551-21 - CHAPTER 21 COSTS AND THE SUPPLY OF GOODS What do...

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CHAPTER 21 - COSTS AND THE SUPPLY OF GOODS What do economists mean by costs, and why are costs so important to firms and managers? How do costs influence a firm’s production decisions? Those questions are discussed in this chapter. ORGANIZATION OF THE BUSINESS FIRM What do firms (like GM and Ford) do? 1. Purchase inputs from households and other firms (labor, materials, etc.) 2. Transform economic inputs into outputs (finished goods) 3. Sell the output to consumers (or other firms) Firms in a market economy are privately owned, and guided by the price system and the profit-loss system (3 Ps of a market economy: Private property, Prices and Profit/loss). Goal of the firm: Maximize Profits or Maximize Shareholder Wealth. Economic profits are a reward to efficient firms that successfully satisfy consumer demand, and losses are a penalty for firms operating inefficiently or unsuccessfully satisfying consumers. Owners (shareholders) of a firm are called "residual claimants." Owners have a "residual" claim to the net income, only after all other expenses are paid: wages, cost of goods sold, interest, taxes, etc. They get what is left over. Also, if a firm is liquidated, the owners are last on the list in the order of payment priority, a residual claim to the assets of the firm after all other parties have been paid: workers, IRS, banks, suppliers, bondholders, etc. Wealth of the owner is tied to costs. The more efficiently the business operates, the more productive the firm is, the greater the profits, the greater the wealth for the shareholders/owners. Owners therefore have an incentive to produce as efficiently/productively as possible, and use resources as efficiently as possible. Max Output and Min Inputs = Max Efficiency. Efficiently operating firms contribute to the overall amount of wealth in the economy, and increase prosperity and standard of living for economy. Two ways to produce: 1) Contracting (Outsourcing) and 2) Team Production (permanent workers hired to work together under the supervision of the owner or manager). Firms typically use a combination of Contracting and Team Production, based on comparing the cost of Internal (Team) Production vs. External Production (outsourcing) using the market. Examples : Advertising, Accounting, Legal Services. Is it cheaper for a firm to have its own advertising dept, accounting dept, legal dept, or is it cheaper to contract (outsource) these services? Building Contractor? Should he/she hire a full-time staff of carpenters, plumbers, painters, drywall workers, cement workers, electricians? Or should some or all of these be contracted out? Requires a comparison of the costs of internal vs. external production. Costs of contracting/outsourcing? 1. Determine what services are needed. 2. Search out potential suppliers (set up a bidding process) 3. Negotiate and enforce the contracting contract.
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