Chapter 4 THE ECONOMICS OF BUSINESS FIRMS ORGANIZING A BUSINESS Sole Proprietorship Partnership...
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Transcript of Chapter 4 THE ECONOMICS OF BUSINESS FIRMS ORGANIZING A BUSINESS Sole Proprietorship Partnership...
Chapter 4
THE ECONOMICS OF BUSINESS FIRMS
ORGANIZING A BUSINESS
Sole Proprietorship
Partnership
Corporation
3 MAIN GROUPS OF AMERICAN BUSINESS
Sole ProprietorMom & Pop StoreBarbershopWeb design
PartnershipAttorneysAccountants
Professional Groups Corporations
General MotorsMicrosoftIBM
SOLE PROPRIETORA business owned by just one person
individual initiative, self-reliance, hard-work
Most common form and simplest to form.
Over 78% of all business in U.S.
Financial investment need not be large.
Limited amount of red tape.
Owner has satisfaction of working for himself.
Flexibility of organization (hours, pay, etc)
Pays taxes only on personal income from business.
Can put money into private pensions.
DISADVANTAGES TO SOLE PROPRIETOROnly 24 hours in a day- can’t work 24/7.
Prosperity depends on talent of one person and no one contains all necessary skills.
Often too close to trees to see the forest.
Often difficult to borrow money from the banks.
Unlimited liability.
Limited Life.
PARTNERSHIPA legal association of two or more persons in a
business as co-owners.
More complicated than S.P.
Each partner agrees to contribute some portion of funding and labor used by the business and to receive some proportion of the profits or losses.
Could be a “silent” partner (put up money,but nothing to say about operations.
Common formation for professional groups.
PARTNERSHIP ADVANTAGES
Easy to form.
Usually has legal standing
Combines skills of several people which enhances ability to create wealth.
Easier to get funding and backing.
Taxed only on personal income.
Limited amount of red tape.
PARTNERSHIP DISADVANTAGES
Unlimited liability (each member of partnership is legally liable for debts of business and other partners in name of business.
Conflicts among partners
Too many chiefs- not enough Indians.
Inside partnership very competitive.
Lifespan somewhat limited.
CORPORATION
A BODY THAT IS AUTHORIZED BY LAW TO ACT AS A PRIVATE PERSON
Legally endowed with various rights and duties
To receive, own, and transfer property.
To make contracts
To sue and be sued.
CORPORATIONS INCLUDE:EXXON, IBM, GENERAL MOTORS, MICROSOFT,
Characteristics:
Shareholders share in the wealth.
Limited Liability (responsibility of shareholders of a corporation is held only to their investment in same)
May own tremendous wealth.
Increased management skills
Ownership divided into equal parts called shares
Can raise large amounts of money
Can borrow money through sale of bonds.
MERGERS
Horizontal
Vertical
Conglomerate
MERGERS
horizontal – two firms that serve the same set of customers
vertical – two firms operating at different stages of the production/distribution process
conglomerate – two firms operating in unrelated industries
MERGERS/CONGLOMERATESMerger= acquisition through sale of one company to another with thepurchasing company remaining dominant.
example: General Motors absorbed Chevrolet CorporationIn 1919- General Motors remained dominant- This is called aHorizontal Merger
General Motors Chevrolet Corporation
Amalgamation = Outsider brings together 2 companies minimumAnd forms a new company
.Pontiac Oldsmobile Buick Cadillac
GeneralMotors1917
VERTICAL MERGERA company in one phase of the business
absorbs or joins a company involved in another phase in order to guarantee a supplier or customer.
Oil fields
Pipeline
Refinery
Distributor
Retailer
Trucking
CONGLOMERATESaw a lot of this type after 1961- union of two corporations whose operations were unrelated…
ITT = 250 operations-
Taxi, motel chain, Madison Square gardens, paper mill,
Food products,cosmetic,
Pharmaceutical.
Phillip Morris is huge!
Coca Cola is huge!
INCOME STATEMENT
Revenues – costs = profits (TR-TC)
• Revenues – money coming into the firm• Costs – money and non-money costs, also called expenses• Profits – revenues exceed costs• Losses – revenues are less than costs
TOTAL REVENUE (TR)
Sales revenue received by the firm
TR = P x Q
MARGINAL REVENUE (MR)
Additional revenue received when the firm sells one more unit of the product.
• MR = (change in revenue)/(change in output)
In most markets, MR slopes downward twice as fast as the demand curve
FIGURE 4-1. DEMAND AND MARGINAL REVENUE
Q0
P10
TR 0
MR
12
9 8
916
+9+7
34
7 6
2124
+5+3
56
5 4
2524
+1 -1
P
DMR
Q
TR = P x QMR = increase in TR/ increase in Q
COSTS
Fixed costs (FC)
Variable costs (VC)
Total costs (TC)
• TC = FC + VC
COSTS
Fixed costs (FC) – payment for the fixed inputs
Variable costs (VC) – payment for the variable inputs
Total costs (TC) = FC + VC
FIGURE 4-2. FC, VC, AND TC
Q VC FC TC0 0 120 120
10 85 120 20520 150 120 27030 240 120 36040 350 120 47050 550 120 670
As output (Q) increases:Fixed Costs (FC) do not change.Variable Costs (VC) increase at an irregular rate.Total Costs (TC) = FC + VC.
AVERAGE FIXED COSTS (AFC)
AFC = FC/Q
If no other costs but fixed, average costs will decline
FIGURE 4-4. AVERAGE FIXED COSTS (AFC)
Q FC AFC0 120
10 120 12.0020 120 6.0030 120 4.0040 120 3.0050 120 2.40
AFC = FC/Q
$
Q
AFC
AVERAGE VARIABLE COSTS (AVC)
AVC = VC/Q
As Q increases, AVC falls to a minimum, then rises rapidly as the firm approaches maximum capacity
FIGURE 4-5. AVERAGE VARIABLE COSTS (AVC)
Q VC AVC0 0
10 85 8.5020 150 7.5030 240 8.0040 350 8.7550 550 11.00
AVC = VC/Q
$
Q
AVC
20
7.50
AVERAGE TOTAL COSTS (ATC)
ATC = TC/Q = AFC + AVC
As Q increases, ATC falls to a minimum, then rises rapidly as the firm approaches maximum capacity.
ATC is always higher than AVC
FIGURE 4-6. AVERAGE TOTAL COSTS (ATC)
Q TC ATC0 120
10 205 20.5020 270 13.5030 360 12.0040 470 11.7550 670 13.40
ATC = TC/Q = AFC + AVC
ATC
40
11.75
$
Q
MARGINAL COST (MC)
MC = (change in TC/change in Q)
MC falls at first, then rises rapidly through the range of normal production
FIGURE 4-7. MARGINAL COSTS (MC)
Q TC MC0 120
10 205 8.5020 270 6.5030 360 9.0040 470 11.0050 670 20.00
MC = (change in TC/change in Q)
$
Q
MC
GRAPH ATC/AVC/AFC$24
20
16
12
8
4
0 10 20 30 40 50Rate of Output (pairs per day)
Cos
ts (
dolla
rs p
er p
air)
I
J
KL M N
O
ATC
AVC
AFC
SUMMARY OF THE BASIC COST CURVES
21-32
FIGURE 4-10. MR, MC AND PROFIT MAXIMIZATION
P
Q
DMR
MC
Pm
Qm
MC = MR Produce the Q, labeled Qm
where MR = MC and profit will be maximized.The demand curve tells you that the price must be Pm.
MR>MC MR<MC
PROFIT MAXIMIZATION RULES
Produce the Q where MR = MC and profit will be maximized.
Price determined from that point also.
Loss minimization occurs.
EXPLICIT AND IMPLICIT COSTS
Explicit costs – actual out-of-pocket payments by the firm, plus depreciation.
Implicit costs – the opportunity costs of the owner’s assets, time and effort.
Total costs = explicit costs + implicit costs
PROFITS
Accounting profit = TR – explicit costs
Economic profit = TR – both explicit costs and implicit costs
Normal profit is the minimum return on investment necessary for the owner to continue to operate the business.
DECISION MAKING
Economic Profit > 0
• Expand the firm.
Economic Profit < 0
• Shrink or close the firm.
Economic Profit = 0
• Keep operating at this level.
MARKET STRUCTURE AND MARKET POWER
Ability to manipulate the market price.
• perfect competition – no market power• monopoly – complete market power• monopolistic competition – some market power at
times• oligopoly – considerable market power at times
PERFECT COMPETITION
Many small firms
Identical products sold at the same price
Easy to enter into and exit from the industry.
Each firm must accept the market price.
Each firm can only choose the quantity to produce (they choose the profit-maximizing quantity).
Economic profit quickly goes to zero or normal.
FIGURE 24-1 THE DEMAND CURVE FOR A PRODUCER OF SECURE DIGITAL CARDS
FIGURE 24-2 PROFIT MAXIMIZATION, PANEL (A)
PROFIT MAXIMIZATION
Quantity (bushels per day)0 1 2 3 4 5 6 7
2
4
6
8
10
12
14
16
$18
Pric
e or
Cos
t (p
er b
ushe
l)
Marginal cost
Price (= MR)
Profit-maximizing rate of output
MCB
MRB
p = MC Profits decreasing
Profits increasing
MONOPOLY
Only one firm produces the product.
• They control the supply curve.There is a total barrier to other firms entering the industry.
Monopolist will choose to produce its profit-maximizing quantity. (MC = MR)
• The demand curve will then identify the market price.• Marginal Revenue falls faster than price.
PROFIT MAXIMIZATION
0 1 2 3 4 5 6 7 8 9
123456789
10111213
$14
Quantity (baskets per hour)
d
Demand
Marginal revenue
Marginal cost
Average total cost
D
Profits
PRICE AND MARGINAL REVENUE
Unlike competitive firms, marginal revenue for a monopolist is not equal to price.
So long as the demand curve is downward-sloping, MR will always be less than price.
MONOPOLIES NOT PERMITTED IN U.S.
WAIT!!!!!!!!!!!!
Don’t we have them anyway?Sure – (natural and companies with large percentage of market.
MONOPOLISTIC COMPETITION
Many intensely competitive firms
Each sells a slightly different version of the product at slightly different prices
Easy entry and exit
One firm’s product innovation captures the customers’ imagination; that firm becomes a short term monopolist
• Earns normal profits
BRAND LOYALTY Will compete with other firms but offer substitutes
makes the demand curve facing the firm less price-elastic.
implies that consumers shun substitute goods even when they are cheaper.
Example: the price differences between computers which are essentially the same.
NON-PRICE COMPETITION
Advertising.
http://www.youtube.com/watch?v=xffOCZYX6F8http://www.youtube.com/watch?v=xffOCZYX6F8http://www.youtube.com/watch?v=xffOCZYX6F8
FIGURE 26-2 COMPARISON OF THE PERFECT COMPETITOR WITH THE MONOPOLISTIC COMPETITOR
OLIGOPOLY
A few large firms dominate the industry.
Significant price-setting power.
Significant barriers to entry.
Name brand producers.
Nation-wide and world-wide distributors.
MARKET POWER
Tom Thumb wants to gain market share from Albertsons.
Wal-Mart wants market share from Kmart… boy did they get it!
Central Market wants market share from Whole Foods
Google wants market share from Facebook.
MARKET SHARE-NORTH TEXAS JULY 2013Grocery Store % of market share
Walmart 27.8
Kroger 14.5
Tom Thumb 10.1
Albertsons 6.9
Target ,super 6.7
Sam’s 5.2
Costco 5.2
HEB Central Market 2.5
Whole Foods 1.2
Market Street 1.0
OLIGOPOLY (CONT'D)
Oligopoly
• A market situation in which there are very few sellers.
• Each seller knows that the other sellers will react to its changes in prices and quantities.
OLIGOPOLY (CONT'D)
Why oligopoly occurs
• Economies of scale
• Barriers to entry
• Mergers
• Vertical mergers
• Horizontal mergers
Pric
e or
Cos
t (d
olla
rs p
er u
nit)
Quantity (units per period)0
Maximizing Oligopoly Profits
Industrymarginal
cost
Industry average
cost
Marketdemand
Industry marginalrevenue
Profits
J
Profit-maximizing
price
Average costat profit-
maximizingoutput
Profit-maximizing output
ECONOMIES OF SCALE
Increase the capacity to produce and costs are lowered.
• …achieve economies of scale.• …up to a point.
How?
• switch from batch mode to assembly line.• employees specialize to task.• buy inputs in bulk at lower prices.
DISECONOMIES OF SCALE
Continued increase in production capacity leads, after a point, to rising costs.
How?
• multiple assistant managers needed.• create a costly bureaucracy.• move decision making authority away from the production line.
IDEAL SIZED PLANT
Build a facility that:
• is big enough to achieve all economies of scale.• operates at lowest cost.• does not get big enough to experience diseconomies of scale.
Economies of Scale
QM0
CO
ST
(do
llars
per
uni
t)
Constant returns to scale
c
ATC1
m1
RATE OF OUTPUT (units per period)
ATCS
QM0
Economies of scale
c
ATC2
m2
ATCS
RATE OF OUTPUT (units per period)
QM0
Diseconomies of scale
c
ATC3
m3ATCS
RATE OF OUTPUT (units per period)
QUESTIONS?