ECON101 Unit 8 Flashcards
What is the definition of a firm? What is their goal?
Institution that hires factors of production (inputs) and organizes those factors of production to produce and sell goods and services (outputs)
- Goal: Maximize profits
What is the difference and key difference between accounting and economic profit?
Accounting: If a firm is earning enough revenue to pay for its expenses and ensuring firms pay the correct amount of taxes to show investors
Economic: Where a firm is using its resources efficiently and is a measure of predicting a firm’s actions and the full opportunity cost of making a business decision
KEY DIFFERENCE: Economic profit includes implicit costs, while accounting profit does not include implicit costs
Generally, opportunity cost is greater than accounting cost and economic profit is less than accounting profit
Three constraints limiting profit maximization: (TIM)
Technology - the firm can produce more only if it hires more resources which increases cost and limits profit of additional output
Information - Cost of coping with limited information reduces profit
Market- Constrained by customers willingness to pay
What is the difference between technological efficiency and economic efficiency?
Technological Efficiency = When a firm uses less of at least one input and no more of the other inputs to produce a given quantity of output
Economic efficiency: When the firm produces a given quantity of output at the least cost
What is the principle agent problem?
Problem of devising compensation rules that induce an agent (managers) to act in the best interest of a principal (stockholders)
What are three strategies to address the principle agent problem? (OIL)
Ownership: gives the managers an incentive to maximize the firm’s profits
Incentives: pay links managers’ or workers’ pay to the firm’s performance
Long-term contracts: tie managers’ or workers’ long-term rewards to the long-term performance of the firm
What are the three types of business structures in Canada?
1) Sole proprietorship (single owner)
2) Partnership (2+ owners)
3) Corporation (1+ stockholders)
What are the traits of a sole proprietorship?
- Easy to set up
- Managerial decision making is simple
- Profits are taxed once
- Bad decisions made by the manager are not subject to review
- Owners entire wealth is at stake
- The cost of capital and labour can be high
What are the traits of a partnership?
- Easy to set up
- Employ diversified decision-making processes
- Profits are taxed only once
- Can survive without withdrawal of a partner
- Achieving consensus about managerial decisions is difficult
- Owners entire wealth is at risk
- Capital is expensive
What are the traits of a corporation?
- Limited liability for owners
- Large scale and low-cost capital that is readily available
- Professional management
- Lower costs from long term labour contracts
- Complex management structure could lead to slow and expensive decision making
- Profits taxed twice
The four types of markets:
1) Perfect competition
2) Monopoly
3) Monopolistic competition
4) Oligopoly
What are the traits of the 4 markets? (# of firms, closeness of subs, barriers to entry)
Perfect Competition
Many firms and buyers
All firms sell an identical product
No restrictions on the entry of new firms into the industry
Monopolistic Competition
Many firms and buyers
Each firm has product differentiation producing similar but different products
No restrictions on the entry of new firms
Oligiopoly
A small number of firms compete
Identical or differentiated products
Barriers to entry
Monopoly
One firm produces the entire output of the industry
No close substitutes
Barriers to entry to protect from competition entering
What is the difference between short run and long run time frames?
Decision time frames - Make decisions to achieve the main objective of profit maximization
Short-run = Time frame where at least one factor of production is fixed
Long run = Time frame where all factors of production can vary
What are the three short-run curves that articulate the relationship between the quantity of labour and a firm’s output? (TMA)
Total product = Total output produced in a given period
Marginal product = change in the total product that results from a one-unit increase in the quantity of labour employed
Average product = Total product/ the quantity of labour employed
Identify and explain short-run cost curves:
Total cost (TC) is the cost of all resources used
Total fixed cost (TFC) is the cost of the firm’s fixed inputs that do not change with output
Total variable cost (TVC) is the cost of the firm’s variable inputs that do change with output
TOTAL COST = TFC + TVC
