ch09 - Chapter 9: Organizing Productions Objectives...

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Chapter 9: Organizing Productions – Objectives Explain what a firm is and describe the economic problems that a ll firms face Distinguish between technological and economic efficiency Define and explain the principal-agent problem and describe how different types of business organizations cope with this problem Describe 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 rules laid down by the Internal Revenue Service and the Financial Accounting Standards Board. Their goal is to report profit so that the firm pays the correct amount of tax and is open and honest about its financial situation with its bank and other lenders. Economists measure profit based on an opportunity cost measure of cost.
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Opportunity Cost A firm’s opportunity cost of producing a good is the best, forgone alternative use of its factors of production. Opportunity cost includes both: Explicit and Implicit Costs Explicit costs are costs paid directly in money Implicit costs are incurred when a firm uses its own capital or its owners’ time but does not make a direct money payment. The firm can rent capital and pay an explicit rental cost reflecting the opportunity cost of using the capital. The firm can also incur an implicit opportunity cost of using its own capital, called the implicit rental rate of
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Opportunity Cost 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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Opportunity Cost Cost of Owner’s Resources The owner often supplies entrepreneurial ability and labor. The return to entrepreneurship is profit. The opportunity cost of the owner’s entrepreneurial ability is the average return from this contribution that can be expected from running another firm. This return is called a 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 opportunity cost of production. A firm’s opportunity cost of production is the sum of
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This note was uploaded on 05/21/2011 for the course ECON 110 taught by Professor Tan during the Spring '07 term at HKUST.

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110Ch09 - Chapter 9: Organizing Productions Objectives...

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