Chapter 10: Organizing Production
1. The firm and its economic problem
2. Opportunity cost (explicit cost + implicit cost)
3. Implicit cost (economic depreciation ,interest forgone , normal
4. Economic profit & Accounting profit
5. Technological efficiency & Economic Efficiency
6. Markets and the competitive environment
Chapter 10: Organizing Production
• Firms must organize their production so that it is as efficient
• Firms operate in markets that differ according to the
competition within the market.
• Firms organize some economic activities while markets are
used for other economic activity.
I. The Firm and Its Economic Problem
• The number and scope of business firms in the economy is
vast and diverse.
A firm is an institution that hires factors of production
and organizes those factors to produce and sell goods
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The firm’s goal is to maximize its profit. If a firm fails to
maximize profit it is either eliminated through
competition or bought out by other firms seeking to
Opportunity Cost and Economic Profit
1. A firm’s decisions respond to opportunity cost and
2. A firm’s opportunity cost of producing a good is the
best, forgone alternative use of its factors of
production, usually measured in dollars.
Opportunity cost includes both:
a) Explicit costs that are paid directly in money,
b) Implicit costs that are incurred when a firm uses
its capital, or its owners’ time in production for
which it does not make a direct money payment.
3. The firm can rent capital and pay an explicit rental
cost reflecting the opportunity cost of using the
4. The firm can also buy capital and incur an implicit
opportunity cost of using its own capital, called the
implicit rental rate of capital. This implicit cost is
made up of:
a) Economic depreciation—the change in the
market value of capital over a given period.
b) Interest forgone, which is the return on the funds
used to acquire the capital.
5. The cost of the owner’s resources is his or her
entrepreneurial ability and labour expended in
running the business.
a) The opportunity cost of the owner’s
entrepreneurial ability is the average return from
this contribution that can be expected from
Copyright © 2006 Pearson Education Canada 154 CHAPTER 9
running another firm. This return is called a
b) The opportunity cost of the owner’s labour spent
running the business is the wage income forgone
by not working in the next best alternative job.
1. Economic profit equals a firm’s total revenue
minus its opportunity cost of production.
2. A firm’s opportunity cost of production is the sum
of the explicit costs and implicit costs.
3. Normal profit is part of the firm’s opportunity costs,
so economic profit is profit over and above normal
4. Table 9.1 (page 199) summarizes the economic
Economic Accounting: A Summary
To achieve profit maximization, the firm must make
five basic decisions:
1. What goods and services to produce and in what
2. How to produce—the production technology to use
3. How to reorganize and compensate its managers
4. How to market and price its products
5. What to produce itself and what to buy from other
Copyright © 2006 Pearson Education Canada 155 CHAPTER 9
The Firm’s Constraints
• A firm faces three basic constraints that limit its maximum
• Technology Constraints A technology is any method of
producing a good or service. At the existing level of
technology, a firm can produce more output only if it
hires more resources, which increases its costs and limits
• Information Constraints A firm has only limited
information about the quality and effort of its work force,
about the current and future buying plans of its
customers, and about the plans of its competitors.
• Market Constraints What a firm can sell and the price it
at are constrained by its customers’ willingness to pay
and by the prices and marketing efforts of other firms.
II. Technological Efficiency and Economic Efficiency
• There typically are many different combinations of inputs
that can produce a specific level of output.
Technological efficiency occurs when a firm produces a
given output by using the least amount of inputs.
Economic efficiency occurs when the firm produces a
given output at the least possible cost. An economically
efficient production process is always technologically
efficient. But, a technologically efficient process might
not be economically efficient.
• The table has 4 different methods of prod