Chapter 7 Flashcards
How may a firm be organized? [6]
- A single proprietorship
- An ordinary partnership
- The limited partnership (general and limited)
- A corporation
- A state-owned enterprise (crown corporation)
- Non-profit organizations
What is an MNE? [3]
- Firms that have operations in more than one country are called multinational enterprises (MNEs).
- This is unusual for single proprietorships and ordinary partnerships, but common for limited partnerships and very common for larger corporations.
- The number and importance of MNEs have increased greatly over the last few decades.
What is the money a firm raises for carrying on its business called?
Financial capital
What are the basic types of financial capital? [2]
Financial capital is distinct from physical capital, which is the firm’s assets, such as factories, machinery, offices, and fleets of vehicles.
The basic types of financial captial used by firms are equity and debt.
Regarding financing of firms, discuss debt. [5]
- The firm’s creditors are not owners.
- A loan with a loan agreement or IOU.
- Firms can borrow from financial institutions.
- Firms can borrow from non-bank lenders using debt instruments or bonds.
- Firms are obligated to pay the principle and interest.
Regarding financing of firms, discuss equity. [3]
- In individual proprietoryships and partnerships, one or more owners provide much of the required funds.
- A corporation acquires funds from its owners in return for stocks, shares, or equities, which are basically ownership certificates.
- Profits that are paid out to shareholders are called dividends.
What are two competing views to the following question?
Is it socially responsible to maximize profits?
- Unadorned capitalism/goal of profit maximization does not serve the broader public interest.
- Goal of maximization profits benefits customers and their employees, and leads to innovation, which improves the living standards.
- What about the environment?
- How does the government fit in?
- How can firms be motivated to change their behaviour?
What four types of inputs for production do firms use?
- Inputs that are outputs from some other firm are called intermediate products
- Inputs provided directly by nature
- Inputs that are the services of labour
- Inputs that are the services of physical capital
What are the three basic forms of firms (i.e., three corners of the business triangle) ?
- Sole proprietorship
- Corporations
- Partnerships
What is a firm?
- Firm = self-contained, profit maximizing entity, that produces and sells goods and services.
- Firm is an economic construct - not the same as a ‘business’
Recall the three corners of the business organization triangle.
What is a sole (single) proprietorship?
- “The owner is the business”
- Owner has unlimited liability
What is a partnership?
- two or more persons (single proprietors) carrying on business in common with a view to a profit
What is a company?
- company is a person (i.e., separate legal entity)
- shareholder has limited liability
What are hybrids of firms? [5]
- General partnership - all unlimited liability
- Limited partnership - on general partner
- Limited liability parnership LLP - all limited partners
- Professional and non-professional partnership
- Crown corporations; NGO - non-profit; MNE
What is capital?
Capital = net worth = equity = assets - liabilities
What is physical capital (K)?
Investment = new ‘PEIR’ (economic term)
What is financial capital?
Financing = RE for investment (finance term)
What is working capital?
Cash flow (business term)
What is the difference between equity financing and debt financing?
-
Equity financing = GRANTING share of control of company in return for GIFT of money
- Equity (economic term)
- Share or stock (business term)
-
Debt financing = BORROWING money.
- Bond (economic term)
- Debt instrument (business term) (‘buy debt’ means loaning; ‘sell debt’ means borrowing)
- IOU
- Principle, interest, redemption period, term
What are the goals of firms? (i.e., the neoclassical assumptions of the firm)
-
Firms seek to maximize profits
- This is a behavioural assumption; firms behave AS IF they are profit maximizers
-
Firms are autonomous decision makers
- Shareholders, directors, managers - all have the same goal → make money!
What are the three definitions of corporate social responsibility?
Bowen: CSR = obligation of business policy to be compatible with social goals and values
Friedman: Firms are free to maximize profits, subject to:
- Government Regulation of social costs;
- Consumer sovereignty
Cause-marketing = Telus advertises, but mentions a cause, which brings in money for the cause. E.g., breast cancer
Why do firms use corporate social responsibility (CSR) ?
Increase sales by…
- ‘signaling device’ that their product is high quality.
- Consumer wanting to indirectly donate to cause.
- ‘halo effect’ whereby good deeds earn customer draw
What does the Brundtland Report say about sustainability?
Sustainability = development that meets the needs of present and future generations.
What are profits?
Total Revenue (TR) - Total Costs (TC)
What is total revenue?
Total revenue (TR) = Price * Quantity of OUTPUTS
- Different for each market structure
What is total cost (TC)?
Assume the same for each market structure
What is a production function?
Maximum output is a function of input.
Output = f (inputs)
Total Product (i.e., output) = Quantity = f (N, K)
What are the five factors of production (inputs) ?
- Capital: person-made resources
- Land: natural resources
- Labour: human resources
- Technology: change in productive process
- Entrepreneurship: innovation, inventions, R&D
What is cost?
The value of the factor used up in production.
Two types: accounting costs and opportunity cost.
What is an accounting cost?
Explicit invoice price of factor
- Acquisition cost
- Book value
- Explicit cost
- Omit intangible assets (goodwill) and liabilities (contingent law suits)
- Not that relevant for decision-making.
What is an opportunity cost?
The value of the next-best foregone alternative which determines decision making in the firm.
What determines decision making in the firm?
Opportunity cost
a.k.a. imputed/implied/implicit cost
What is sunk cost?
An asset that has no alternative use.
- Opportunity cost is zero
- No ‘salvage’ value
- e.g., specialized computer programme
- sunk costs are therefore omitted from opportunity cost
What is economic profit?
Economic profit = Total revenue - Accounting cost - normal profit
What is economic profit?
- The difference between the revenues received from the sale of output and the opportunity cost of the inputs used to make the output.
- Economic profit = revenues - (explicit and implicit costs)
- Economic profit = accounting profits - implicit costs
- Negative economic profits are called economic losses
What is marginal product?
The change in total output that results from using one more unit of a variable factor.
The marginal product (MP) of labour is given by:
MP = ΔTP / ΔL
Operating decisions are made in the […].
Short run
Planning decisions are made in the […].
Long run
Growth decisions are made in the […].
Very long run
Describe the variables of production functions in the short run, long run, and very long run.
SR (at least one of the factors is fixed besides technology):
Q = f (variable factor, fixed, technology fixed)
LR (all the factors vary except technology):
Q = f (all variable, technology fixed)
VLR (all factors vary, including technology):
Q = f (all variable)
Compare short run and long run.
What does the short run production function look like for total, average, and marginal product?
(Be sure to discuss stage I, II, and III, inflection points, mins/maxes)
Since short run; at least one input is fixed.
What does the TP curve or SR production function measure?
Measures output as a function of one variable input, other factors held constant (partial derivative).
Q = TP = Output = production
What is the law of diminishing marginal product?
= Law of diminishing marginal returns (LDMR)
= Law of diminishing retruns (LDR)
= As more of the variable factor is added to a given amount of the fixed factor, the additional output diminishes, after a certain point (inflection point), ceteris paribus.
Reason:
- More variable factor has less of fixed factor to work with!
- Same reasons as the shape of the TP curve!
Give the symbol and definition of different types of costs.
Describe how the relation of output to changes in the quantity of the variable factor (labour) can be looked at in three different ways in the short run. (i.e., total, average, marginal products)
Define short-run costs.
What is marginal cost?
The increase in total cost resulting from increasing output by one unit.
Marginal costs are always marginal variable costs because fixed costs do not change as output varies.
MC = ΔTC / ΔQ
Where does the MC curve intersect with the ATC and AVC curves?
MC curve intersects the ATC and AVC curves at their minimums.
Note TFC does not change with output.
Describe the shape of the ATC curve.
U-shaped
ATC curve declines initially as output increases, reaches a minimum, and then rises as output increases further.
Describe shifts in short-run cost curves. [3]
- An increase in the price of a variable factor shifts ATC and MC upward.
-
An increase in the price of a fixed factor increases the firm’s total fixed costs, but its variable costs are unchanged.
- The ATC curve shifts upward, but the MC curve does not change.
Give the equations for Total cost, average cost, and marginal cost.
TC = TFC + TVC
AC = AFC + AVC
MC = 0 + MVC
Describe TC, MC and AC in stage 1 and stage 2.
Summarize how you get the cost curves.
What is the H.C. FACE ?
How does the short run cost curve shift when there is a change in PRICE of factors (fixed and variable)?
- increase in price of variable inputs shifts BOTH curves upward
- increase in price of fixed inputs shifts ONLY ATC upward
How does the short run cost curve shift from changes in QUANTITY of fixed factors?
- There is a different happy face for each level of fixed input
- An increase in plant sie may shift cost curves down
