Chapter 6 Introducing supply decisions David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9th Edition, McGraw-Hill, 2008 PowerPoint presentation by Alex Tackie and Damian Ward 1

Forms of business organisation Sole trader owned by an individual; entitled to income and responsible for losses Partnership jointly owned by two or more people unlimited liability Company ownership divided among shareholders legal entitlement to produce and trade limited liability shares of public companies resold on the stock exchange See Section 6-1 in the main text. 2

Some key terms Revenues the amount a firm earns by selling goods and services in a given period Costs the expenses incurred in producing goods and services during the period Profits the excess of revenues over costs See Section 6-2 in the main text. 3

A firm’s balance sheet Assets what the firm owns Liabilities what the firm owes Balance sheet lists a firm’s assets and liabilities at a point in time See Section 6-2 in the main text. 4

Snark International balance sheet 31 December 2007 ASSETS Liabilities Cash 40 Loans 90 Accounts Receivable 70 Mortgage 150 Stocks 100 Bank Credit 60 Factory Building 330 Total Liabilities 300 Net Worth 240 Total 540

Costs and the economist Accounting cost actual payments made by a firm in a period Opportunity cost amount lost by not using a resource in its best alternative use Economists include opportunity cost in a firm’s total costs Economic profit is more than the accountant’s profit because of the opportunity cost. See Section 6-2 in the main text. 6

The production decision For any output level, the firm attempts to minimize costs Assume the firm aims to maximize profits Profits depend on both COSTS and REVENUE each of which varies with the level of output Marginal cost (MC) is the rise in total cost if output increases by 1 unit Marginal revenue (MR) is the rise in total revenue if output increases by 1 unit See Sections 6-5 in the main text. 7

Maximising profits If MR > MC, an increase in output will increase Q1 E MC, MR MC MR If MR < MC, a decrease in output will increase profits. So profits are maximized when MR = MC at Q1 See Section 6-3 in the main text, and Figure 6-3. (as long as the firm covers variable costs) 8

Costs, Revenue and Output Total Cost Marginal Cost Price Total Revenue Marjinal Revenue 10 - 1 25 15 21 2 36 11 20 40 19 3 44 8 57 17 4 51 7 18 72 5 59 85 13 6 69 16 96 81 12 105 9

Will firms try to maximise profits? Large firms are not run by their owners there is separation of ownership and control Managers may pursue different objectives e.g. size, growth But firms not maximising profits may be vulnerable to takeover or managers may be given share options to influence their incentive to maximise profits See Section 6-3 in the main text. 10