Chapter 6
The Firm: Production and Costs
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Types of Business Organizations
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Sole Proprietorship – 1 owner/manager
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Easy to start and run
Total control
Unlimited liability
Limited life
Partnership – 2 or more owner/manager
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Specialization
Unlimited liability
Corporations – separation of owners and management
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Principal-agent problem
Limited liability
Large amount of funds available
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Selling stock
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Investors will invest if firms that maximize profits
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New York Stock Exchange
Unlimited life
Double taxation
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Shareholders get dividends
S Corporation and LLC’s avoid this problem
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Business combine factors of production
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Production function – relationship between inputs and
maximum output
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Physical Product – output of each worker
Average Physical Product – output/inputs
Marginal Physical Product – Change in output/change in inputs
Diminishing Returns – As you add more of an input at
some point output increases at a decreasing rate
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All production occurs here
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The firm faces its costs
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Totals
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Fixed costs – do not vary with output
Variable costs – do vary with output
Total Costs = FC + VC
Averages
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Average Fixed Costs = FC/output
Average Variable Costs = VC/output
Average Total Costs = AFC + AVC = TC/output
Marginal Costs = Change in TC/change in output
Time
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Short run – at least on input is fixed
Long run – all inputs can be changed
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Profits
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Accounting Profits = Total Revenue – Explicit
Costs
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Total Revenue = Price x Output
Explicit costs are out of pocket expenses
Tells how much you made
Economic Profit = Total Revenue – Explicit
Costs – Opportunity Costs
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Tells if you made the right decision