1、Organizing ProductionCHAPTER9After studying this chapter you will be able toExplain what a firm is and describe the economic problems that all firms faceDistinguish between technological efficiency and economic efficiencyDefine and explain the principal-agent problem and describe how different types

2、 of business organizations cope with this problemDescribe and distinguish between different types of markets in which firms operateExplain why markets coordinate some economic activities and firms coordinate othersSpinning a WebTim Berners-Lees idea, the World Wide Web, has provided a platform for t

3、he creation of thousands of profitable businesses from tiny owner-operated firms to giant multinationals.This chapter explains the role of firms and the choices they make to cope with scarcity.The Firm and Its Economic ProblemA firm is an institution that hires factors of production and organizes th

4、em to produce and sell goods and services.The Firms GoalA firms goal is to maximize profit. If the firm fails to maximize profits it is either eliminated or bought out by other firms seeking to maximize profit.The Firm and Its Economic ProblemMeasuring a Firms ProfitThe firms goal is to report profi

5、t so that it pays the correct amount of tax and is open and honest about its financial situation with its bank and other lenders.Accountants measure a firms profit using Internal Revenue Service rules based on standards established by the Financial Accounting Standards Board.Economists measure profi

6、t based on an opportunity cost measure of cost.The Firm and Its Economic ProblemOpportunity CostA firms decisions respond to opportunity cost and economic profit.A firms opportunity cost of producing a good is the best, forgone alternative use of its factors of production, usually measured in dollar

7、s.Opportunity cost includes both Explicit costs Implicit costsThe Firm and Its Economic ProblemExplicit costs are costs paid directly in money.Implicit costs are costs incurred when a firm 1. Uses its own capital.2. Uses its owners time or financial resources.The firm can rent capital and pay an exp

8、licit rental cost. Or the firm can buy capital and incur an implicit opportunity cost of using its own capital, called the implicit rental rate of capital.The Firm and Its Economic ProblemThe implicit rental rate of capital is made up of1. Economic depreciation2. Interest forgoneEconomic depreciatio

9、n is the change in the market value of capital over a given period.Interest forgone is the return on the funds used to acquire the capital.The Firm and Its Economic ProblemCost of Owners ResourcesThe owner often supplies entrepreneurial ability and labor.The return to entrepreneurship is profit and

10、the return that an entrepreneur can expect to receive on the averge is called normal profit. The opportunity cost of the owners labor spent running the business is the wage e that the owner forgoes by not working in the best alternative job.The Firm and Its Economic ProblemEconomic ProfitEconomic pr

11、ofit equals a firms total revenue minus its total cost. A firms total cost of production is the sum of the explicit costs and implicit costs. Normal profit is part of the firms total costs, so economic profit is profit over and above normal profit.The Firm and Its Economic ProblemEconomic Accounting

12、: A SummaryTo maximize profit, a firm must make five basic decisions:1. What goods and services to produce and in what quantities2. How to producethe production technology to use3. How to organize and compensate its managers and workers4. How to market and price its products5. What to produce itself

13、 and what to buy from other firmsThe Firm and Its Economic ProblemThe Firms ConstraintsThe firms profit is limited by three features of the environment: Technology constraints Information constraints Market constraintsThe Firm and Its Economic ProblemTechnology Constraints Technology is any method o

14、f producing a good or service. Technology 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. The Firm and Its Economic ProblemInformation Constraints A firm never poss

15、esses complete information about either the present or the future. It 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 limits profit.Th

16、e Firm and Its Economic ProblemMarket Constraints What a 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 will

17、ingness of people to work for and invest in the firm. The expenditures a firm incurs to e these market constraints will limit the profit the firm can make.Technology and Economic EfficiencyTechnological EfficiencyTechnological efficiency occurs when a firm produces a given level of output by using t

18、he least amount inputs. There may be different combinations of inputs to use for producing a given good, but only one of them is technologically inefficient. If it is impossible to produce a given good by decreasing any one input, holding all other inputs constant, then production is technologically

19、 efficient.Technology and Economic EfficiencyEconomic EfficiencyEconomic efficiency occurs when the firm produces a given level of output at the least cost. The economically efficient method depends on the relative costs of capital and labor.The difference between technological and economic efficien

20、cy is that technological efficiency concerns the quantity of inputs used in production for a given level of output, whereas economic efficiency concerns the cost of the inputs used.Technology and Economic EfficiencyAn economically efficient production process also is technologically efficient.A tech

21、nologically efficient process may not be economically efficient.Changes in the input prices influence the value of the inputs, but not the technological process for using them in production.Information and OrganizationA firm organizes production by combining and coordinating productive resources usi

22、ng a mixture of two systems: Command systems Incentive systemsInformation and OrganizationCommand SystemsA command system uses a managerial hierarchy. Commands pass downward through the hierarchy and information (feedback) passes upward. These systems are relatively rigid and can have many layers of

23、 specialized management.Information and OrganizationIncentive SystemsAn incentive system, uses market-like mechanisms to induce workers to perform in ways that maximize the firms profit.Information and OrganizationMixing the SystemsMost firms use a mix of command and incentive systems to maximize pr

24、ofit. They use commands when it is easy to monitor performance or when a small deviation from the ideal performance is very costly. They use incentives whenever monitoring performance is impossible or too costly to be worth doing.Information and OrganizationThe Principal-Agent ProblemThe principal-a

25、gent problem is the problem of devising compensation rules that induce an agent to act in the best interests of a principal. For example, the stockholders of a firm are the principals and the managers of the firm are their agents. Information and OrganizationCoping with the Principal-Agent ProblemTh

26、ree ways of coping with the principal-agent problem are: Ownership Incentive pay Long-term contractsInformation and OrganizationOwnership, often offered to managers, gives the managers an incentive to maximize the firms profits, which is the goal of the owners, the principals. Incentive pay links ma

27、nagers or workers pay to the firms performance and helps align the managers and workers interests with those of the owners, the principal.Long-term contracts can tie managers or workers long-term rewards to the long-term performance of the firm. This arrangement encourages the agents work in the bes

28、t long-term interests of the firm owners, the principals.Information and OrganizationTypes of Business OrganizationThere are three types of business organization: Proprietorship Partnership CorporationInformation and OrganizationProprietorshipA proprietorship is a firm with a single owner who has un

29、limited liability, or legal responsibility for all debts incurred by the firmup to an amount equal to the entire wealth of the owner.The proprietor also makes management decisions and receives the firms profit.Profits are taxed the same as the owners other e.Information and OrganizationPartnershipA

30、partnership is a firm with two or more owners who have unlimited liability.Partners must agree on a management structure and how to divide up the profits.Profits from partnerships are taxed as the personal e of the owners.Information and OrganizationCorporation A corporation is owned by one or more

31、stockholders with limited liability, which means the owners who have legal liability only for the initial value of their investment.The personal wealth of the stockholders is not at risk if the firm goes bankrupt.The profit of corporations is taxed twiceonce as a corporate tax on firm profits, and t

32、hen again as e taxes paid by stockholders receiving their after-tax profits distributed as dividends.Information and OrganizationPros and Cons of Different Types of FirmsEach type of business organization has advantages and disadvantages. Information and OrganizationProprietorshipsAre easy to set up

33、Managerial decision making is simpleProfits are taxed only onceBut bad decisions made by the manager are not subject to reviewThe owners entire wealth is at stakeThe firm dies with the ownerThe cost of capital and labor can be highInformation and OrganizationPartnershipsAre easy to set upEmploy dive

34、rsified decision-making processesCan survive the withdrawal of a partnerProfits are taxed only onceBut achieving a consensus about managerial decisions difficultOwners entire wealth is at riskCapital is expensiveInformation and OrganizationCorporation Limited liability for its ownersLarge-scale and

35、low-cost capital that is readily availableProfessional managementLower costs from long-term labor contractsBut complex management structure may lead to slow and expensive Profits taxed twiceas corporate profit and shareholder e.Information and OrganizationThe Relative Importance of Different Types a

36、nd FirmsThere are a greater number of proprietorships than other form of business, but corporations account for the majority of revenue received by businesses. Information and OrganizationFigure 9.1(a) shows the frequency of each type of business organization.Figure 9.1(b) shows the dominant type of

37、 business organization for various industries.Markets and the Competitive EnvironmentEconomists identify four market types:1. Perfect competition2. Monopolistic competition3. Oligopoly4. MonopolyMarkets and the Competitive EnvironmentPerfect competition is a market structure withMany firmsEach sells

38、 an identical productMany buyersNo restrictions on entry of new firms to the industryBoth firms and buyers are all well informed about the prices and products of all firms in the industry.Markets and the Competitive EnvironmentMonopolistic competition is a market structure withMany firmsEach firm pr

39、oduces similar but slightly different productscalled product differentiationEach firm possesses an element of market powerNo restrictions on entry of new firms to the industry Markets and the Competitive EnvironmentOligopoly is a market structure in whichA small number of firms compete.The firms mig

40、ht produce almost identical products or differentiated products.Barriers to entry limit entry into the market. Markets and the Competitive EnvironmentMonopoly is a market structure in whichOne firm produces the entire output of the industry.There are no close substitutes for the product.There are ba

41、rriers to entry that protect the firm from competition by entering firms.Markets and the Competitive EnvironmentMeasures of ConcentrationTwo measures of market concentration in common use are The four-firm concentration ratio The HerfindahlHirschman index (HHI)Markets and the Competitive Environment

42、The Four-Firm Concentration RatioThe four-firm concentration ratio is the percentage of the total industry sales accounted for by the four largest firms in the industry.The HerfindahlHirschman index The HerfindahlHirschman index (HHI) is the square of percentage market share of each firm summed over

43、 the largest 50 firms in the industry.The larger the measure of market concentration, the less competition that exists in the industry.Markets and the Competitive EnvironmentConcentration Measures for the U.S. EconomyFigure 9.2 shows some concentration ratios and HHIs for the United States.Concentra

44、tion measures are a useful indicator of the degree of competition in a market. A market with an HHI of less than 1,000 is regarded as being highly competitive. A market with an HHI between 1,000 and 1,800 is regarded as being moderately competitive. A market with an HHI greater than 1,800 is regarde

45、d asbeing petitive. Markets and the Competitive EnvironmentFigure 9.2 shows the four-firm concentration ratio for various industries in the United States.Markets and the Competitive EnvironmentLimitations of Concentration MeasuresThe main limitations of only using concentration measure as determinants of