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ECO101H1 (177)
Chapter 7

ECO100Y1 Chapter 7 Notes

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Robert Gazzale

ECO100Y1 Textbook Notes Chapter 7 7.1 What are Firms?  A firm can be organized in several ways: o Single Proprietorship  Has one owner-manager who is personally responsible for all aspects of the business, including its debts. o Ordinary Partnership  Has two or more joint owners, each of whom is personally responsible for all the partnership’s debts. o Limited Partnership  Provides 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. o Corporation  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.  Private corporation: stocks are not traded on any stock exchange.  Public corporation: stocks are traded on stock exchanges. o State-Owned Enterprise  Owned by the government but is usually under the direction of a more or less independent, state-appointed board.  The organization and legal status of a state-owned enterprise are similar to those of a corporation.  Called Crown corporations in Canada. o Non-Profit Organizations  Established with the explicit objective of providing goods or services to customers but having any profits that are generated remain with the organization and not claimed by individuals.  Multinational Enterprises (MNEs): firms that have operations in more than one country.  Not all production in the economy takes place within firms (governments provide services/goods).  Financial capital: the money a firm raises for carrying on its business.  Real capital: the firm’s physical assets.  Basic types of financial capital are: o Equity  The funds provided by the owners of the firm.  Dividends: profits paid out to shareholders of a corporation.  Retained earnings: reinvesting current profits, which adds to the value of the firm and raises the market value of existing shares, instead of paying them out to shareholders. o Debt  The funds borrowed from creditors outside the firm.  Debt instruments (bonds): loan agreements.  Two characteristics are common amongst all debt instruments:  Carry an obligation to repay the amount borrowed (principal).  Carry an obligation to make some form of payment to the lender (interest).  Redemption date: the time at which the principal is to be repaid.  Term: the amount of time between the issue of the debt and its redemption date.  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  Inputs can be classified into: o Intermediate Products  Inputs that are outputs from some other firm. o Land  Inputs that are provided directly from nature. o Labour  Inputs that are provided directly by people (i.e. labour). o Capital  Human-made aids to production (i.e. machines).  Production function: a functional relation showing the maximum output that can be produced by any given combination of inputs. = Q = flow of output L = flow of labour services K = 𝑓𝑙𝑜𝑤 𝑜𝑓 𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑠𝑒𝑟𝑣𝑖𝑐𝑒𝑠 f = the production function itself  Profits: are obtained by taking the revenue earned from selling their output and subtracting all the costs associated with their inputs. = =  Explicit costs include wages, rental of equipment, interest payments on debt etc.  Implicit costs: items for which there is no market transaction but for which there is still an opportunity cost for the firm that should be included in the complete measure of costs. o Two most important are:  Opportunity cost of the owner’s time  Owners spend tremendous amounts of time improving the business and often pay themselves less than they could earn if they were instead
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