Forms of Business Organization Economics Breedlove

Quick Write As a result of both Absolute and Comparative Advantage, economies will opt towards specialization. Explain how specialization is both a “good” and “bad” thing for economies. Be specific.

Sole Proprietorship Advantages Owner is always the boss Easiest to organize Profits go to the individual owners Owners can react quickly to changes in industry No corporate income tax Disadvantages Funding is limited Lack of opportunity for employees There is unlimited liability Owner’s death = end of the firm

Partnership Advantages Profits go to the individual owners Owners can react quickly to changes in industry No corporate income tax More capital funds to start-up and expand business Disadvantages Funding is limited Each owner is more personally liable There is unlimited liability Often requires a lawyer to establish Owner’s death = end of the firm

Corporations Advantages Can operate indefinitely Limited Liability!!! Ownership can be transferred through stock sale Lots of capital funds to start-up and expand business Can buy/sell shares without ending the business Disadvantages Often requires a lawyer to establish Double taxation (corporate and individual) Management often separate from ownership Government regulation

Four Functions of Business - ALL Identify Consumer Wants  What to Produce? Organize Production  Efficiency (make a profit)  How to produce Allocate Revenue  Who do I pay? How much do I pay? Real Capital Investment  Assuming profit – how do I invest excess capital?

Costs/Revenue/Profit

Costs –Cost Maxims Costs belong to actions, NOT things Costs are incurred by making a choice Costs always lie in the future “Sunk Costs” –Fixed Costs – costs that do not change w/ the quantity of goods & services produced Examples? DEPRECIATION, $ for capital goods, property taxes –Variable Costs – costs that increase with each additional unit produced Examples? Labor, raw materials, utilities –TC = FC + VC (aka “Explicit Costs”)

Fixed, Variable, and Total Costs

Which Costs Matter? Should the firm ONLY consider both fixed and variable costs when making production and pricing decisions? For businesses, the concepts of average and marginal cost need to be taken into consideration

Marginal Cost (MC) The change in total cost when one more unit of output is produced:

Marginal Cost (MC) Curve

Average Total Cost (ATC) Total cost divided by the quantity produced in a given time period:

Marginal Cost vs. Average Cost Marginal cost is a basic determinant of short-run production decisions. Covering marginal cost is a minimal condition for supplying additional output. To remain in business in the long run, firms must cover average total costs. When marginal costs > average total costs firms must determine value of extra production

Revenue & Profits Total Revenue –$ a firm receives from the sale of goods & services –TR = P x Q Profit –Accounting Profit = TR – “Explicit Costs” (TC) $ a firm makes after all costs are covered –Does not take into account Implicit Costs –Economic Profits = TR – “Implicit Costs” Implicit Costs are the owner’s opportunity costs Owner Compensation Normal Rate of Return - $ earned if owner’s investment were placed elsewhere at a “Normal Rate of Return” –Goal is Economic Profits (not Accounting Profits) Economic Profits need to be > than Accounting Profits!!!

SMG Research – Industry Types Energy/Natural Resources Retail Food Services Consumer Goods Technology Military/defense Entertainment Agriculture Medical/Healthcare