Chapter 7 Business organization and behaviour David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 6th Edition, McGraw-Hill, 2000 Power Point presentation by Peter Smith

7.1 The theory of supply Costs of production Revenues Firms decisions about how much output to supply depend upon the costs of production and the revenue they receive from selling the output. Firm chooses level of output

7.2 Forms of business organization n Sole trader – owned by an individual entitled to income and responsible for losses n Partnership – jointly owned by two or more people – unlimited liability n Company – ownership divided among shareholders – legal entitlement to produce and trade – limited liability – shares of public companies resold on the stock exchange

7.3 Some key terms n Revenues – the amount a firm earns by selling goods and services in a given period n Costs – the expenses incurred in producing goods and services during the period n Profits – the excess of revenues over costs

7.4 A firms balance sheet n Assets – what the firm owns n Liabilities – what the firm owes n Balance sheet – lists a firms assets and liabilities at a point in time

7.5 Snark International balance sheet 31 December 2000

7.6 Costs and the economist n Accounting cost – actual payments made by a firm in a period n Opportunity cost – amount lost by not using a resource in its best alternative use n Supernormal profit – profit over and above the return earned at the market rate of interest n Economists include opportunity cost in a firms total costs

7.7 The production decision n For any output level, the firm attempts to mimimize costs n Assume the firm aims to maximize profits n Profits depend on both COSTS and REVENUE – each of which varies with the level of output n Marginal cost (MC) is the rise in total cost if output increases by 1 unit. n Marginal revenue (MR) is the rise in total revenue if output increases by 1 unit

7.8 Maximizing profits Output Q1Q1 E MC, MR MC MR 0 If MR > MC, an increase in output will increase profits. If MR < MC, a decrease in output will increase profits. So profits are maximized when MR = MC at Q 1 (so long as the firm covers variable costs)

7.9 Will firms try to maximize profits? n Large firms are not run by their owners – there is separation of ownership and control n Managers may pursue different objectives – e.g. size, growth n But firms not maximizing profits may be vulnerable to takeover – or managers may be given share options to influence their incentive to maximize profits