1. Ch. 10: ORGANIZING PRODUCTION
Definition of a firm
The economic problems that firms face
Technological vs. economic efficiency
Different types of markets in which firms operate

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

3. Accounting vs Economic Profits
Accounting profits
IRS or Financial Accounting Standards Board rules
Goals
report profit so that the firm pays the correct amount of tax
Truthful representation of financial situation
Economic profits
Measured based on an opportunity cost measure of cost.
Primary difference between accounting and economic profits is in measurement of costs.

4. Opportunity Cost
A firm’s opportunity cost of producing a good is the best forgone alternative use of its factors of production, usually measured in dollars.
Opportunity cost of production includes
Explicit costs
costs paid directly in money
Implicit costs
Opportunity cost of owner’s resources for which no direct money payment is made.

5. Cost of capital can be explicit or implicit
The firm can rent its capital and pay an explicit rental rate
The firm can buy capital and incur an implicit opportunity cost of using its own capital (implicit rental rate) which includes
Economic depreciation
change in market value of capital over a given period.
Differs from accounting depreciation.
Interest forgone
foregone interest on the funds used to acquire the capital.

6. Economic vs. Accounting Profit
Accounting Profit = TR – Explicit Costs
Economic Profit = TR – Opportunity Costs of production
= TR – Expl. Costs – Impl. Costs
= Acc. Profits – Implicit Costs
If Economic Profit > 0  Acc Profits > Implicit Costs  Firms enter
If Economic Profit < 0  Acc Profits < Implicit Costs  Firms exit

7. Technological vs. Economic Efficiency
Technological efficiency
occurs when a firm produces a given level of output by using the least amount of inputs.
may be different combinations of inputs that achieve technological efficiency
Economic efficiency
occurs when the firm produces a given level of output at the least cost.
economically efficient method depends on the relative costs of capital and labor

8. Information and Organization
3 Types of Business Organization
Proprietorship
Partnership
Corporation

9. Information and Organization
Proprietorship
single owner
unlimited liability
proprietor makes management decisions and receives the firm’s profit.
profits are taxed the same as the owner’s other income.

10. Information and Organization
Partnership
two or more owners
unlimited liability.
partners must agree on a management structure and how to divide up the profits.
profits are taxed as the personal income of the owners.

11. Information and Organization
Corporation
owned by one or more stockholders
limited liability
Profits are taxed twice
corporate tax on firm profits
income taxes paid by stockholders on dividends.

12. Pros and Cons of Different Types of Firms
Proprietorships
Easy to set up
Managerial decision making is simple
Profits are taxed only once
The owner’s entire wealth is at stake
The firm dies with the owner
The cost of capital and labor can be high

13. Pros and Cons of Different Types of Firms
Partnerships
Easy to set up
Employ diversified decision-making processes
Can survive the death or withdrawal of a partner
Profits are taxed only once
partnerships make attaining a consensus about managerial decisions difficult
Place the owners’ entire wealth at risk
The cost of capital can be high, and the withdrawal of a partner might create a capital shortage

14. Pros and Cons of Different Types of Firms
Corporations
Perpetual life
Easy to dissolve
Limited liability
Large-scale and low-cost access to financial capital
Slower and expensive decision-making
Profits taxed

15. Information and Organization
# of proprietorships vs. share of revenue?
Why does type of organization differ across industries?

16. Types of Markets Perfect competition Monopolistic competition
Oligopoly
Monopoly

17. Perfect competition Many firms Homogeneous products
No single firm can control price
Many buyers
No restrictions on entry of new firms to the industry
Both firms and buyers are all well informed of the prices and products of all firms in the industry.
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18. Monopolistic competition
Many firms
Product differentiation
Each firm possesses an element of market power (i.e. can control price)
No restrictions on entry of new firms to the industry

19. Oligopoly A small number of firms compete
The firms might produce homogeneous or differentiated products
Barriers to entry limit entry into the market.
Firms anticipate how other firms will respond to a change in price, quality, or advertising.

20. Monopoly One firm produces the entire output of the industry
There are no close substitutes for the product
There are barriers to entry that protect the firm from competition by entering firms

21. Measures of Concentration
The four-firm concentration ratio
Sum of market shares for 4 largest firms.
The Herfindahl–Hirschman index (HHI)
Sum of squared market shares for all firms.
DOJ uses the HHI to classify markets.
HHI<1,000  highly competitive
1000<HHI<1800 moderately competitive
HHI>1800  not competitive (oligopoly, monopoly)
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22. Measures of Concentration
4 firm CR and HHI for various industries in the United States.

23. Measures of Concentration
Limitations of Concentration Measures as measures of competition.
Geographic boundaries
Product boundaries.
Barriers to Entry
Ability to Collude

24. Markets and the Competitive Environment
The economy is mainly competitive.
Has become more competitive over time

25. Markets and Firms Why Firms?
Firms coordinate production when they can do so more efficiently than a market.
4 reasons firms could be more efficient than market
Lower transactions costs
Economies of scale
Economies of scope
Principal-Agent problem can make firms less efficient.