Key issuesFirmSources of production: U.S.Government's share of productionLegal forms of for-profit firmsCorporationsSlide 7Limited Liability Companies (LLCs)Management of FirmsObjectivesManagers vs. ownersSlide 12Other major fraudsGovernment acts (belatedly)OptionsSlide 16Problem with optionsProduction efficiencyProduction efficiency and profitProductionProduction functionProduction function with 2 inputsVariability of inputs over timeShort-run productionExampleSlide 26Slide 27Marginal product of labor (MPL)Average product of labor (APL)Graphical relationshipsEffect of extra laborCobb-DouglasSolved problemAnswerAnswer (continued)Law of diminishing marginal returns (product)Mistake 1Mistake 2 ("Dismal Science")Slide 39Technical progressLong-run production: Two variable inputsIsoquantSlide 43Family of IsoquantsSlide 45Isoquants and indifference curves3 major properties of isoquantsShape of isoquantsPerfect Substitutes: Fixed ProportionsCannot be SubstitutedImperfectly Substitutable InputsSubstituting inputsMarginal rate of technical substitution (MRTS)How the Marginal Rate of Technical Substitution Varies Along an IsoquantSubstitutability of inputsWhy MRTS falls as we substitute L for KReturns to scaleConstant returns to scale (CRS)Increasing returns to scale (IRS)Decreasing returns to scale (DRS)Slide 61Slide 62Slide 63Slide 64(a) Thread Mill: Decreasing Returns to Scale(b) Shoe Factory: Constant Returns to Scale(c) Concrete Blocks and Bricks: Increasing Returns to ScaleVarying returns to scaleVarying Scale EconomiesRelative productivityEfficiency, Actual Output as Percentage of Efficient OutputSlide 72Slide 73Neutral technical changeSlide 75Organizational changeApplication: Just-in-time deliveryDell1 Ownership and management of firms2 Production3 Short-run production4 Long-run production5 Returns to scale6 Productivity and technical changeKey issues1. ownership and management of firms2. production (using existing technologies)3. short-run production: one variable and one fixed input4. long-run production: two variable inputs5. returns to scale6. productivity and technical changeFirm an organization that converts inputs (labor, materials, and capital) into outputs (goods and services)Sources of production: U.S.•firms: 84% of U.S. national production•government: 12%•nonprofit institutions: 4%•private households: 0.2%Government's share of production•United States: 12%•Ghana 37%•Zambia 38%•Sudan 40%•Algeria 90%•Bangladesh, Paraguay, and Nepal 3%Legal forms of for-profit firms•sole proprietorships: owned and run by a single individual•partnerships: jointly owned and controlled by two or more people•corporations: owned by shareholders in proportion to the numbers of shares of stock they holdCorporations•shareholders elect a board of directors who run the firm(Lucent’s directors)•board of directors usually hire managersBusiness Sales Number of FirmsSole proprietorships 6% 75%Partnerships 5% 7%Corporations 90% <20%Limited Liability Companies (LLCs)•due to changes in corporate and tax laws over last decade, LLCs have become common•owners are liable only to the extent of their investment (as in a corporation)•can play an active role in management (as in a partnership or sole proprietorship)•when an owner leaves, the LLC does not have to dissolve as with a partnershipManagement of Firms•small firm owner usually manages•corporations and larger partnerships use managersObjectives •conflicting objectives between owners, managers, and other employees•employees want to maximize their earnings or utility•owners want to maximize profit: = R - C•R = revenue = pq = price x quantity•C = costManagers vs. owners The 2000 stock market crash followed by revelations that managers had perpetrated outrageous frauds (Enron, WorldCom)•managers engaged in actions that directly benefited themselves at expense of unsuspecting shareholders•often frauds involved misreporting of earnings to mislead investors and raise the price of the stock temporarilyOther major frauds•large telecommunication firm, WorldCom (now called MCI), was thrown into bankruptcy as a result of poor investments that were allegedly not properly handled in its accounts nor revealed•WorldCom made a loan of about $400 million to its CEOGovernment acts (belatedly)•SEC began to look into tightening accounting standards to prevent firms from reporting income in ways that, while technically accurate, distort a companies overall financial picture•Congress passed the Sarbanes-Oxley law, which places increased reporting requirements on firms and attempts to limit possible conflicts of interest between managers and shareholders.Options•use of options as a device to pay and motivate employees came under scrutiny•an option provides the owner with the right to buy a stock at a fixed price•an option at a strike price of $10 allows its owner to purchase one share of stock for $10 even if stock price is $50•firms give options to employees, especially in high tech companies, to motivate them•if an employee receives an option for $10 when the stock is trading at $5, option is not worth much•option becomes valuable if the stock price rise substantially: creates an incentive for employees to act to raise stock priceProblem with options•some believe that options so cloud executives’ thinking that it encourages them to misreport earnings and engage in actions that cause stock prices to rise for long enough that they can exercise their options•but an executive should expect that a fraudulent short-run strategy will be discovered when the company’s stock•use of accounting gimmicks and even the use of options likely to diminish: In 2003, Microsoft, one of the largest users of options as a payment device, announced it would use stock ownership rather than options to motivate employees.Production efficiency given current knowledge about technology and organization:•current level of output cannot be produced with fewer inputs •given quantity of inputs used, no more output could be producedProduction efficiency and profit production efficiency is•a necessary condition to maximize profit•not a sufficient condition to maximize profit (must produce optimal output level)Production•production process: transform inputs or factors of production into outputs•common types of inputs:•capital (K): buildings and equipment•labor services (L)•materials (M):
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