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.
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
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
Not all production in the economy takes place within firms (governments
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:
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.
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
Carry an obligation to make some form of payment to
the lender (interest).
Redemption date: the time at which the principal is to be
Term: the amount of time between the issue of the debt and its
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.
Inputs that are provided directly from nature.
Inputs that are provided directly by people (i.e. labour).
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
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