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Department
Economics
Course
ECON 1050
Professor
Eveline Adomait
Semester
Fall

Description
Chapter 1: What is Economics? 11/12/2013 11:17:00 AM Economics’ fundamental definition says that we as humans want more than we can get. This is called scarcity. Demands and needs are limited by the limited resources available. Incentive: a reward that encourages an action or a penalty that encourages one Economics is the social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices Microeconomics: the study of the choices that individuals and businesses make, the way these choices interact in markets, and the influence of governments. Macroeconomics: the study of the performance of the national economy and the global economy. Goods and services are the objects that people value and produce to satisfy human wants. They are produced by using the four factors of production: Land: Can also be known as natural resources such as oil, gas, coal, water, air, forests and fish. Earns rent. Labour: The work, time and effort that people devote to producing goods and services. Earns wages. Capital: The tools, instruments, machines, buildings, and other constructions that businesses use to produce goods and services. Earns interest. Entrepreneurship: The human resource that organizes labour, land and capital. Earns profit. Self interest is a choice made that best suits you. Social interest is a choice made that best suits the well being of society. Efficiency is achieved when the available resources are used to produce goods and services at the lowest possible cost and in the quantities that give the greatest possible value or benefit. Can these be achieved equally? We can attempt to determine whether they can or not by using four examples: Globalization means the expansion of international trade, borrowing and lending, and investment. It is in the self-interest of consumers who buy low cost goods and services produced in other countries. This example isn‟t so fair for workers in countries like Malaysia. Information-Age Economy revolves around the ever changing technology. Arguably, the self-interest of technology titans did not match the social- interest. Climate Change states that we all have a carbon footprint. Possible ways to fix this would be riding a bike, planting a tree, or some sort of clean energy. Economic Instability talks about banks , basically, stealing money from their customers through interest rates and loans. When banks get into financial trouble, they get loans from governments thus creating instability within the economy. In the end, the economic way of thinking something through will often end in a tradeoff; an exchange of giving something up to gain something else. A rational choice is one that compares costs and benefits and achieves the greatest benefit over cost for the person making the choice. The benefit of something is the gain or pleasure it brings and is determined by preferences. Benefits can be measured by the most a person is willing to give up to get something. How much you are willing to give up can be measured by opportunity cost, which is the highest valued alternative that must be given up to get something. Marginal Benefit is the benefit that arises from increasing time spent doing something. The marginal benefit of studying one more hour the night before a test is a grade boost the next day. Marginal Cost is the opportunity cost of increasing time spent doing the same „something‟. The marginal cost of studying one more hour the night before a test is a lost hour that could be spent playing WoW or CoD. If marginal benefit exceeds marginal cost, you study that extra hour. If marginal cost exceeds marginal benefit, you don‟t study the extra hour. Chapter 2: The Economic Problem 11/12/2013 11:17:00 AM In this chapter, expect to see economic models-the production possibility frontier-that explains how factors that affect the production of some given product can be examined, whether production is efficient or inefficient, and how we can gain by trading with others. A Production Possibility Frontier is the boundary between combinations of goods and services that can be produced and those that cannot. Under the line represents attainable quantities and outside represents unattainable. We can examine the PPF for producers of pizza and cola: Possibility Pizzas(millions) Cola(millions) A 0 15 B 1 14 C 2 12 D 3 9 E 4 5 F 5 0 This chart shows that as we go up and down in the columns, we must give up some of one product to gain some of the other product. We can produce production efficiency if we produce goods and services at the lowest possible cost. If we were to graph the points in the table above, it would make a continuous down sloping line. Points on the graph are efficient. If we were to drop a point anywhere inside the PPF, these amounts would be inefficient because we are giving up or misallocating more goods than necessary. Every choice along the PPF signifies a tradeoff. At any given time, we have a fixed amount of land, labour, capital and entrepreneurship. By using what we have, we can employ these resources to product goods and services but we are limited in production by what we have. To produce more coke, we must give up pizza. Every tradeoff faces an opportunity cost. We are able to use our resources efficiently. When goods and services are produced at the lowest possible cost and in the quantities that provide the greatest possible benefit, we have achieved allocative efficiency. The marginal cost of a good is the opportunity cost of producing one more unit of it. We can calculate this from the slope of the PPF. The marginal benefit of a good or service is the benefit received from consuming one more unit of it. In the past 30 years, production possibilities in Canada has doubled. This is called economic growth. This, however, does not eliminate scarcity or opportunity cost, but rather accelerate it. Technological change is the development of new goods and of better ways of producing goods and services. Capital accumulation is the growth of capital resources, including human capital. Producing only one or few goods is called specialization. People can specialize and gain from trade from finding themselves with a comparative advantage. A person has a comparative advantage in an activity if they can perform the activity at a lower opportunity cost than anyone else. A person has an absolute advantage if they can perform multiple activities at a lower cost than anyone else. An example: Liz‟s Production Possibilities Item Minutes to Produce 1 Quantity per hour Smoothies 2 30 Salads 2 30 Liz‟s opportunity cost of producing 1 smoothie is 1 salad and the opportunity cost of producing 1 salad is 1 smoothie Joe‟s Production Possibilities Item Minutes to Produce 1 Quantity per hour Smoothies 10 6 Salads 2 30 Joe‟s opportunity cost of producing 1 smoothie is 5 salads and the opportunity cost of producing 1 salad is 1/5 of a smoothie From this, we can see that Liz has a comparative advantage in the production of smoothies and Joe has a comparative advantage in the production of salads. So in the end: a)Before trade Liz Joe Smoothies 15 5 Salads 15 5 b)Specialization Liz Joe Smoothies 30 0 Salads 0 30 c)Trade Liz Joe Smoothies Sell 10 Buy 10 Salads Buy 20 Sell 20 d)After trade Liz Joe Smoothies 20 10 Salads 20 10 e)Gains from trade Liz Joe Smoothies +5 +5 Salads +5 +5 A market is any arrangement that enables buyers and sellers to get information and to do business with each other. An example of this is the world oil market. Markets can only work when property rights exist. Property rights are the social arrangements that govern ownership, use and disposal of anything that people value. Real property includes land and buildings, financial property includes stocks and bonds and money in the bank, and intellectual property is the intangible product of creative effort. Chapter 3: Supply and Demand 11/12/2013 11:17:00 AM Competitive Market- A market that has many buyers and sellers, so no single buyer or seller can influence the price Price- The number of dollars that must be given up in exchange for an item, also known as the Money Price Opportunity Cost- The highest valued alternative forgone Relative Price- The ratio of one price to another, also known as the opportunity cost Demand- If you demand something, this entitles that you want it, can afford it, and plan to buy it Wants- are the unlimited desires or wishes that people have for goods and services Quantity Demanded- the amount of goods and services that consumers plan to buy during a given time period at a particular price The Law of Demand: Other things remaining the same, the higher the price of a good, the smaller the quantity demanded; the lower the price of a good, the higher the quantity demanded Substitution Effect: When the price of a good rises, as does its opportunity cost. As the opportunity cost rises, the economic solution would be to switch to a substitute product of the same relation Income Effect: As a products price rises, the income of some people becomes too low to afford the product at its new price. Demand- itself, refers to the entire relationship between the price of a good and the quantity demanded of that good Demand Curve- shows the relationship between the quantity demanded of a good and its price when all other influences on consumers‟ planned purchases remain the same Chapter 4: Elasticity 11/12/2013 11:17:00 AM How do we tell which quantity(soft drinks or pizza) demanded is more responsive to a price change? The question must be answered with a measure of responsiveness that is independent of units of measurement. This measure is called Elasticity. Price elasticity of demand- a units free measure of the responsiveness of the quantity demanded of a good to a change in its price when all other influences on buying plans remain the same Calculating it: percentage change in quantity demanded percentage change in price We can express the change in price as a percentage of the average price and the change in quantity demanded as a percentage of the average quantity. By using the averages, this allows us to use a point exactly between the old point and the new point. Price: With the old point being 20.50$ a pizza and the new price being 19.50$ a pizza, the average price sits at 20.00$ a pizza. We call this %ΔP. Which means… %ΔP= (ΔP/P ave) x 100 = ($1/$20) x 100 = 5% Quantity Demanded: With the old quantity of pizza demanded being 9 pizzas and the new quantity demanded being 11 pizzas, we can call the average amount of pizzas demanded 10. We call this %ΔQ. Which means… %ΔQ= (ΔQ/Q ave x 100 = (2/10) x 100 = 20% SOOO: Price elasticity of demand= percentage change in quantity percentage change in price =%ΔQ %ΔP = 20% 5% = 4 Percentages and Proportions- elasticity is the ratio of two percentage changes. A percentage change is a proportionate change multiplied by 100. Minus sign and elasticity- When the price of a good rises, the quantity demanded falls. This means that because a positive change in price occurs, a negative change in quantity demanded occurs which makes the price elasticity of demand a negative number. We ignore the negative sign and just pay attention to the magnitude and the absolute value. Perfectly inelastic demand- when the quantity demanded remains constant with a change in price and the elasticity is zero. Unit elastic demand- if the percentage change in quantity demanded equals the percentage change in price then the price elasticity equals one. Perfectly elastic demand- if the quantity demanded changes by an infinitely large percentage in response to a tiny price change, then the price elasticity of demand is infinity. Chapter 5: Efficiency and Equity 11/12/2013 11:17:00 AM The goal for this chapter is to evaluate the ability of markets to allocate resources efficiently and fairly. Problems with Scarcity: We know that resources are scarce so they must be allocated efficiently. These scarce resources are allocated through Market Price Command Majority Rule Contest First come, first served Lottery Personal Characteristics Force Market Price – The people who are willing and able to pay that price get that resource. There are two kinds of people: those who can afford to pay but choose not to buy, and those who cannot afford to buy. Command – Allocates resources by the command of someone in authority. This is used within firms, and government departments. In a job context labour would be allocated via command. Majority Rule – allocates resources in a way that a majority of voters choose. (i.e tax rates, allocating scarce resources, etc) Contest – allocates resources to a winner or group of winners First Come First Served – allocates resources to those who are first in line. It is most optimal when there are fewer people in need of a resource. Personal Characteristics – People with the “right” characteristics get the resources. i.e who you chose for a marriage partner, or sometimes in unacceptable ways i.e giving the promotion to a white Anglo-Saxon protestant (w.a.s.p) male over a minority on the basis of “w.a.s.p” status. Force – War and the use of military force by one nation against another is one way that resources are allocated. Benefit, Cost, and Surplus Resources are allocated efficiently and in social interest when they are used in the ways that people value most highly. In a demand sense, value is what we get and price is what we pay. The value of one more unit of a good or service is its marginal benefit. Marginal benefit is the maximum price that is willingly paid for another unit of the good or service. A demand curve is a marginal benefit curve. Individual Demand and Market Demand The relationship between the price of a good and the quantity demanded by one person is called individual demand. The relationship between the price of a good and quantity demanded by all buyers is market demand. Consumer Surplus Is the excess of the benefit received from a good over the amount paid for it. Consumer surplus occurs when we buy something for less than it is worth to us. Supply Cost and Minimum Supply Price Producers distinguish between cost and price like we consumers distinguish between value and price. Cost: What a firm gives up when it produces a good or service Marginal Cost is the min price the producers must receive to induce them to offer one more unit of a good or service for sale. A Supply curve is a marginal cost curve. The relationship between the price of a good and the quantity supplied by one producer is called Individual Supply. The relationship between the price of a good and the quantity supplied by all producers is called Market Supply. The Market Supply Curve is the horizontal sum of the individual supply curves and is formed by adding the quantities supplied by all the producers at each price. Efficiency of Competitive Equilibrium The market demand curve for a good or service tells us the marginal social benefit from it. At equilibrium the marginal social benefit = marginal social cost. Competitive markets push the prices and quantity demanded to equilibrium points. The sum of consumer surplus and producer surplus is called Total Surplus. Market Failure occurs when a market delivers an inefficient allocation of resources. The scale of efficiency is measured by Deadweight Loss, which is the decrease in total surplus that results in an inefficient level of production. An Example of Overproduction A firm produces 15k pizzas a day, however at this quantity, consumers are only willing to pay 10$ for pizzas that cost 20$ to produce. This means that by producing the last pizza, $10 of resources are lost which reduces the total surplus to less than it‟s max. Sources of Market Failure Price and Quantity regulation Taxes and Subsidies Externalities Public Goods and common resources Monopoly High Transaction costs Price and Quantity Regulations Price regulations occur when a cap is put on something like rent or minimum wage. These can block price adjustments that the market would normally make and lead to underproduction. Quantity regulations that limit the amount that a firm is able to produce can lead to underproduction as well. Taxes & Subsidies Taxes increase the prices paid by buyers and lower the prices received by sellers. This means taxes decrease the quantity produced by sellers leading to underproduction. Subsidies – are payments by the government to producers, they decrease the prices paid by buyers and increase the prices received by sellers. As a result firms produce too much and we have overproduction Externalities A cost or benefit that affects someone other than the seller or the buyer. External costs arise when we fail to consider elements such as pollution costs. As a result we overproduce disregarding our heavy external costs. External benefit can arise when a condo owner puts a fire alarm in your neighbours apartment. As a result, you benefit from decreased fire risk. Public Goods and Common Resources A public good is a good or service that is consumed simultaneously by everyone even if they don‟t pay for it. (i.e free health care, national defense etc) Common Resources are owned by no one but available to everyone for use. For Example Atlantic Salmon  owned by nobody, so we over produce it at the cost of the well being of the species. This results in an overused resource. Monopoly Monopoly - A firm that is the sole provider of a good or service. Its goal is to maximize profits. To achieve it‟s goal of maximum profit, it produces too little and overcharges. This is an example of underproduction. High Transaction Costs Transaction costs are the costs of the services that enable a market to bring buyers and sellers together. Utilitarianism – we should strive to achieve the greatest happiness for the greatest number. It was argued that wealth should be transferred from the rich to the poor until there was a balance of marginal benefit per dollar. (the 2 millionth dollar a rich person has brings them little joy yet 1 dollar given to a bum brings them significant happiness). The problem with this approach is that is neglects to consider the effects of transaction costs. This leads to a Big tradeoff where we are torn between efficiency and fairness. The greater amount of income redistribution through income taxes, the greater the inefficiency and the smaller the economic pie is. A solution to this is to make the poorest as well off as possible. Rawls theory takes into account transfer fees and finds the most efficient ways to provide the poor with resources while not shrinking the pie. The Symmetry Principle: the requirement that people in similar situations be treated similarly. Fairness obeys 2 rules the state must enforce laws that establish and protect private property private property may be transferred from one person to another only by voluntary exchange. Chapter 6: Government Actions in Markets 11/12/2013 11:17:00 AM Government regulation that makes it illegal to charge a price higher than a specified level is called a price ceiling/price cap. If a price ceiling is set above the equilibrium price, then there is no effect Yet when the price ceiling is below the equilibrium price, there is a huge effect on the market. There is a conflict between force of law and market forces which often result in shortages. Housing Shortages When rent ceilings are put into effect below the equilibrium we experience a shortage of houses available and increased demand. This leads to more search activity, which is the time, spent looking for someone to do business with. It can also lead to a black market, which is an illegal market where the equilibrium price surpasses the imposed price ceiling. It is inefficient because the marginal social benefit is exceeding the cost meaning we will have an underproduction of housing. Labour Markets – Minimum Wage Minimum wage is a price floor applied to labour markets. At a wage rate above the equilibrium wage, there is a surplus of labour because the quantity of people willing to supply is higher than the amount of positions in demand. The demand curve measures the marginal social benefit from labour. This benefit is the value of goods and services produced. Unregulated labour markets allocate resources to the jobs in which they are valued most highly. The market is efficient. Inefficient labour markets are the product of more people willing to work for a wage than firms are willing to supply. As a result 20 million people are employed but now an extra 2 million people don‟t have jobs, which would have existed had the minimum wage not increased. Taxes Tax Incidence – the division of the burden of a tax between buyers and sellers. A tax on sellers leads to an increased cost which causes them to reduce their supply. A tax on buyers reduces demand. Regardless of who pays the tax, the outcome is the same. Demand will be reduced and so will the resulting suppy. Tax Incidence and Elasticity of Demand Perfectly inelastic demand – Buyers pay Perfectly elastic demand – sellers pay Taxes and Fairness The Benefits Principle The proposition that people should pay taxes equal to the benefits they receive from them. The Ability To Pay Principle – the proposition that people should pay taxes according to how easily they can bear the burden of the tax. (high income tax on high incomes) Production Quota’s and Subsidies A Production Quota is an upper limit to the quantity of a good that may be produced in a specified period. The effects of a Production Quota below the equilibrium quantity are Decrease in supply Rise in price Decrease in marginal cost Inefficient underproduction Incentive to cheat and overproduce A Subsidy is a payment made by the government to a producer. The effects of a subsidy are similar to the effects of a tax but they go in the opposite directions. These effects are an increase in supply a fall in price with increased quantity produced an increase in marginal cost payments by government inefficient overproduction Markets for Illegal Goods A free market for a drug – the cheaper the drug, the more bought. (think marijuana sticks in Colorado) When the drug becomes illegal, the cost of trading is increased. Larger penalties and heavy policing on both the seller and or buyer will influence the price. Penalties on Sellers – Rises the price of the drugs and decreases the quantity supplied Penalties on buyers – Lowers the price, decreases quantity supplied Penalties on both buyers and sellers – both supply and demand decrease Chapter 7: Global Markets in Action 11/12/2013 11:17:00 AM Comparative Advantage drives international trade. National Comparative advantage refers to a nations ability to produce a good or service at a lower opportunity cost than any other nation. Comparative advantages are how countries decide what they will produce (export), and what they will import. Essentially we produce what we can most efficiently and import what we produce least efficiently. i.e Canada produces fighter jets inexpensively, China produces clothes inexpensively. So we trade and all parties win. This is advantageous because we can now sell more of our products at an increased price due to a larger world market. By introducing global trade we now sell our products at a universal world price. International trade lowers the price of imported goods and raises the price of exported goods. As a result buyers of imported goods benefit from cheaper prices (think of cheaper clothing prices), and exporters get to sell their products for more! (China buys our jets for more than we would charge if we just sold them domestically). Government Regulation Governments use tariffs, import quotas, export subsidies and other import barriers to control how much we import and export. These measures are used to protect domestic suppliers. Tariff: a tax on a good that is imposed by the importing country. When a tariff is put into effect, the price of the good goes up by the amount of the tariff. This decreases demand, and takes away some of the competitive pricing benefits. $2 tariff raises price in Canada to $7 Canada imports decrease by 1 mill per year Canadian government collects the tax revenue of 2 mill a year (purple box) Winners & Losers from Tariffs Canadian Consumers Lose (have to pay more for the product) Canadian Producers Gain (Imported competition have less of a price advantage now) The consumers lose more than producers gain so we now have a Deadweight Loss! Area C and E are the deadweight loss due to the tariffs. Area D is tariff revenue claimed by the government The Consumer surplus shrinks and the producer claims area B. Import Quota’s An Import quota is a restriction that limits the max quantity of a good that may be imported in a given period. With the Quota (t-shirt supply becomes S + Quota) The price rises to $7 The quantity produced in Canada increases and the quantity bought decreases. Imports decrease Winners and Losers from Import Quota’s. Canadian consumers of t-shirts lose Canadian producers of t-shirts gain Importers of t-shirts gain and society loses because the markets are not running at max efficiency. Import quota raises the price of a t-shirt to $7 and decreases imports. Area B is transferred from consumer surplus to producer surplus. Importers profit the sum of areas D C+E is the deadweight loss. *in free trade C, E and D‟s +B would all be consumer surplus and we‟d have no deadweight loss Other import barriers are regulations such as health and safety which restrict international trade. Export subsidies are payments made by the government to a domestic producer of an exported good. They bring gains to domestic producers but often result in overproduction in the domestic economy and underproduction for the rest of the world leading to a deadweight loss. 2 Arguments against Protection The Infant Industry argument 2) The dumping argument Infant industry argument – it is important to protect a new industry from import competition allowing it to grow and compete in world markets. It has been argued that these firms would learn by doing which would not warrant protection from competition. Dumping occurs when foreign firm sells it‟s exports for a lower price than its cost of production. We cannot protect these firms because it is impossible to determine a firms costs Even if they drove out all domestic firms, new ones would pop up thus preventing a global monopoly If a global monopoly did occur, we could simply just regulate it rather than restrict it. Arguments for protection include Saving jobs, allows us to compete with cheap foreign labour, penalize lax environmental standards, prevents rich countries from exploiting developing countries. Free trades destroys some jobs but creates new better jobs. Free trade also increases foreign income and allows them to buy domestic production. Free trade allows poorer countries to acquire wealth allowing them to have enough money to take the environment into consideration. Offshore Outsourcing Hire Canadian labor and produce in Canada. Hire foreign labour and produce in another country Buy finished goods, components, or services from firms in Canada Buy finished goods, components, or services from other countries. Outsourcing: occurs when a firm in Canada buys finished goods, components or services from firms in Canada or buys finished goods, components, or services from firms in other countries. Offshoring – occurs when a firm in Canada hires foreign labour and produces in another country. Or buys goods components and or services from firms in other countries. Offshoring Outsourcing – occurs when a firm in Canada buys finished goods, components, or services from firms in other countries. Rent Seeking – lobbying and other political activity that seeks to capture the gains from trade. Chapter 8: Utility and Demand 11/12/2013 11:17:00 AM Consumption choices are broken into 2 categories Consumption Possibilities, and Preferences. Consumption Possiblities are all the things that you can afford to buy. Budget Line – shows the limits of her consumption possibilities. Utility – the benefit or satisfaction attained by consuming a good or service Total Utility – the total benefit a person gets from the consumption of goods. Generally, more consumption gives more total utility. Marginal Utility – The change in total utility that results from a one unit increase in the quantity of the good consumed. Total utility increases as more of a product is consumed however it‟s marginal utility diminishes significantly. The direct way to find the utility maximizing choice is to make a table and calculate. We want to find the just affordable combinations, the total utility for each just affordable combination, and the utility maximizing one is the consumers choice. Consumer Equilibrium occurs when someone has allocated all of their available income in the way that maximizes their total utility. In the table this occurs when total utility is at 315. To calculate the marginal utility per dollar we take the marginal utility from (movies) MU M and the price of a movie P M.We now know the marginal utility per dollar from movies is MU M P M .he same could be down with another product and you could compare the two marginal utilities per dollar to help achieve maximum utility. Utility maximizing rules Spend all available income 2) Equalize the marginal utility per dollar for all goods In Row C MU /P = MU /P P p M M This maximizes total utility. The price of one good changes the demand for another good. If the price falls for a good the consumer changes quantities consumed. In this instance the price of movies has fallen and so now Lisa is seeing more movies and drinking less pop to get her consumer equilibrium. When income increases the demand for a normal good increases (pop, movies etc). The Paradox of Value Why is water which is essential to life, far cheaper than diamonds which are not essential? We can answer this by using the concepts of total utility and marginal utility. We use so much water that the marginal utility from water consumed is very small but the total utility is huge. We buy very few diamonds so the marginal utility from diamonds is large with a small total utility. Behavioural Economics studies the ways in which limits on the human brain‟s ability to compute and implement rational decisions influences economic behaviour –both the decisions that people make and the consequences of those decisions for the way markets work. There are 3 impediments to rational choice Bounded Rationality – Rely on listening to others views‟ or gut instincts Bounded Willpower –less than perfect willpower that prevents us from making a decision that we know we will later regret Bounded Self-Interest – Suppressing our own interests to help others. The Endowment Effect – the tendency for people to value something more highly simple because they own it. (i.e owning a Volkswagon Golf ;) Chapter 10: Organizing Production 11/12/2013 11:17:00 AM A firm is an institution that hires factors of production and organizes those factors to produce and sell goods and services. A firm‟s goal is to maximize profits. If this isn‟t a firms main priority then they will either end up going under or getting taken over by a more healthy firm. Economic Profit is equal to total revenue minus total cost, with total cost measured as the opportunity cost of production. Accounting Profit on the other hand is the dollar amount. A firm‟s opportunity cost of production is the value of the best alternative use of resources that a firm uses in production. A firm‟s opportunity cost of production is the sum of the cost of using resources either A) bought in the market  firms incur an opportunity cost when it buys resources in the market. The purchasing of these resources can be considered an opportunity cost because they could have bought a different resource to create a different good or service. B) owned by the firm  firms incur an opportunity cost when it uses its own capital. This is an opportunity cost because instead of using it, they could sell it and rent capital from another firm. The implicit rental rate of capital is when a firm rents its capital from itself. This has two parts. I) Economic Depreciation – is the fall in the market price of capital at the start of the year minus the market price of capital at the end of the year. II) Forgone Interest – the funds used to buy capital could have been used for some other interest gaining purpose. C) supplied by the firm‟s owner  a firm‟s owner might supply both entrepreneurship and labour. I) Entrepreneurship – the organizing and decision making of the firm. The average profit that the firm earns through entrepreneurship is called a normal profit which is the cost of entrepreneurship which is an opportunity cost of production. II) Owner’s Labour Services – the owner might supply labour without a wage. The opportunity cost of the owner choosing to do this is the labour forgone by not taking a good alternative job. In order to maximize profits, the firm must make five decisions: 1. What to produce and in what quantities 2. How to produce 3. How to organize and compensate its managers and workers 4. How to market and price its products 5. What to produce itself and what to buy from other firms The Firm’s Constraints Technology Constraints – any method of producing a good or service. It advances over time and firms must hire more resources. Information Constraints – firms will never be able to possess full information about the present or the future therefore it is limited by not knowing buying plans and such. This will, in the end, limit profits. Market Constraints – firms are limited because they cannot predict their customers‟ willingness-to-pay and they have no say on other firm‟s marketing strategies. Efficiencies in the Firm Technological Efficiency – occurs when the firm uses the least amount of input to produce a large number of output. Economic Efficiency – occurs when the firm produces a given amount of output at the lowest cost. This depends on the relative costs of capital and labour. The difference in the two is that technological efficiency considers the quantity of input whereas economic efficiency considers the price of input. Information and Organization Command System uses a managerial hierarchy. Comman
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