Lecture9_Ch10_Organizing_Production

PowerPoint Presentation: 

CHAPTER 10 Organizing Production October 20, 2011

Objectives: 

Objectives Explain what a firm is and describe the economic problems that all firms face. Explain firm’s goals, profit, costs and distinguish between technological efficiency and economic efficiency.

The Firm and Its Economic Problem: 

The Firm and Its Economic Problem A firm is an institution that hires factors of production and organizes them to produce and sell goods and services. The Firm’s Goal A firm’s goal is to maximize profit. If the firm fails to maximize profits it is either eliminated or bought out by other firms seeking to maximize profit.

The Firm and Its Economic Problem: 

The Firm and Its Economic Problem Measuring a Firm’s Profit Accountants measure a firm’s profit using rules laid down by the IRS and the Financial Accounting Standards Board. Their goal is to report profit so that the firm pays the correct amount of tax and is open and honest about its financial situation with its bank and other lenders. Economists measure profit based on an opportunity cost measurement. Economic profit equals a firm’s total revenue minus its opportunity cost of production.

Opportunity Cost : 

Opportunity Cost Opportunity cost of any action is the highest valued alternative forgone. For the firm, the opportunity cost of producing a good is the value of the firm’s best alternative use of its resources (factors of production), usually measured in dollars.

Opportunity Cost : 

Opportunity Cost Opportunity cost is a real alternative forgone and includes both: Explicit costs and Implicit costs. Explicit costs: are costs paid directly in money. The amount paid for a resource that could have spent on something else (opportunity cost of using the resource) Implicit costs: are costs incurred when a firm forgoes an alternative action but does not make a direct money payment. Firms incur implicit costs when it Uses its own capital Uses its owner’s time or financial resources

Opportunity Cost : 

Opportunity Cost Example: Capital and Opportunity Costs Explicit Cost: The firm can rent capital and pay an explicit rental cost reflecting the opportunity cost of using the capital. Implicit Cost: The firm can use its own capital—implicit cost– because the firm could rent the capital to another firm and get a rental income. So the rental income forgone is an opportunity cost and it is called the implicit rental rate of capital.

Opportunity Cost : 

Opportunity Cost The implicit rental rate of capital is made up of: Economic depreciation Economic depreciation is the change in the market value of capital over a given period. Interest forgone Interest forgone is the return on the funds used to acquire the capital. The funds that buys capital could have been used for some other purpose—an interest income.

Opportunity Cost : 

Opportunity Cost Cost of Owner’s Resources: is his or her entrepreneurial ability—organizing the business, making business decisions, innovations, taking the risk of running the business,etc.. The return to entrepreneurship is profit and the return that an entrepreneur can expect to receive on average is called normal profit . Normal profit is part of firm’s opportunity cost because it is the cost of a forgone alternative--running another firm.

Opportunity Cost: 

Opportunity Cost The owner of the firm can also supply labor in addition to entrepreneurship. The return to labor is a wage. The opportunity cost of the owner’s time spent working for the firm is the wage income forgone by not working in the next best alternative job.

Economic Profit : 

Economic Profit Economic Profit Economic profit equals a firm’s total revenue minus its opportunity cost of production. A firm’s opportunity cost of production is the sum of the explicit costs and implicit costs. Normal profit is part of the firm’s opportunity costs, so economic profit is profit over and above normal profit.

The Firm and Its Economic Problem: 

The Firm and Its Economic Problem Economic Accounting: To maximize profit, a firm must make five basic decisions: What goods and services to produce and in what quantities How to produce—the production technology to use 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

Technology and Economic Efficiency: 

Technology and Economic Efficiency Two concepts of production efficiency: Technological Efficiency Economic Efficiency Technological Efficiency : occurs when a firm produces a given level of output by using the least amount inputs. There may be different combinations of inputs to use for producing a given level of output.

Technology and Economic Efficiency: 

Technology and Economic Efficiency Economic Efficiency: occurs when the firm produces a given level of output at the least cost. It depends on the relative costs of capital and labor. The difference between technological and economic efficiency is that technological efficiency concerns the quantity of inputs used in production for a given level of output, whereas economic efficiency concerns the cost of the inputs used.

Technology and Economic Efficiency: 

Technology and Economic Efficiency An economically efficient production process also is technologically efficient. A technologically efficient process may not be economically efficient. Changes in the input prices influence the value of the inputs, but not the technological process for using them in production. Firms that is not economically efficient does not maximize profit Inefficient firms go out of business or are taken over by firms with lower costs.