The Role of Business
Chapter 7
And
Chapter 3
The Firm

Any organization that brings together
the factors of production for the
purposes of producing and/or
distributing goods and services.
• Location
• Size
• Organization
Business Organizations
Sole Proprietorship
One owner
 Started - obtain business license and
financing
 74% of all businesses
 6% of all business revenues
 Annual average revenue - $47,000
 Oldest and most common form

Sole Proprietorship

Advantages
• easy to form and
dissolve
• all decision-making
power resides with
the owner
• profits taxed once

Disadvantages
• unlimited liability
• limited life
• limited fund raising
ability
Partnership
Two or more owners
 Started - obtain license, sign partnership agreement, and obtain financing
 8% of all businesses
 4% of all business revenues
 Average annual revenue - $280,000
 Preferred by many professionals

Partnerships

Advantages
• easy to form
• allows for effective
specialization
• profits taxed once
• reduces monitoring
of job performance

Disadvantages
• unlimited liability
• limited life
• decision making can
be more costly
Corporation
Many owners called shareholders
 Started - draw up corporate charter, sell
stock, elect directors, and hire officers
 18% of all businesses
 90% of all business revenues
 Average annual revenue - $2,700,000
 Dominates in economy

Corporate Structure
Shareholders
Provide funds
Elect Board of Directors
Board of Directors
Set policy
Hire officers
Officers
President
Treasurer and Secretary
Run daily operations and supervise department managers
VP Advertising
Marketing the product
VP Manufacturing
Assembling the product
VP Distribution
Delivering product to
the stores and
tracking inventory
VP Operations
Planning,
finance, and
personnel
VP Legal
Advise officers
on laws concerning
the company
Corporation

Advantages
• limited liability
• unlimited life
• excellent position to
raise funds

Disadvantages
• profits taxed twice
• separation of
ownership and
control
The S Corporation
Designed for small businesses - fewer
than 75 shareholders
 Enjoy limited liability and other
corporation advantages
 Profits must be immediately distributed
are are taxed as personal income avoid double taxation

Other Forms of Business
Organization
Government
Corporation
Owned and
operated by local,
state or federal
government
Not-for-profit
Corporation
Cooperative
Business Finance
Why do business firms need
money?
Meet everyday expenses
 Replace and expand inventory
 Expand plant size and equipment
 Meet interest payments on debt

Short vs. Long-term Financing

Short-Term
• Less than one-year
• Funds for operation
• Forms
– Trade Credit
– Bank Loans

Long-Term
• More than a year
• Expansion and/or
renovation
• Forms
– Retained Earnings
– Long-Term Loans
– Equity financing
• Stocks
• Bonds
Production and Productivity
U. S. Productive Capacity

Why can U. S. outproduce all other
nations?
• The quantity and quality of its resources
– abundant supply of land, labor, capital, and
entrepreneurship
– BUT - world supplies of natural resources are
shrinking
• Its productivity
– efficiency with which we produce goods and
services
Productivity



The efficiency of a
factor of production
The ability to create
more goods and
services from less
resources
Output /hour/worker
Production


All goods and
services are the
result of combining
labor, capital, and
land.
Production function
• Q=f(L,K)

Entrepreneurs do
the organizing
The Reward of Organizing for
Production

Profit Motive
• Revenue = P x Q
• Costs = wages +
rents + interest +
normal profit
• Revenue - Costs =
economic profit
Things to Consider
What is the least-combination of labor
and machinery that I can use in production?
 How many should I produce?
 What price should I charge?

Law of Diminishing Marginal
Returns

As you add
additional factors of
production,
productivity
increases up to a
point. After that
point, productivity
decreases.
• Fixed and Variable
inputs
Economies of Scale

Reducing per unit costs by expanding
production
•
•
•
•
•
Specialization
Quantity Discounts
Greater productive equipment
Access to credit
Research, development, and by-products
Diseconomies of Scale
Further expansion causes per unit
costs to increase
Management costs
Productivity in the U.S.

Standard of living
• improves when supply of goods and
services increase faster than population

How can we improve productivity?
• Invest in capital equipment
– technology
• Invest in “human capital”
– education and training
Market Structure
The environment in which the firm sells
its product
 Essential characteristics

•
•
•
•

Number of sellers
Barriers to entry
Nature of the product
Use of nonprice advertising
Characteristics determine the firm’s
ability to control price
Perfect Competition

Number of Sellers
• lots and lots

Barriers to entry
• none

Nature of product
• standardized

Nonprice advertising
• none (industry)

Control over price
• none
Monopolistic Competition

Number of sellers
• lots

Barriers to entry
• a few

Nature of product
• differentiated

Nonprice advertising
• extensive

Control over price
• little
Oligopoly

Number of sellers
• few

Barriers to entry
• substantial

Nature of product
• differentiated

Nonprice advertising
• extensive

Control over price
• some
Monopoly

Number of sellers
• one

Barriers to entry
• total

Nature of product
• unique

Nonprice advertising
• none (image)

Control over price
• much
Types of Monopoly

Geographic

Government

Technological

Natural
Pricing in Perfect Competition
The market sets price for the firm in perfect competition.
$70
S1
$70
$60
$60
$50
$50
$40
$40
$30
$30
$20
$20
D1
$10
$0
d1
$10
$0
0
1
2
3
Market
4
5
6
0
1
2
3
The Firm
4
5
6
Market Structure and Elasticity
of Demand
80
70
60
50
40
Perfect Competition
Monopolistic
Competition
Oligopoly
30
20
10
0
Monopoly
Measuring Monopoly Power

Concentration Ratio
• % of an industry’s
total output produced
by the four largest
firms

Examples
• Cars - 98
• Soft drinks - 75
• Women’s dresses - 8
Merging toward Monopoly

Pool
• agreement to split market and set price

Trust
• shareholders place firm in hands of trustees

Holding Companies
• own controlling interest in other corporations

Interlocking Directorates
• same people on the board of several firms

Cartel
• several independent firms agree to form monopoly
Government Regulation

Interstate Commerce Act (1887)
• created ICC to regulate railroads

Sherman Antitrust Act (1890)
• prohibited combinations or conspiracies to restrict trade

Clayton Antitrust Act (1914)
• corrected the weaknesses of the Sherman Act

Robinson - Patman Act (1936)
• sought to protect small businesses from unfair competition

Celler - Kefauver Antimerger Act (1950)
• prohibited mergers that would create monopolies
Merging toward Monopoly

Horizontal Merger
• merge with other businesses that are
engaged in the same stage of production

Vertical Merger
• merge with firms at different stages of
production of the same good

Conglomerate Merger
• merge with firms that produce unrelated
products
Pros and Cons

Pros
• Economies of scale
• Global competition
• Expensive to fight in
court
• Unclear that consumer
benefits from break up of
monopolies
• Growth appears natural
• Benefits small companies

Cons
• Higher prices
• Lower output and
standards of living
• Inefficient and wasteful
• Insensitive to consumer
demand
• Unfair competition
• May lead to recession
• Pervert the political
process