CHAPTER 2

FIRM
 A collection of resources that is transformed into products demanded by consumers.
PROFIT
 difference between revenue receive and cost incurred
 It is the aim of the firm to maximize profit
TRANSACTION COST
 incurred when a company enters into a contract with other entities
 These cost, include the original investigation to find the outside firm, followed by the cost of
negotiating a contract, and later, enforcing the contract and coordinating transactions.
 Influenced by uncertainty, frequency of recurrence and asset specificity.
 The most important of these characteristics is asset specificity
ASSET SPECIFICITY
 If buyer contracts for a specialized product with just one seller, and furthermore if the
product necessitates the use of some specialized machinery, the two parties are become
tied to one another.
UNCERTAINTY – kawalan ng kasiguraduhan
Future changes in market conditions may lead to OPPORTUNISTICS BEHAVIOR, where one of the
parties seeks to take advantage of the order.
When transaction cost are high, a company may choose to provide the service or product itself.
Employees will try to decrease monitoring cost by using incentives to increase employees output
 Bonuses, benefits, and perquisites
Buy and sell – the external cost will increased
Kung ikaw ang gagawa ng product – the internal cost will increase
George Sugler, article 1951 – produced everything internally will tend to experience “vertical”
“disintegration”. Transaction cost have decreased and that the possibility of “opportunistic
behavior” has also diminished.

THE ECONOMIC GOAL OF THE FIRM AND OPTIMAL DECISION MAKING

Economic theory of the firm – the foundation on which much of managerial economics rest –
assumes the principal objective of the firm is to maximize its profits (or minimize its losses)
PROFIT MAXIMIZATION HYPOTHESIS
 assumes the principal objective of the firm is to maximize its profits (or minimize its losses)
OPTIMAL DECISION
 Managerial economics is one that brings the firm closer to this goal.
To maximize its profits (or minimize its loss) a firm should price its products at a level where the
revenue earned on the last unit of a product sold (marginal revenue) is equal to the additional cost
of making this last unit (marginal cost)
In other words, the optimal price equates the firms marginal revenue with its marginal cost.

SHORT RUN VS. LONG RUN

 Nothing to do directly with calendar time
 Short run – firm can vary amount of some resources but not others
 Long run – firm can vary amount of all resources
 At times short run profitability will be sacrificed for long run purposes.
GOALS OTHER THAN PROFIT
 A. ECONOMIC GOALS
Objective of “value” or “shareholder wealth” maximization and consider some of the other
alternatives concerning a company’s activity during a single period of time.
 Market share, growth rate  Technological advancement
 Profit margin  Customer satisfaction
 Return on investment, return on assets  Shareholder value
B. NONECONOMIC OBJECTIVES
 Good work environment  It would be worthwhile for a company to spend
 Quality products and services resources on such noneconomic objectives
 Corporate citizenship, social responsibility consistent with increases in revenue and profit.

DO COMPANIES MAXIMIZE PROFIT?

 Today’s corporations do not maximize. Instead, their aim is to “satisfice”.
TWO PARTS OF THE IDEA
o Position and power of stockholders
o Position and power of management
 SATISFICING – a concept in economics based on the principle that owners of a firm
(especially stockholders in a large corporation) may be content with adequate return and
growth since they really cannot judge when profits are maximized.

MAXIMIZING THE WEALTH OF STOCKHOLDERS

 This consideration in particular is affected by risk, so risk becomes another components of
the valuation of the business.
A. BUSINESS RISK
 Involves variation in returns due to the ups and downs of the economy, the industry
and the firm.
 This kind of risk that attends all business organizations, although to varying degrees.
B. FINANCIAL RISK
 Concerns the variation in returns that is induced by leverage.
 LEVERAGE signifies the proportion of a company financed by debt.

ECONOMIC PROFIT
 Everybody agrees that profit = revenue – cost (and expenses). But economics do not agree with accountants on
the concept of cost.
 An accountant reports cost on a historical basis. (past performance)
 The economics is concerned with the cost that a business considers in making decisions, that is future cost.
 Economics deals with something they call opportunity costs or alternative cost.
 This means that the cost of a resources is what a business must pay for it to attract it into its employ or to put
differently what a business must pay to keep this resource from finding employment elsewhere.

Historical cost vs. Replacement Cost

 Economic – replacement cost is important
 Accountant – measures cost/depreciation/historical cost
Implicit costs and normal profits
 Normal profits – represent the return that these resources demand to remain committed to a
particular firm.
Economic Costs
 Include not only the historical costs and explicit costs recorded by the accountants, but also the
replacement costs and implicit costs (normal profits) that must be earned on the owner’s resources.
Economic Profits
 Total revenue minus all the economic cost.