Microeconomics Chapter 21: Rents, Profits, and the Financial Environment of Business

Payment made to the owner of a resource; that is opportunity cost- the minimum payment that would be necessary to call forth production of that amount (and quality) of the resource

The term "rent" was used to designate payment for the use of land

1. Assumes all land is equally productive
2. Assumes quantity of land is fixed- so land's opportunity cost is 0
3. Graphically draw supply curve vertically (zero price elasticity)

Was thought to be a vertical line; deeming it inelastic in that no matter the market price, the quantity of land supplied would remain the same

The equilibrium price will rise, the quantity of land remains insensitive to change in price (hardly or does not shift) and, demand line shifts to the right

The quantity of land remains insensitive to change in price making the supply curve perfectly inelastic

Not only land and and natural resources; is more often applicable to labor: movie stars, models, sports superstars etc.

Specific resources cannot be replicated exactly

Allocates resources to their highest valued use; it directs resources to the people who can use them most efficiently

An organization that brings together factors of production- labor, land, physical capital, human capital, and entrepreneurial skills- to produce a product or service in hopes to sell at a profit

Entrepreneur, managers, and workers

The leftover after all expense are paid that the entrepreneur receives

The most common form of business organization; owned by one individual, makes all the decisions, earns all the profits, and is legally responsible for all debts of the firm; smaller business

Easy to form and dissolve; all decision making power lies with the sole-proprietor; (no partners or shareholders); profit is only taxed once as the net income of the sole proprietor

Proprietor faces unlimited liability for the debts of the firm; lenders are reluctant to lend sums; they end with the death of the proprietor

The second most important business organization; owned or shared by two or more; tend to be larger in business; shared responsibility of profits and are all legally responsible for debts of the company

Easy to form; help limit cost of job performance monitoring; permits more effective specialization in occupations; subject only to personal taxation as the income is treated a personal

Partners each have unlimited liability; (personal assets of each partner are at risk); decision making is more costly; dissolution of the co. occurs if a partner dies or withdraws

A legal entity that may conduct business in its own name just as an individual does; the owners are called shareholders; Shareholders have limited liability; account for fewer than 20% of firms in US; responsible for over 80% of all business revenues in the US

Owners have limited liability; limited to the value of their shares; the corporation continues to exist if an owner is no longer an owner; in position to raise large sums for financial capital;

Corporate income is subject to double taxation; corporation profits 1st, then, any after tax profits such as dividends as they are treated as personal income; subject to problems associated with separation of ownership and control

Accounting Profit = Total Revenues - Explicit Cost

Known as accounting profit; appropriate when used by accountants to determine a firm's taxable income

Expenses that must be paid out by the firm

Expenses that managers do not have to pay out of pocket but are costs to the firm as they represent an opportunity cost; they do not involve any direct cash outlay therefore must be measured as the opportunity cost principle

They are measured by what the resources (land, capital) currently used in producing a good or service could earn in other uses

The opportunity cost of using factors that a producer does not buy or hire but already owns

Accounting profits formula considers total revenue and explicit costs only; whereas Economic profits considers total revenues, explicit and implicit costs

Income the entrepreneur's earn, over and above all costs, including their own opportunity cost of time, plus, the opportunity cost of capital they have invested in their business

Regarded as total revenues-total opportunity costs; but we must now include all costs

Economic Profits = Total Revenue- (Explicit Costs + Implicit Costs)

The price paid by debtors to creditors for the use of loanable funds; payment for obtaining credit; payment for the current rather than the future command over resources

Rate expressed as percentage of a loan calculate on an annual basis

In the business sector; interest allocates funds to different firms and businesses and therefore to different investment projects.

An investment, or project, with a rate of return will higher than the market rate of interest in the market, will be undertaken, given loanable funds.
The rate of return for an investment must be at or exceed the current market rate of interest for loanable funds to be provided.

The value of a future amount expressed in today's dollars: the most that someone would pay today to receive a certain sum in the future

What sum must I put aside today at the market interest rate of 5% to receive $105 a year from now?

(1+.05)PV1 = $105

PV1 = $105/1.05 = $100

PV1 = FV1/ 1 + i

How much would have to be put in the same savings account today, to have $105 two years from now if the account pays a rate of 5% per year compounded annually?

After one year, the sum would have to be set aside, call this PV2, would have grown to PV2 x 1.05

The amount during the second year would increase to:
PV2 x 1.05 x 1.05 or PV2 x (1.05)^2

PV2 x (1.05)^2 = $105

Solved: PV2 = $105/ (1.05)^2 = $95.24

A legal claim to the share of the corporation's future profits: common and preferred

A legal claim against the firm entitling the owner of the bond to a fixed annual coupon payment, plus a lump sum payment at the maturity of the bond date; are issued in return for funds lent to the firm

Occurs when the firm uses some of its own profits to purchase new capital equipment rather than paying the profits out as dividends to its shareholders; primary means of financing for existing firms