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Chapter 7

Chapter 7 - Producers in the Short Run.docx

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ECON 101
Robert Gateman

7.1 What are firms? 10-30-2012 Organization of Firms  Single proprietorship – one owner-manager, personally responsible and liable  Ordinary partnership – two or more owners, personally responsible for all the partnership’s debts  Limited partnership – general partners (liable for all the firms debts) and limited partners (no part in running the business, limited liability to the amount they’ve invested in the company)  Corporation – separate entity, owners aren’t personally responsible (though directors may be) o Shares – private (not traded) vs. public (traded on stock exchanges) corporation  State owned enterprise – state-appointed board, similar organization and legal status as a corporation, aka Crown corporations  Non-profit organizations – profit goes back into the organization, revenues = sales and donations  Multinational enterprises – locations in more than one country  International trade – business transactions between different MNEs (includes different regional operations of the same corporation)  Globalization – evidenced by growing number of MNEs  Government agencies – goods and services provided to citizens who aren’t directly charged; financed through tax revenues Financing of Firms  Financial capital – money a firm raises for carrying on its business o Equity – provided by firm’s owners  Corporations gets funds from owners in exchange for stocks, shares and equities (ownership certificates)  Shareholders become owners but risk the loss of their money; gain voting rights and right to profits  Dividends – profit paid to shareholder  Retained earnings – financing investment, way to raise money, instead of distributing dividends right away; raises market value of existing shares o Debt – borrowed from outside creditors  Creditors ≠ owners  Lent money in return for some form of loan agreement  Debt instruments or bonds – carry obligation to repay the amount borrowed (principal of loan) and some form of payment (interest)  Redemption date – by when principal should be repaid  Term – time between issue of the debt and redemption date  Real capital – physical assets Goals of Firms  Assumptions: All firms are assumed to be profit-maximizers; a firm is a single, consistent decision-making unit  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.  Ignore the firm’s internal organization and its financial structure  First, study the choices open to the firm, the effect of each choice on profits. Then, predict what the firm will select (whichever is profit-maximizing). 7.2 Production, Costs and Profits 10-30-2012 Production  In order to produce, each firm needs inputs/factors of production o Inputs provided by nature – land o Inputs provided by people – labour o Inputs provided by factories, machinery and human-made aids - capital o Inputs that are outputs from some other firm  Intermediate products – all outputs that are used as inputs by other producers  Production function – relationship between the inputs used and outputs produced by a firm Q = f(L,K)  Quantity/Output is a function of labour and capital Costs and Profits  Production function – shows the maximum amount of output that can be obtained from any given amount of inputs  Profits = Revenue – Expenses o Accounting profits = Revenues – Explicit costs (costs that actually involve a purchase of goods/services, including depreciation) o Economic profit (aka pure profit) = Revenues – (Explicit costs + Implicit costs)  Implicit costs – no market transaction involved, opportunity cost (of owner’s time and owner’s capital)  OC of Time – when small, new firms spend a lot of time developing the business; ex. owner pays herself $1000 when she can be earning $4000 working for someone else  OC of Capital – financial capital tied up in a firm; what could be earned if this capital was invested/lent else where? o Economists include both implicit and explicit costs in their measurement of profits, whereas accounting profits include only explicit costs. Economic profits < accounting profits. o Possible to have positive accounting profits and zero economic profits; economists are more interested in how profits affect resource allocation o Resources are valued by the OC, costs show how much the resource would earn if used o Economic profits and losses play a crucial signaling role in the workings of a free-market system.  Economic profits in an industry are the signal that resources an profitably be moved into that industry. Profit Maximizing Output  Π = TR –TC  What happens to profits as output varies depends on what happens to both revenues and costs  Costs and revenues are combined to see find the profit-maximizing choices Time Horizons for Decision Making  Short run – how best to use existing capital o Fixed factors (capital = plant, equipment) cannot be changed o Variable factors  Long run – what new capital and production processes to select o All inputs may be varied given the technological possibilities o Expand scale of operations, branch out into new products, change method of production = Planning Decisions o Able to choose from a variety of production processes  Very long run – development of new technological techniques o New and improved products and production methods o Innovation and improvement o Technology is varied 7.3 Production in the Short Run 10-30-2012  Fixed factors – machinery and equipment  Variable inputs – intermediate inputs and labour services  How output changes as the firm varies its amount of labour Total, Average and Marginal Products  Total product – total amount that is produced; changes as more or less of th
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