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Dr. Mohammed Alwosabi

Dr. Mohammed Alwosabi

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Published by coldpassion
Econ 140 Notes, By Dr.Awosabi
Econ 140 Notes, By Dr.Awosabi

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Published by: coldpassion on Dec 07, 2009
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12/07/2009

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Dr. Mohammed Alwosabi ECON 140 Ch. 9
1
Notes on Chapter 9
ORGANIZING PRODUCTION
 
Firms differ in the size and in the type of business they are doing but all firmsperform the same basic economic functions.
 
A
firm
is an institution that hires factors of production and organizes them toproduce and sell goods and services.
 
To predict a firm's behavior, we need to know the firm's goals and theconstraints it faces.
The Firm's Main Goal
 
A firm’s goal is to maximize profit.
 
If the firm fails to maximize profits it is either eliminated or bought out by otherfirms seeking to maximize profit.
 
Profit
is the difference between total revenue and total cost
π
= TR – TC.
 
To maximize profit, a firm must make five basic decisions:
 
What goods and services to produce and in what quantities
 
What to produce itself and what to buy from other firms
 
How to produce—the production technology to use
 
How to organize and compensate its managers and workers
 
How to market and price its products
MEASURING A FIRM'S COSTS (OPPORTUNITY COST)
 
Accountants typically count money costs only and ignore any resource use thatdoes not result in an explicit money payment.
 
Thus, Accounting cost = explicit cost
 
When calculating costs, economists on the other hand, consider the opportunitycost of all resources used in production whether they are paid or not.
 
Dr. Mohammed Alwosabi ECON 140 Ch. 9
2
 
Opportunity cost of any action – as you remember - is the highest-valuedalternative forgone. For a firm, the opportunity cost of production is the valueof the firm's best alternative use of resources.
 
Opportunity cost includes both explicit and implicit cost. This is calledeconomic cost.
 
Economic Cost
(also called resource cost)
 
refers to the value of all resourcesused to produce a good or service, whether the resources are paid or unpaid.
 
Economic Cost = opportunity cost= explicit cost + implicit cost
 
Explicit cost
is cost paid directly in money.
 
 
Implicit cost
is the value of resources used even when no direct monetarypayments are made to these resources. It incurred when a firm gives up analternative action. A firms incurs implicit costs when it uses its own capital,and/ or it uses its owner's resources
1.
 
The cost of firm's own capital
o
 
If the firm rents capital from another firm, it incurs an explicit cost; thecost of rental payments.
o
 
If the firm buys the capital it uses, it incurs an implicit cost (or the
implicit rental rate
of capital) which is made up of i.
 
Interest forgone:
The funds used to buy the capital could have beenused for some other purpose. They would have yielded a return - aninterest income. This forgone interest is an implicit cost and it is part of the opportunity cost of using the capitalii.
 
Rent forgone:
The firm could rent its capital to another firm. Therental income forgone is the firm's opportunity cost of using its owncapital.iii.
 
Economic depreciation
: is the decline in the market value of capitalover a given period. It is calculated as the market price of the capital atthe beginning of a period minus the market price of the capital at theend of the period.
 
Dr. Mohammed Alwosabi ECON 140 Ch. 9
3
 
2.
 
The cost of the owner's resources
A firm's owner could offer his resources in two ways:a.
 
As an entrepreneur
: The owner's skills and talent as an entrepreneurcould be used in running another business and expect to receive a returncalled normal profit.
o
 
Normal profit
 
 
Normal profit is the cost of forgone entrepreneurial abilitiesand talent in running another firm.
 
It is the average return that could be obtained from runninganother business.
 
It is an amount equal to what the owners of a business couldhave earned if their resources had been employed elsewhere.
 
It is equivalent to the opportunity cost of running the firm.
o
 
It is the minimum return a firm's owner must earn in order to stay inoperation. A lower rate would cause some of the established firms toleave; a higher one would cause new firms to enter.
o
 
It is part of economic cost (part of implicit cost) but it is part of accounting profit.b.
 
As a labor
: Wage is the return to labor. The opportunity cost of theowner's time spent on working for the firm is the wage income forgoneby not working in the best alternative job.

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