What is a firm's fundamental goal and what happens if the firm doesn't pursue this goal?
A firm's fundamental goal is to maximize its profit. If the firm
... [Show More] fails to maximize profit it is either eliminated or bought out by other firms maximizing profit.
Why do accountants and economists calculate a firm's cost and profit in different ways?
Accountants and economists have different reasons for computing a firm's costs. An accountant calculates a firm's cost and profit to ensure that the firm pays the correct amount of income tax and to show its investors how their funds are being used. An economist calculates a firm's cost and profit in a way that enables him or her to predict the firm's decisions.
What are the items that make opportunity cost differ from the accountant's measure of cost?
A firm's opportunity cost includes the cost of using resources bought in the market, owned by the firm and supplied by the firm's owner. Economists and accountants both include the price of resources bought in the market as costs. But accountants omit costs included by economists. For instance, use of a building the owner has already purchased has an opportunity cost that accountants do not include. Additionally the normal profit, interest foregone, and economic depreciation are other opportunity
costs not recorded by an accountant.
Why is normal profit an opportunity cost?
Normal profit is the return to a firm's owner for the owner's supply of entrepreneurial ability and labor
to the firm's production process. Using the owner's ability to run the business implies that the owner
could have received a return for using it in another capacity, such as running another firm. This cost is
an opportunity cost for the firm because it is the cost of a forgone alternative, which is running another firm, and must be included in calculating the firm's opportunity cost of production
What are the constraints that a firm faces? How does each constraint limit the firm's profit?
The three types of constraints a firm faces are technology constraints, information constraints, and market constraints. Technology is any specific method of producing a good or service and it advances over time. Using the available technology, the firm can produce more only if it hires more resources, which will increase its costs and limit the profit of additional output. Information is never complete, for
the future or the present. A firm is constrained by limited information about the quality and effort of its
work force, current and future buying plans of its customers, and the plans of its competitors. The cost
of coping with limited information itself limits profit. Market constraints mean that what each firm can sell and the price it can obtain are constrained by its customers' willingness to pay and by the prices and marketing efforts of other firms. The resources that a firm can buy and the prices it must pay for them are limited by the willingness of people to work for and invest in the firm. The expenditures a firm
incurs to overcome these market constraints will limit the profit the firm can make.
Is a firm technologically efficient if it uses the latest technology? Why or why not?
Technological efficiency occurs when a firm produces a given level of output using the least amount of
inputs. Adopting the latest available technology does not necessarily imply that a firm's production process is technologically efficient. As long as the firm is getting the maximum possible output for a given combination of inputs, it is technologically efficient.
Is a firm economically inefficient if it can cut its costs by producing less? Why or why not?
Economic efficiency occurs when the firm produces a given level of output at the least cost. If a firm can
decrease production costs by decreasing output, it is not necessarily economically inefficient. If it is producing the new level of output at the least possible cost, it is achieving economic efficiency
Explain the key distinction between technological efficiency and economic efficiency.
The difference between technological and economic efficiency is that technological efficiency concerns
the quantity of inputs used in production for a given level of output, whereas economic efficiency concerns the value of the inputs used. Economic efficiency requires technological efficiency, but technological efficiency does not require economic efficiency.
Why do some firms use large amounts of capital and small amounts of labor while others use small amounts of capital and large amounts of labor?
The mix of resources used, such as large amounts of capital versus small amounts of capital, depends on economic efficiency. Economic efficiency is based on minimizing the value of the resources used, not the quantity. A firm will use the mix that produces output at the lowest possible cost, without regard to specific physical quantities or ratios of inputs. As the cost of capital decreases relative to the cost of other resources, capital-intensive production methods will become economically efficient and firms will avoid labor-intensive methods
Explain the distinction between a command system and an incentive system
A command system uses a managerial hierarchy, where commands pass downward through the hierarchy and information (feedback) passes upward. These systems are relatively rigid and can have many layers of specialized management. Incentive systems use market-like mechanisms to induce workers to perform in ways that maximize the firm's profit.
What is the principal-agent problem? What are three ways in which firms try to cope with it?
The principal-agent problem is the problem of devising compensation rules that induce an agent to act
in the best interests of a principal. There are three ways of coping with this problem: Ownership, often
offered to managers, gives the agents an incentive to maximize the firm's profits, which is the goal of the
owners, the principals; incentive pay links managers' or workers' pay to the firm's performance and helps
align the managers' and workers' interests with those of the owners, the principal; long-term contracts tie
managers' or workers' long-term rewards to the long-term performance of the firm, encouraging the
agents to work in the best long-term interests of the firm owners, the principals
What are the three types of firms? Explain the major advantages and disadvantages of each.
The three main ways of organizing a firm have both advantages and disadvantages:
1. Proprietorship. ADVANTAGES—easy to set up; managerial decision-making is simple and rapid; and profits are taxed only once. DISADVANTAGES—bad decisions on the part of the owner are not subject to review; the owner's entire wealth is at stake because of unlimited liability; the firm dies with the owner; and acquiring capital and labor is expensive.
2. Partnership. ADVANTAGES—easy to set up; has diversified decision-making so that more than one person's expertise can be utilized; can survive the death or withdrawal of a partner; and profits are taxed only once. DISADVANTAGES—all the owners' wealth is at risk because of unlimited liability; if there are many partners, gaining a consensus about managerial decisions may be difficult; the withdrawal of partner may create capital shortage; labor costs are high compared to corporations; and capital costs can be high.
3. Corporation. ADVANTAGES—perpetual life; limited liability for its owners; readily available, largescale, and low-cost capital; can rely on professional managers rather than the talents of the owners; and reduced costs from long-term labor contracts. DISADVANTAGES—potentially complex management structure may lead to slow and expensive decision-making; and profits are taxed twice, once as corporate profit and once as income to the stockholders.
What are the four market types? Explain the distinguishing characteristics of each
1. Perfect competition is a market with many firms, each selling an identical product. There are many
buyers and no restrictions on entry of new firms. Firms and buyers are all well informed of prices
and products of all firms in the industry.
2. Monopolistic competition is a market with many firms that produce similar but slightly different
goods.
3. Oligopoly is a market in which a small number of firms compete and each firm may produce almost
identical or differentiated goods.
4. Monopoly is a market in which only one firm produces the entire output of the industry. There are
no close substitutes for the monopolist's p
Is the U.S. economy competitive? Is it becoming more competitive or less competitive?
The U.S. economy would be considered competitive since three-quarters of the value of goods and services bought are in markets characterized as perfect competition or monopolistic competition. The U.S. economy has become increasingly competitive over the decades.
What are the two ways in which economic activity can be coordinated?
Firms and markets both coordinate resources.
What determines whether a firm or markets coordinate production?
Firms coordinate resources when they can do so at lower cost than can a market.
1. Firms may reduce transactions costs, which are the costs arising from finding someone with whom
to do business, reaching agreement on the price and other aspects of the exchange, and ensuring that the terms of the agreement are fulfilled.
2. Firms can capture economies of scale, which occurs when the cost of producing a unit falls as its output
rate increases.
3. Firms can capture economies of scope, where one firm can use specialized inputs to produce a range
of different goods at a lower cost than otherwise.
4. Firms can engage in team production, in which the individuals specialize in mutually supportive tasks.
Firms coordinate economic activity when they can perform a task more efficiently than markets can. In such a situation, it is profitable to set up a firm. If markets can perform a task more efficiently than a firm can, firms will use markets, and any attempt to set up a firm to replace such market coordination will be doomed to failure
What are the main reasons why firms can often coordinate production at a lower cost than markets can?
Firms can often coordinate production at a lower cost than can markets because firms lower transactions costs and achieve economies of scale, scope, and team production. These opportunities are not present when markets coordinate production.
Distinguish between the short run and the long run.
The short run is a period of time during which the quantity of at least one factor of production is fixed and cannot be changed. The long run is a period of time long enough so that the quantities of all factors of production can be varied. [Show Less]