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Lecture

ECON 208 Chapter 7 - Textbook Notes.pdf


Department
Economics
Course Code
ECON 208
Professor
Lee Ohanian

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Chapter 7 Producers in the Short Run
7.1 What are Firms?
Organisation of Firms
1)
Single proprietorship
x
Has one owner who is personally responsible for the firm’s actions and debts
2)
Ordinary partnership
x
Has two or more joint owners, each of whom is personally responsible for the firm’s
actions and debts
3)
Limited partnership
x
Has two classes of owners:
x
General partners
x
Take part in managing the firm
x
Are personally liable for the firm’s actions and debts
x
Limited partners
x
Take no part in the management of the firm
x
Risk only the money that they have invested
4)
Corporation
x
Has a legal existence separate from that of the owners
x
Owners not personally responsible
x
Private
x
Shares not traded on any stock exchange
x
Public
x
Shares traded on stock exchanges
5)
State-owned enterprise
x
Owned by the government
x
Under the direction of a more or less independent state-appointed board
x
Organisation and legal status similar to corporation
6)
Non-profit organisations
x
Provide goods and services with the objective of just covering their costs
x
Earn their revenues from sales and donations
Multinational Enterprises (MNEs)
x
Firms that have operations in more than one country
x
Their growing number reveals an increasing role for these corporations in the ongoing process
of globalisation
Not all production in the economy takes place within firms. Many government agencies provide goods
and services (financed by tax revenues)

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Financing of Firms
Financial capital: the money a firm raises for carrying on its business
basic types: equity & debt
Real capital: the firm’s physical assets (factories, machinery, offices, finished goods)
EQUITY
x
Individual proprietorships & partnerships
x
One or more owners provide much of the required funds
x
Corporations
x
Acquire funds from its owners in return for stocks, shares, or equities
x
Dividends
x
Profits that are paid out to shareholders
x
Retained Earnings
x
Retaining current profits rather than paying them out to shareholders
x
Way for an established for to raise money
x
Add value to the firm, raise market value of existing shares
DEBT
x
Debt instruments
x
Loan agreements
x
Characteristics
x
They carry an obligation to:
x
repay the amount borrowed (aka, the principal of the loan)
x
make some form of payment to the lender (aka, interest)
x
Bonds
x
A debt instrument carrying a specified amount, a schedule of interest payments,
and (usually) a date of redemption of its face value
x
Redemption date: the time at which the principal is to be repaid
x
Term: the amount of time between the issue of the debt and its
redemption date
Goals of Firms
The desire to maximise profits is assumed to motivate all decisions made within a firm, and such
decisions are assumed to be unaffected by the peculiarities of the persons making the decisions and by
the organisational structure in which they work
x
Assumptions
1)
Firms are profit-maximisers
2)
Each firm is a single, consistent decision-making unit
x
Allow
x
the theory to ignore the firm’s internal organisation and its financial structure
x
economists to predict behaviour of firms

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x
the firm will select an alternative that produces the largest profits
x
Social responsibility
a)
Every firm has a responsibility to society that goes beyond
the responsibility to its shareholders;
VS
b)
By maximising profits, firms are providing a valuable service
to society
7.2 Production, Costs, and Profits
Production
INPUTS
x
Intermediate products
x
All outputs that are used as inputs by other producers in a further stage of production
x
Inputs that are provided directly by nature (Land)
x
Inputs that are provided directly by people (Labour)
x
Inputs that are provided by the factories and machines (Capital)
PRODUCTION FUNCTION
x
Functional relation showing the maximum output that can be produced by any given
combination of inputs
x
Q = f (L, K)
Q: flow of output
K: flow of capital services
L: flow of labour services
f: production function itself
x
Changes in the firm’s technology, which alter the relationship between inputs and output, are
reflected by changes in the function f.
Costs and Profits
Firms arrive at profits by taking the revenues they obtain from selling their output by subtracting all the
costs associated with their inputs.
ECONOMIC VERSUS ACCOUNTING PROFITS
x
Accounting profits = Revenues – Explicit costs
x
Explicit costs: costs that actually involve a purchase of goods or services by the firm
E.g.: hiring of workers, renting equipment, interest payments on debt, purchase of
intermediate inputs
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