Economics 1021A Chapter 10 20131103
A firm is an institution that hires factors of production and organizes them to produce and sell goods and
A firm’s goal is to maximize profit.
Profit equals total revenue minus total cost.
If the firm fails to maximize its profit, the firm is either eliminated or taken over by another firm that seeks to
Accountants measure a firm’s profit to ensure that the firm pays the correct amount of tax and to show its
investors how their funds are being used.
Economists measure a firm’s profit to enable them to predict the firm’s decisions, and the goal of these
decisions is to maximize economic profit.
Economic profit is equal to total revenue minus total cost, with total cost measured as the opportunity
cost of production.
A firm’s opportunity cost of production is the value of the best alternative use of the resources that a firm
uses in production.
A firm’s opportunity cost of production is the sum of the cost of using resources:
Bought in the market
The amount spent by a firm on resources bought in the market is an opportunity cost of production because
the firm could have bought different resources to produce some other good or service.
Owned by the firm
If the firm owns capital and uses it to produce its output, then the firm incurs an opportunity cost, because it
could have sold the capital and rented capital from another firm.
The firm implicitly rents the capital from itself.
The firm’s opportunity cost of using the capital it owns is called the implicit rental rate of capital.
The implicit rental rate of capital is made up of
Economic depreciation is the change in the market value of capital over a given period.
Interest forgone is the return on the funds used to acquire the capital.
Supplied by the firm's owner
The owner might supply both entrepreneurship and labour.
The profit that an entrepreneur can expect to receiveon average is called normal profit.
Normal profit is the cost of entrepreneurship and is an opportunity cost of production. In addition to supplying entrepreneurship, the owner might supply labour but not take a wage.
The opportunity cost of the owner’s labour is the wage income forgone by not taking the best alternative
Economic profit equals a firm’s total revenue minus its total opportunity cost of production.
To maximize profit, a firm must make five basic decisions:
What to produce and in what quantities
How to produce
How to organize and compensate its managers and workers
How to market and price its products
What to produce itself and what to buy from other firms
The firm’s profit is limited by three features of the environment:
Technology is any method of producing a good or service.
Using the available technology, the firm can produce more only if it hires more resources, which will
increase its costs and limit the profit of additional output.