Chapter 10 ECO101

What is a firm?

A firm is an institution that hires factors of production andorganizes them to produce and sell goods and services.​

The goal of a firm: to maximize profits and if it fails to do that, it will be eliminated or taken over by another firm that seeks to maximize profit.

Accounting Profit​

Accountants measure a firm’s profit to ensure that the firmpays the correct amount of tax and to show it investorshow their funds are being used. ​

Profit = total revenue - total cost

Accountants use IRS rules based on standards established by the Financial Accounting Standards Board to calculate a firm’s depreciation cost.​

Economic accounting

Economists measure a firm’s profit to enable them topredict the firm’s decisions, and the goal of thesedecisions is to maximize economic profit.​

Economic profit = total revenue - total cost, total cost is measured at the opportunity cost of production.

The Firm’s Decisions​

To maximize profit, a firm must make five basic decisions:​

1. What to produce and in what quantities​

2. How to produce​

3. How to organize and compensate its managers andworkers​

4. How to market and price its products​

5. What to produce itself and what to buy from other firms

Technological and ​
Economic Efficiency​

Technological efficiency occurs when a firm uses the least amount of inputs to produce a given quantity of output.

Economic efficiency occurs when the firm produces a given quantity of output at the least cost. ​

The difference between technological and economic efficiency is that technological efficiency concerns the quantity of inputs used in production for a given quantity of output, whereas economic efficiency concerns the cost of the inputs used.​

Markets and the​
Competitive Environment​

Perfect competition is a market structure with​

• Many firms and many buyers​

• All firms sell an identical product​

• No restrictions on entry of new firms to the industry​

• Both firms and buyers are all well informed about the prices and products of all firms in the industry

Monopolistic competition is a market structure with​

• Many firms​

• Each firm produces similar but slightly different products—called product differentiation​

• Each firm possesses an element of market power​

• No restrictions on entry of ​
  new firms to the industry ​

Oligopoly is a market structure in which​

• A small number of firms compete.​

• The firms might produce almost identical products or differentiated products.​

• Barriers to entry limit entry into the market. ​

Monopoly is a market structure in which​

• One firm produces the entire output of the industry.​

• There are no close substitutes for the product.​

• There are barriers to entry that protect the firm from ​
  competition by entering firms.​

A Firm’s Opportunity Cost of Production​

Includes resources:

• Bought in the market:

The firm incurs an opportunity cost when it buys resources in the market.​

The firm incurs an opportunity cost of production because the firm could have bought different resources to produce some other good or service.

• Owned by the firm​:

If 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’s opportunity cost of using the capital it owns is called the implicit rental rate of capital.

• Supplied by the firm's owner:

The 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. ​