Slide 1After studying this chapter, you will be able to:Slide 3The Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemThe Firm and Its Economic ProblemTechnological and Economic EfficiencyTechnological and Economic EfficiencyTechnological and Economic EfficiencySlide 22Information and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationInformation and OrganizationMarkets and the Competitive EnvironmentMarkets and the Competitive EnvironmentMarkets and the Competitive EnvironmentMarkets and the Competitive EnvironmentMarkets and the Competitive EnvironmentMarkets and the Competitive EnvironmentMarkets and the Competitive EnvironmentMarkets and the Competitive EnvironmentProduce or Outsource? Firms and MarketsProduce or Outsource? Firms and MarketsProduce or Outsource? Firms and MarketsProduce or Outsource? Firms and MarketsSlide 50Slide 5110ORGANIZING PRODUCTION© 2014 Pearson Addison-WesleyAfter studying this chapter, you will be able to:¨Explain the economic problem that all firms face¨Distinguish between technological efficiency and economic efficiency¨Define and explain the principal–agent problem¨Distinguish among different types of markets¨Explain why markets coordinate some economic activities and why firms coordinate others© 2014 Pearson Addison-WesleyThe invention of the World Wide Web has paved the way for the creation of thousands of profitable businesses, such as Facebook, Apple, and Google.Most of the firms don’t make the things they sell. They buy them from other firms. For example, Apple doesn’t make the iPhone. Intel makes its memory chip and Foxconn assembles the iPhone. Why doesn’t Apple make its iPhone? How do firms decide what to make themselves and what to buy from other firms?How do the millions of firms around the world make their business decisions?© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemA firm is an institution that hires factors of production and organizes them to produce and sell goods and services.The Firm’s GoalA firm’s goal is to maximize profit. If the firm fails to maximize its profit, the firm is either eliminated or taken over by another firm that seeks to maximize profit.© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemAccounting ProfitAccountants measure a firm’s profit to ensure that the firm pays the correct amount of tax and to show it investors how their funds are being used. Profit equals total revenue minus total cost. Accountants use Internal Revenue Service rules based on standards established by the Financial Accounting Standards Board to calculate a firm’s depreciation cost.© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemEconomic AccountingEconomists measure a firm’s profit to enable them to predict the firm’s decisions, and the goal of these decisions is to maximize economic profit.Economic profit is equal to total revenue minus total cost, with total cost measured as the opportunity cost of production.© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemA Firm’s Opportunity Cost of ProductionA firm’s opportunity cost of production is the value of the best alternative use of the resources that a firm uses in production.A firm’s opportunity cost of production is the sum of the cost of using resources Bought in the market Owned by the firmSupplied by the firm's owner© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemResources Bought in the MarketThe amount spent by a firm on resources bought in the market is an opportunity cost of production because the firm could have bought different resources to produce some other good or service.© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemResources Owned by the FirmIf the firm owns capital and uses it to produce its output, then the firm incurs an opportunity cost.The firm incurs an opportunity cost of production because it could have sold the capital and rented capital from another firm.The firm implicitly rents the capital from itself. The firm’s opportunity cost of using the capital it owns is called the implicit rental rate of capital.© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemThe implicit rental rate of capital is made up of1. Economic depreciation2. Forgone interestEconomic depreciation is the change in the market value of capital over a given period.The interest forgone is the return on the funds used to acquire the capital.© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemResources Supplied by the Firm’s OwnerThe owner might supply both entrepreneurship and labor.The return to entrepreneurship is profit.The profit that an entrepreneur can expect to receive on average is called normal profit. Normal profit is the cost of entrepreneurship and is an opportunity cost of production.© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemIn addition to supplying entrepreneurship, the owner might supply labor but not take a wage. The opportunity cost of the owner’s labor is the wage income forgone by not taking the best alternative job.Economic Accounting: A SummaryEconomic profit equals a firm’s total revenue minus its total opportunity cost of production.The example in Table 10.1 on the next slide summarizes the economic accounting. Figure© 2014 Pearson Addison-WesleyThe Firm and Its Economic Problem© 2014 Pearson Addison-WesleyThe Firm and Its Economic ProblemDecisionsTo maximize profit, a firm must make five basic decisions:1. What to produce and in what quantities2. How to produce3. How to organize and compensate its managers and workers4. How to market and price its products5. What to produce itself and what to buy from other firms© 2014 Pearson Addison-WesleyThe Firm and Its Economic