Theory of a Firm

1,950 views
1,869 views

Published on

Published in: News & Politics, Business
0 Comments
5 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total views
1,950
On SlideShare
0
From Embeds
0
Number of Embeds
47
Actions
Shares
0
Downloads
0
Comments
0
Likes
5
Embeds 0
No embeds

No notes for slide

Theory of a Firm

  1. 1. The U.S. Economic Meltdown
  2. 2. Chapter 7 Production, Firms, and the Market
  3. 3. Theory of the Firm <ul><li>What is a firm? </li></ul><ul><li>Entities that use scarce resources to produce goods and services which are (hopefully) demanded by consumers. </li></ul><ul><li>What are the origins of the firm? </li></ul><ul><li>Began with trading and the utilization of money. Moved to division of labour. </li></ul><ul><li>What is the goal/role of the firm? </li></ul><ul><li>Goal = To Create Profit </li></ul><ul><li>Role = To Create Goods and Services </li></ul>
  4. 4. Theory of the Firm <ul><li>The Importance of Profit </li></ul><ul><li>Most decisions take into account the bottom line. </li></ul><ul><li>This indicates if a firm can stay in business. </li></ul><ul><li>Most firms attempt to maximize profit. </li></ul>
  5. 5. Theory of the Firm <ul><li>The Benefits of Profit </li></ul><ul><li>Incentive or reward for hard work and risks. </li></ul><ul><li>Least expensive form of money to expand or grow. </li></ul><ul><li>Evaluate and compare themselves. </li></ul><ul><li>Indicates which areas are most effective. </li></ul><ul><li>Public Corporations can pay dividends. </li></ul>
  6. 6. Theory of the Firm <ul><li>Accounting Profit </li></ul><ul><li>Usually what we think of </li></ul><ul><li>(Total Revenue – Total Costs) </li></ul><ul><li>(Total Revenue – Explicit Costs) </li></ul><ul><li>Explicit Costs = Payments for resources (wages, suppliers, bank loans, etc) </li></ul><ul><li>Economic Profit </li></ul><ul><li>Total Revenue – Total Costs </li></ul><ul><li>(including opportunity cost) </li></ul><ul><li>(Total Revenue – Explicit and Implicit Costs </li></ul><ul><li>Implicit Costs = The cost of the forgone alternative </li></ul><ul><li>Example: </li></ul><ul><li>OC- Owners time (salary forgone) </li></ul><ul><li>OC – Owners money (interest forgone) </li></ul><ul><li>OC – Owners land (rent forgone) </li></ul>
  7. 7. Rocky’s Mountain Bikes’ <ul><li>Rocky Sold $150,000 worth of bikes during the year. The Wholesale cost was $50,000. Utilities and other services were $10,000. Rocky also paid $8,000 in interest to the bank. </li></ul><ul><li>At the beginning of the year Rocky was offered a job to work elsewhere for $40,000 put he declined. He was also asked to rent his shop for $2,000 a month, but he refused. </li></ul><ul><li>What is the Accounting Profit? </li></ul><ul><li>What is the Economic Profit? </li></ul>
  8. 8. Theory of the Firm <ul><li>To understand how firms make decisions we must know the relationship between </li></ul><ul><li>PROTITS, REVENUES, COSTS </li></ul><ul><li>(THEORY OF THE FIRM) </li></ul>
  9. 9. Theory of the Firm <ul><li>Total Profit = Total Revenue –Total Cost </li></ul><ul><li>Total Revenue = Money received from sales. Influenced by 2 factors. The decided price and the quantity you can sell @ that price. </li></ul><ul><li>TP = (Price x Quantity) - TC </li></ul>
  10. 10. Theory of the Firm <ul><li>Total Cost: to be profitable firms must manage costs. </li></ul><ul><li>Fixed Costs: Remain the same @ all levels of output. They must be paid whether or not the firm produces. Overhead costs </li></ul><ul><li>Variable Costs: Change with the level of production. </li></ul><ul><li>Total Costs = (FC + VC) </li></ul>
  11. 11. Theory of the Firm <ul><li>COSTS (Which are Variable and Fixed?) </li></ul><ul><li>Rent Labour </li></ul><ul><li>Fuel Property Tax Insurance Premiums Power </li></ul><ul><li>Raw Materials Interest on Loans </li></ul>
  12. 12. Theory of the Firm <ul><li>COSTS </li></ul><ul><li>Fixed Costs Variable Costs </li></ul><ul><li>Rent Labour </li></ul><ul><li>Property Tax Fuel </li></ul><ul><li>Insurance Premiums Raw Materials </li></ul><ul><li>Interest on Loan Power </li></ul>
  13. 13. Theory of the Firm <ul><li>Therefore: </li></ul><ul><li>Total Profit = (P x Q) – (FC + VC) </li></ul>
  14. 14. Short Run vs. Long Run <ul><li>Economists consider two different time periods when assessing the overall costs of a business. </li></ul><ul><li>Short Run: Period over which the firm’s max capacity becomes fixed due to a shortage of one resource. </li></ul><ul><li>Long Run: Period when all costs become variable. Firm is able to adjust all factors of production. </li></ul>
  15. 15. Example <ul><li>The Demand for hockey sticks has greatly increased. </li></ul><ul><li>The following are needed: </li></ul><ul><li>Raw materials, Labour, Machinery, Factory </li></ul><ul><li>In the short term raw materials and labour can be easily increased. </li></ul><ul><li>In the short run we cannot add another factory (fixed), but in the long run all inputs are variable, including factory space. </li></ul>
  16. 16. Marginal Revenue Marginal Cost <ul><li>Economists try to determine the production level that will result in the most profit. </li></ul><ul><li>To maximize profit firms must produce up to the point at which there is no added benefit (profit) from producing one more. </li></ul><ul><li>Must produce where MR=MC. </li></ul>
  17. 17. Marginal Revenue Marginal Cost <ul><li>MR= Additional revenue from one additional unit’s sale. </li></ul><ul><li>MC = Additional cost from producing one more unit. </li></ul><ul><li>Average Cost Per Unit = Total Cost/Total Output. </li></ul>
  18. 18. Marginal Cost Marginal Revenue $35 $185 $100 $200 2 $30 $150 $100 $100 1 - $120 - $0 0 Marginal Cost Total Cost Marginal Rev Total Rev Units Sold
  19. 19. Marginal Revenue Marginal Cost <ul><li>Economies of Scale refers to the greater efficiency that some firms can achieve when they produce a large amount of output </li></ul><ul><li>Law of diminishing returns is the eventual decline in the rate of extra output. </li></ul>
  20. 20. Controlling the Costs of Production <ul><li>Instead of attempting to control revenue firms tend to focus their efforts on controlling costs of production. </li></ul><ul><li>Productivity = maximizing the output from the resources used. </li></ul><ul><li>Efficiency = producing at the lowest possible cost. </li></ul>
  21. 21. Controlling the Costs of Production <ul><li>Output per worker is the most common measure of productivity. </li></ul><ul><li>Factors that influence productivity: skills, education, experience, quantity and quality of resources, </li></ul><ul><li>When a firm improves productivity it can produce more goods and services for the same costs. </li></ul>
  22. 22. Controlling the Costs of Production <ul><li>Cost per unit produced and unit labour cost are the most common measures of efficiency when applied to either a firm or an economy. </li></ul><ul><li>Cost per unit takes into account all costs entailed in creating a product. </li></ul><ul><li>Unit labour cost measures only the cost of labour involved in producing one unit. </li></ul>
  23. 24. Choosing Production Methods <ul><li>Cost per unit produced and unit labour cost are the most common measures of efficiency when applied to either a firm or an economy. </li></ul><ul><li>Cost per unit takes into account all costs entailed in creating a product. </li></ul><ul><li>Unit labour cost measures only the cost of labour involved in producing one unit. </li></ul>

×