Business organization and behavior PRODUCER Business organization and behavior

Forms of business organization an individual proprietorship – a business owned by an individual, who is fully entitled to the profit earned by the business and fully responsible for any losses the business incurs A partnership a business jointly owned by two or more people who share its profit. All owners, or partners are jointly responsible for any losses the business incurs A corporation is an organization legally permitted to carry on certain activities, such as running a railroad or producing a newspaper. The owners of corporation are liable only for their investment in the corporation, even if these are not sufficient to cover the losses it incurs. Ownership of corporation divided among its shareholders

Profit maximization Owners of all forms of business want the firms maximize profits the assumption that business maximizes profit subject to two criticisms: 1. business decisions complex and often are made on the basis of little information 2. a large number of shareholders cannot effectively control corporate management. Managers free to pursue their own goals

Do business maximize? Profit maximization an outcome of competition process Other than profit maximization goals: the size of the firm (managers’ salaries usually higher the larger the firm); blocking an attempt to take over badly run firm by an outsider How to motivate managers to maximize profit? Bonus schemes increasing their salaries, payment in part with stock in the company But generally managers who do not serve shareholder interests are less likely to retain their jobs than are those who do

Firm’s social objectives Business social responsibility: donations to charity, providing funds for public TV or act in other philanthropic ways Are this actions benefitting shareholders? Indirect method to increase profits Some theories claim: business more like citizens than profit maximizing machines

Some definitions Revenue: amount firm receives from the sale goods and services during a certain period Costs: the expenses of producing goods and services sold during this period Profit (net income): the excess of revenue over costs

The income statement revenue $ 1.000 000 Minus expenses (or costs) Wages paid to people rented out $ 700.000 Newspaper advertising $ 50.000 Office rent $ 45.000 Wages for office workers $ 80.000 Other office expences $ 17.000 Depreciation on typewriters $ 3.000 Interest on bank loan $ 900.000 Net income (profit before tax) $ 100.000 Corporate income tax $ 20.000 Profit after tax

The Balance Sheet assets liabilities cash $ 40.000 Accounts payable $ 90.000 $ 70.000 Salaries payable $ 50.000 inventories $ 100.000 Mortage from insurance company $ 150.000 Factory building $ 200.000 Loan from the bank $ 60.000 equipment Total liabilities $ 350.000 Original cost - depreciation $ 300.000- $ 120.000 $ 180.000 Net worth $ 240.000 Total assets $ 590.000 Total liabilities and net worth

Accounting and market value Intangible assets - assets that do not appear on its balance sheet, ignored by accountants: skills of employees and their ability to work, good prospects for future growth; reputation with customers and suppliers the company could be sold for more than its net worth

Accounting cost and opportunity cost The accounting costs on income statement omit real economic cost of doing business Accounting profit>economic profit Accountants focus on costs that can be easily measured; for an economists – opportunity cost is important Opportunity cost of using of any resource: the amount that could have been earned by putting that resource to its best alternative use examples: opportunity cost of owners labor, opportunity cost of the owners financial capital

Technical and economic efficiency Method of production is „technical” efficient if: 1. there is no other method that uses less of at least one input and no more of any other output to produce a given level of output; or 2. the output is the maximum possible using the specified amounts of inputs Both say: no waste The economically efficient method – method that minimizes the opportunity cost of the inputs; all costs considered

Production in the short run The total product curve: the relationship between the input of variable factor and the resulting level of output produced The marginal product of any variable factor: addition to the output obtained by employing an additional unit of that factor The law of diminishing returns: if the quantities of some factors are fixed, the marginal product of any variable factor will, beyond some level of input, decline as the input of that factor is increased

Total and marginal products of labour Labour input (number of workers) Total product Marginal product of labour 1 0.8 2 1.8 1.0 3 3.1 1.3 4 4.3 1.2 5 5.4 1.1 6 6.3 0.9 7 0.7 8 7.5 0.5 9 7.8 0.3

The law of diminishing returns If the quantities of some factors are fixed, the marginal productivity of any variable factor (labor) will, beyond some level of output , decline as the input of that factor is increased The total cost curve becomes steeper as diminishing returns set in

Different types of cost Fixed and variable costs: total costs (TC)=fixed costs (FC) + variable costs (VC) Fixed costs that can not be avoided even by going out of business – sunk costs (investment in specialized equipment Average variable cost AVC = VC/output Average fixed costs AFC = AFX/output Average total costs ATC = TC/output Marginal costs MC = ∆TC/∆ output

Output and costs in „Global Production” Labor input (the cost of each unit labor= $200) Fixed cost (FC) Variable costs (VC) Total cost (TC) Marginal cost (MC) 500 1 1.7 340 840 2 2.8 560 1060 220 3 3.6 720 1220 160 4 4.5 900 1400 180 5 5.6 1120 1620 6 7.0 1900 280 7 8.9 1780 2280 380

Average and marginal costs output FC AFC VC AVC TC ATC MC 500 - 1 340 840 2 250 560 280 1060 530 220 3 167 720 240 1220 407 160 4 125 900 225 1400 350 180 5 100 1120 224 1620 324 6 83 233 1900 317 7 71 1780 254 2280 326 380

Average and Marginal costs Average costs (AC) increases when marginal costs (MC) higher than AC Average costs (AC) diminishes when marginal costs (MC) lower than AC Show that on the graph

Production and costs in the long run The long run average costs curve (LAC) shows the lowest cost of producing any given level of output, allowing all factors of production to vary optimally to minimize costs Very large firms experience economies and diseconomies of scale Diseconomies of scale: workers become less motivated communication inside the firm becomes slower Economies of scale (internal): 1. purchasing and selling more efficient, 2. financing less costly, 3. managerial experts in every area , 4. the best technology and equipment affordable , 5. marketing costs spread over large output External economies of scale: benefits of the industry growth

The long-run average cost curve

diseconomies of scale Management more difficult as firm becomes larger The localization of new companies worse: higher transport costs, higher costs of raw materials exploitation Minimum efficient scale (MES) different in different industries

Revenue, costs and profits Output Price Total revenue Total cost Profit Marginal revenue Marginal cost 1 25 10 15 21 13 2 23 46 14 3 20 60 38 22 12 17 4 18 72 55 5 75 6 12.5 98 -23