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Firm
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an entity concerned with the purchase and employment of resources in the production of various goods and services
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1. Sole Proprietorship
2. Partnership
3. Corporation
2. Partnership
3. Corporation
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forms of business organizations
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Sole Proprietorship
answer
easy to setup and organize viz. partnership and corporation
all profits and all costs assumed by the owner
unlimited liability
all profits and all costs assumed by the owner
unlimited liability
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Partnership
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less legal expense and paperwork viz. corporation; greater specialization possible
partnership is dissolved when partner dies
unlimited liability
partnership is dissolved when partner dies
unlimited liability
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Corporation
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most dominant form of business enterprise
most effective for raising financial capital
when any of its owners dies, corporation is not dissolved
substantial legal expense in setting up
principal-agent problem may occur
most effective for raising financial capital
when any of its owners dies, corporation is not dissolved
substantial legal expense in setting up
principal-agent problem may occur
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Production Function
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a physical relationship between the inputs of a firm and its output of goods and services
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Inputs of a Firm
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resources that contribute to the production of a good
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1. Fixed input
2. Variable input
2. Variable input
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types of input
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Fixed Inputs
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resources that are used at a constant amount in the production of a commodity
will exist over a short planning period
will exist over a short planning period
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Variable Inputs
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resources that can change in quantity depending on the level of output being produced
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Total Product (TP or Q)
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refers to the total amount of output produced by the firm
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Marginal Product (MP)
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the change in output for a one unit change in the quantity of an input
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Principle of Diminishing Marginal Product
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as the use of an input increases, a point will eventually be reached at which the resulting additions to output decrease
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Average Product
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measures the total output per unit of input used
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Stage I
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stage of production where MP > AP
stops when AP reaches its maximum point (MP = AP)
stops when AP reaches its maximum point (MP = AP)
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Stage II
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starts when AP begins to decline
Q continues to increase at a decreasing rate
MP declines until it reaches zero
Q continues to increase at a decreasing rate
MP declines until it reaches zero
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Stage III
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starts when MP is negative
Q falls as more inputs are used in production
TP, AP, and MP curves are decreasing
Q falls as more inputs are used in production
TP, AP, and MP curves are decreasing
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Opportunity Cost Principle
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the economic cost of an input used in a production process is the value of output sacrificed elsewhere
what could have been done with what was given up
what could have been done with what was given up
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Explicit Costs
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payments made by one entity/individual to another
"out of pocket" costs
"out of pocket" costs
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Implicit Costs
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imputed costs of self-owned or self-employed resources based on their opportunity costs
an assumed value given to an item when the actual value in unknown
an assumed value given to an item when the actual value in unknown
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Costs in Short Run
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at least one cannot be adjusted or is fixed. Costs can be divided into fixed and variable
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Total Fixed Cost (TFC)
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sum of all fixed costs
sunk cost or overhead cost
independent of the level of output produced
sunk cost or overhead cost
independent of the level of output produced
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Total Variable Cost (TVC)
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sum of all variable costs
as the level of output increases, the total variable cost increases
as the level of output increases, the total variable cost increases
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Total Cost (TC)
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= TFC + TVC
as the level of output increases, the total cost increases
as the level of output increases, the total cost increases
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Average Fixed Cost (AFC)
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= TFC / Q
declines as the level of output increases
never becomes zero
declines as the level of output increases
never becomes zero
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Average Variable Cost (AVC)
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= TVC / Q
as the level of output increases, the average variable cost initially declines and then rises
as the level of output increases, the average variable cost initially declines and then rises
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Average Cost (AC)
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= AFC + AVC or
= TC / Q
as the level of output increases, the average cost initially declines and then rises
= TC / Q
as the level of output increases, the average cost initially declines and then rises
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Marginal Cost (MC)
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= △TC / △Q
shows the change in total cost for a unit change in output
as the level of output increases, the marginal cost initially declines and then rises
intersects AVC first then AC at their lowest points
shows the change in total cost for a unit change in output
as the level of output increases, the marginal cost initially declines and then rises
intersects AVC first then AC at their lowest points
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Costs in Long Run
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all costs are variable
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Long run Average Cost (LAC)
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= LTC / Q
envelope curve of all possible plant sizes
also known as planning curve
traces the lowest average cost of producing each level of output
U-shaped because of economies of scale and diseconomies of scale
envelope curve of all possible plant sizes
also known as planning curve
traces the lowest average cost of producing each level of output
U-shaped because of economies of scale and diseconomies of scale
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Economies of Scale
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long run average cot decreases as output increases
causes: technological factors, specialization
causes: technological factors, specialization
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Diseconomies of Scale
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long run average cost increases as output increases
causes: problems with management as firm becomes bigger
causes: problems with management as firm becomes bigger
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