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Chapter 10

Economics Chapter 10 Organizing Production.docx

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ECON 1050
Eveline Adomait

Chapter 10 Organizing Production Firm- an institution that hires factors of production and organizes those factors to produce and sell goods and services A firms goal is to maximize profit Depreciation- the fall in the value of a firm’s capital Economic profit- equal to total revenue minus total cost, with total cost measured as the opportunity cost of production Opportunity cost of production- the value of real alteratives forgone, expressed in $ - the sum of the cost of using resources bought in the market, owned by the firm and supplied by the firm’s owner o Resources bought in the market- opportunity cost of production because the firm could have bought different resources to produce some other good or service o Resources owned by the firm- opportunity cost because it uses its own capital, which means it implicitly rents from itself Implicit rental rate of capital is composed of the economic depreciation and forgone interest. Economic Depreciation: the fall in the market value of a firm’s capital over the year: the market price of the capital at the start of the year minus the market price of capital at the end of the year Forgone Interest: the funds used to buy capital could’ve been used for other purposes, and they would’ve earned interest in their next best use- this forgone interest is an opportunity cost of production o Resources supplied by the firm’s owner Entrepreneurship: organizes a firm an makes its decisions Normal profit is the cost of entrepreneurship and is an opportunity cost of profit, it’s how much profit the entrepreneur earns on average Owner’s labour services: the owner of a firm might supply labour but not talk a way, the opportunity cost of the owner’s labour is the wage forgone by not taking the best alternative job Decisions- to achieve the objective of maximum economic profit there are 5 decisions that must be made 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 buy from others Firm’s Constraints- three features of a firms environment limit the max economic profit it can make: - technology constraints o technology is any method of producing a good or service. - information constraints- limited information about the quality and efforts of its workforce, the current and future buying plans of its customers, the plans of its competitors - market constraints- the quantity each firm can sell and the price it can obtain are constrained by its customers’ willingness to pay and by the prices and market efforts of other firms Technology and Economic Efficiency Technological efficiency occurs when the 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 cost Each firm organizes production of goods/ services by combining and coordinating productive resources it hires. Use a mixture of command and incentive systmes. Command systems: a method of organizing productin that uses a managerial hierarchy. Commands pass downward thru the hierarchy, info passes up. Incentive systems: a method of organizing production that uses a market-like mechanism inside the firm. Senior managers create compensation schemes to induce workers to perform in ways the maximize the firm’s profit Principal-agent problem: problem of devising compensation rules that induce an agent to act in the best internet of a principal. - each principal must create incentives that induce each agent to work in the interest of the principal. - Three ways of coping with the principal-agent problem are ownership, incentive pay, and long-term contracts Ownership: by assigning ownership of a business to managers or workers, it is sometimes possible to induce a job performance that increases a firm’s profits Incentive pay: pay related to performance, based on a variet of performance criteria Long-term contracts: tie the l
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