Definition of a firm and goal of a firm why do firms exist Firm an institution that hires factors of production and organizes those factors to produce and sell goods and services The firm s goal to maximize profit Concept of economic profit accounting profit and normal profit compute one of them Economic profit equal to total revenue minus total cost measured as the opportunity cost of production TR TC Accounting profit total revenue minus explicit cost Normal profit average profit return made by similar firms Efficiency technological vs economic efficiency A factory will have a few ways to produce something identify the efficient method Technological efficiency occurs when the firm produces a given output by using the least amount of inputs Economic efficiency occurs when the firm produces a given output at the least cost Depends on the relative costs of resources uses a smaller amount of the more expensive resource and a larger amount of the less expensive resource Legal forms of business organization proprietorship etc pros and cons of each type i e limited liability is a disadvantage of which type Type of Firm Proprietorship a firm with a single owner proprietor who has unlimited liability Pros Easy to set up Simple decision making Profits taxed only once as owner s income Bad decisions not checked Cons Owner s entire wealth at risk Firm dies with owner Cost of capital and labor is higher Partnership a firm with two or more owners who have unlimited liability Corporation a firm owned by one or more limited liability stockholders many Easy to set up Diversified decision making Can survive withdrawal of partner Profits taxed only once as owner s income Owners have limited liability Large scale low cost capital available Professional management not Achieving consensus may be slow and expensive Owners entire wealth at risk Withdrawal of partner may create capital shortage Cost of capital and labor is relatively high Complex management structure can make decisions slow and expensive Retained profits taxed twice as company profit and as stockholders capital gains 1 owners restricted by ability of owners Perpetual life Long term labor contracts cut labor costs Definitions of four types of markets and examples of each market in the US i e Corn production is which kind of market Perfect competition most extreme form of competition o Arises when there are many firms each selling an identical product many buyers and no restrictions on the entry of new firms into the industry o i e market for corn rice and other grain crops Monopolistic competition o A market structure in which a large number of firms compete by making similar but slightly different products Product differentiation making a product slightly different from the product of a competing firm o i e pizzas are slightly different Oligopoly o A market structure in which a small number of firms compete o i e computer software airplane manufacture Monopoly least extreme form of competition o Arises when there is one firm which produces a good or service that has no close substitutes and in which the firm is protected by a barrier preventing the entry of new firms o i e Microsoft corporation Measures of concentration HHI and the concentration ratio compute and say which market it is the four firm concentration ratio o four firm concentration ratio the percentage of the value of sales accounted for by the four largest firms in an industry ranges from 0 perfect competition to 100 monopoly less than 60 competitive market more than 60 oligopoly o main measure used to assess market structure the Herfindahl Hirschman Index HHI o HHI the square of the percentage market share of each firm summed over the largest 50 firms in a market If there are 4 firms in a market and the market shares of the firms are 50 25 15 and 10 the HHI 502 252 152 102 3450 2 o In perfect competition the HHI is small In monopoly the HHI is large o Less than 1000 competitive between 1000 1800 moderately competitive exceeds 1800 uncompetitive Characteristics Number of firms Product Perfect Competition Many Identical Monopolistic competition Many Differentiated None None 0 Barriers to entry Firm s control over price Concentration ratio HHI approx Examples None Some Low Characteristics of long run vs short run Oligopoly Monopoly Few Either identical or differentiated Moderate Considerable High One No close substitutes High Considerable or regulated 100 Less than 100 Wheat corn 101 999 Food clothing More than 1 000 Computer chips 10 000 Local water supply Chapter 11 output and cost The short run fixed The long run o Short run a time frame in which the quantity of at least one factor of production is Usually capital land and entrepreneurship are fixed factors of production Plant the fixed factors of production o Short run decisions are easily reversed The firm can increase or decrease its output in the short run by increasing or decreasing the amount of labor it hires o Long run a time frame in which the quantities of all factors of production can be varied o To increase output in the long run a firm can change its plant as well as the quantity of labor it hires o Long run decisions are not easily reversed Concept of total product average product marginal product definition shape of graph and formula Total product Marginal product o The maximum output that a given quantity of labor can produce o Similar to PPF curve increases sharply and then slows o The increase in total output that results from a one unit increase in the quantity of labor employed input with all other inputs remaining the same o Measured by slope of total product curve o Change in total output change in total input TP L L labor 3 Average product o Equal to total product output divided by the input labor machinery etc o Tells how productive workers are on average o Upside down u shape curve Relationship between marginal product and average product For the number of workers at which marginal product exceeds average product average product is increasing For the number of workers at which marginal product is less than average product average product is decreasing Concept of Total cost average cost and marginal cost definition shape of graph and formula Given a graph without labels label the lines Total Cost in the short run Total cost TC the cost of all the factors of production a firm uses upward slope o Total fixed cost TFC the cost of the firm s fixed factors straight line Total fixed cost is the same