6. Introducing supply decisions

Question 1

A sole trader is a business owned by a single individual.
A partnership is a business jointly owned by two or more people, sharing the profits and being jointly responsible for any losses.
A company is an organization legally allowed to produce and trade.
Shareholders of a company have limited liability. The most they can lose is the money they spent buying shares.

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Question 2

Stocks are measured at a given point in time; flows are corresponding measures during a period of time.

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Question 3

Revenue is what the firm earns from selling goods or services in a given period, cost is the expense incurred in production in that period and profit is revenue minus cost.

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Question 4

A firm’s cash flow is the net amount of money actually received during the period.
Physical capital is machinery, equipment and buildings used in production.
Depreciation is the loss in value of a capital good during the period.

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Question 5

Inventories are goods held in stock by the firm for future sales

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Question 6

A firm’s net worth is the assets it owns minus the liabilities it owes

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Question 7

Retained earnings are the part of after-tax profits ploughed back into the business.

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Question 8

The Supernormal profit is pure economic profit; it measures all economic costs properly.

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Question 9

The A principal or owner may delegate decisions to an agent. If it is costly for the principal to monitor the agent, the agent has inside information about its own
performance, causing a principal agent problem.

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Question 10

Marginal cost is the rise in total cost when output rises by 1 unit.
Marginal revenue is the rise in total revenue when output rises by 1 unit.

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Question 11

The theory of supply is the theory of how much output firms choose to produce.

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Question 12

There are three types of firm: self-employed sole traders, partnerships and companies. Sole traders are the most numerous but are often very small businesses. The large firms are companies.

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Question 13

Companies are owned by their shareholders but run by the board of directors.

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Question 14

Shareholders have limited liability. Partners and sole traders have unlimited liability

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Question 15

Revenue is what the firm earns from sales. Costs are the expenses incurred in producing and selling. Profits are the excess of revenue over costs.

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Question 16

Costs should include opportunity costs of all resources used in production.
Opportunity cost is the amount an input could obtain in its next-highest-paying use. In particular, economic costs include the cost of the owner’s time and effort
in running a business. Economic costs also include the opportunity cost of financial capital used in the firm. Supernormal profit is the pure profit accruing to the owners after allowing for all these costs.

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Question 17

Firms are assumed to aim to maximize profits. Even though the firm is run by its managers, not its owners, profit maximization is a useful assumption in understanding the firm’s behavior. Firms that make losses cannot continue in business indefinitely.

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Question 18

In aiming to maximize profits, firms necessarily produce each output level as cheaply as possible. Profit maximization requires minimization of costs for each
output level.

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Question 19

Firms choose the optimal output level to maximize total economic profits. This decision can be described equivalently by examining marginal cost and marginal
revenue. Marginal cost is the increase in total cost when one more unit is produced. Marginal revenue is the corresponding change in total revenue and depends on the demand curve for the firm’s product. Profits are maximized at the output at which marginal cost equals marginal revenue. If profits are negative at this output, the firm should close down if doing so reduces losses.

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Question 20

An upward shift in the marginal cost curve reduces output. An upward shift in the marginal revenue curve increases output.

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Question 21

It is unnecessary for firms to calculate their marginal cost and marginal revenue curves. Setting MC equal to MR is merely a device that economists use to mimic the hunches of smart firms who correctly judge, by whatever means, the profit-maximizing level of output.

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