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Lecture 6

Week 6 study guide

Economics for Management Studies
Course Code
Gordon Cleveland

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Chapter 7 Producers in the Short Run Notes
7.1 What are Firms?
Organization of Firms
1. A single proprietorship has one owner-manager who is personally responsible for all aspects of the business, including its debts.
2. An ordinary partnership has two or more joint owners, each of whom is personally responsible for all of the partnership’s debts.
3. The limited partnership, which is less common than ordinary partnerships, provides for two types of partners. General partners
take part in the running of the business and are liable for all the firm’s debts. Limited partners take no part in the running of the
business, and their liability is limited to the amount they actually invest in the enterprise.
4. A corporation is a firm regarded in law as having an identity of its own; its owners are not personally responsible for anything
that is done in the name of the firm, though its directors may be. The shares of a private corporation are not traded on any stock
exchange whereas the shares of a public corporation are.
5. A state-owned enterprise is owned by the government but is usually under the direction of a more or less independent, state-
appointed board. Although its ownership differs, the organization and legal status of a state-owned enterprise are similar to those
of a corporation. In Canada, such state-owned enterprises are called Crown corporations.
6. Non-profit organizations are established with the explicit objective of providing goods or services to customers, but any profits
that are generated remain with the organization and are not claimed by individuals. In many cases, some goods or services are
sold to consumers while others are provided free of charge. Non-profit firms therefore earn their revenues from a combination of
sales and donations.
x multinational enterprises (MNEs) : firms that have operations in more than one country
Financing of Firms
x basic types of financial capital used by firms are equity, funds provided by the owners of the firm, and debt, funds borrowed
from creditors outside the firm
x dividends : profits paid out to shareholders of a corporation; sometimes called distributed profits
x bonds : debt instrument carrying specified amount and schedule of interest payments and date for redemption of its face value
Goals of Firms
x the desire to maximize 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 organizational structure in which they work
7.2 Production, Costs, and Profits
x in order to produce the goods or services that it sells, each firm needs inputs, which can be grouped into four broad categories:
— inputs to the firm that are outputs from some other firm
— inputs that are provided directly by nature
— inputs that are provided directly by people
— inputs that are provided by the factories and machines used for manufacturing
x intermediate products : all outputs that are used as inputs by other producers in a further stage of production
x production function : functional relation showing maximum output produced by each and every combination of inputs
x it is written as Q = f (L, K) where Q is the flow of output, K is the flow of capital services, L is the flow of labour services, f is
the production function itself
x changes in firm’s technology, which alter the relationship between inputs and outputs, are reflected by changes in the function f
Costs and Profits
x accounting profit = revenues – explicit costs
x economic profit : the difference between the revenues received from the sale of output and the opportunity cost of the inputs
used to make the output; negative economic profits are called economic losses
x economic profits = revenues – (explicit costs + implicit costs) = accounting profits – implicit costs
x especially in small and relatively new firms, owners spend a tremendous amount of their time developing the business and often
they pay themselves far less than they could earn if they were instead to offer their labour services to other firms
x implicit costs are just as important as explicit costs; economists include both implicit costs and explicit costs in their
measurement of profits, whereas accounting profits include only explicit costs; economic profits are therefore less than
accounting profits
x economic profits and losses play a crucial signalling role in the workings of a free-market system
Profit Maximizing Output
x (profit) = TR (total revenue)TC (total costs)
x Q = f (L, K) where Q is quantity of output per period of time, L is the flow of labour services employed in production, K is the
flow of capital services used, f stands for the relation that links the inputs to the output
Time Horizons for Decision Making
x economists classify the decisions that firms make into three types: (1) how best to use existing plant and equipment—the short
run; (2) what new plant and equipment and production processes to select, given known technical possibilities—the long run;
and (3) how to encourage, or adapt to, the development of new techniques—the very long run
x short run : a period of time in which the quantity of some inputs cannot be increased beyond the fixed amount that is available
x fixed factor : an input whose quantity cannot be changed in the short run
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