Chapter 7
Business Firms
 An organization that uses resources to produce goods
and services that are sold to consumers, other firms or
the government
 Shirking – the behavior of a worker who is putting
forth less than the agreed to effort
 Monitoring – to have a person responsible to
coordinate team production, to reduce shirking
Three type of firms
 Sole proprietorships
 Partnerships
 Corporations
Advantages of sole proprietorships
 Easy to form and to dissolve
 All decision making power resides with
the sole proprietor
 The profit of the firm is taxed only
once.
Disadvantages of Sole
proprietorships
 The sole proprietor faces unlimited
liability
 Limited ability to raise funds
 Ends with retirement or death of the
proprietor
Advantages of partnerships
 Benefit of specialization
 Profits are taxed only once. No corporate tax, just
personal income tax.
Disadvantages of partnerships
 General Partners face unlimited liability
 Decision making can be complicated and frustrating,
if the partners do no agree
Advantages of Corporations
 Owners (stockholders) are not personally liable for the
debts of the company
 Companies continue to exist even if one or more
owners sell their shares or die.
 Corporations can raise large amounts of money by
selling stock
Disadvantages of Corporations
 Corporations are subject to double taxation.
 Corporations are complicated to set up.
Franchise
 A contract by which a firm (usually a corporation) lets
a person or group use its name and sell its goods in
exchange for certain payments or requirements
 Advantages – national advertising, buying a successful
business
 Disadvantages – sometimes franchiser fails to provide
financial support and training, franchisee does not
provide the quality that the franchiser expects,
expensive
Ethics in Business
 Ralph Nader –
 believes that businesses have the responsibility to
provide their customers with full information about the
products they sell.
 Businesses should treat their employees well
 Milton Friedman
 There is one and only one social responsibility of
business – to use its resources and engage in activities
designed to increase its profits so long as it stays within
the rules of the game
 Asymmetric Information
Locations of businesses
 Why are so many businesses located so close to one
another?
Costs
 Fixed cost – A cost, or expense, that is the
same no matter how many units of a good
are produced.
 Variable cost - A cost, or expense, that
changes with the number of units of a good
produced.
 Total cost – The sum of fixed and variable
costs
Costs
 Average Total Cost – The total cost divided by the
quantity of output
 Marginal Cost – The cost of producing an additional
unit of a good; the change in total cost that results
from producing an additional unit of output
Revenue
 Marginal Revenue – The revenue from selling an
additional unit of a good. The change in total revenue
that results from selling an additional unit of output.
 Marginal Revenue (MR) =ΔTR/ΔQ
 How much to produce?
 MR>MC - - Produce
 MC>MR - - Do not produce
Every firm wants to maximize
Profits
TC=FC + VC
TR= P x Q
Profit (or loss)= TR-TC
How many workers should a
firm hire?
 Law of diminishing returns: if additional units of one
resource are added to another resource in fixed supply,
eventually the additional output will decrease.