Economics - Micro - Organizing Production

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Organizing Production

Types of Opportunity Cost/Relation to Economic Profit

Opportunity cost - return a firm's resources could have earned elsewhere in its next most valuable use.  Consists of both explicit and implicit costs

• Explicit - observable, measureable
• Implicit - nonobservable
• Rental Rate - cost to a firm of using its own capital - i.e. it could have given capital to another firm.  Equal to economic depreciation of assets + foregone interest.
• Normal Profit - opportunity cost of owner's entrepreneurship expertise

Economic Profit - considers both explicit and implicit costs

Accounting Profit - only considers explicit costs - it is greater than Economic

Constraints to profit maximization:

• Technology - limited by cost of adopting new production techniques
• Information - information is limited, or if available can be expensive to obtain
• Market - how much customers will pay, and what competitors are doing
• Also resource markets - prices/availability of inputs, investors, etc

Technological Efficiency and Economic Efficiency

• Technological - using least amount of specific inputs to produce a given output
• On an absolute basis, whatever requires less of a given resource is the more technologically efficient
• Economic - producing given output at the lowest cost
• Need to account for input costs
• If something is not technologically efficient, it is also not going to be economically efficient

Command systems and incentive systems and the principal agent problem

• Command - follow a managerial chain of command
• Work better when workers are easier to monitor
• Incentive - system of rewards to encourage workers to act in a way that maximizes profits
• Work when workers are more difficult to monitor
• Many companies have a mix
• Principal Agent Problem
• Incentives/motivations of managers/workers (agents) is not the same as that of owners (principals)
• Essence of the issue is that it is costly for principals to monitor actions of agents
• Can be addressed with giving ownership interests, incentive pay, and long-term contracts (ensure long term success of firm)

Types of business organization

• Proprietorship - single owner, unlimited liability for debts and legal obligations.  Income flows to owner who pays taxes on it as personal income.
• Advantages
• Easy to establish, simple decision process, profits only taxed once
• Disadvantages
• Decisions not checked by group, owner's wealth at risk, business may cease to exist when owner dies, raising capital difficult and expensive
• Partnership - two or more owners, unlimited liability, income allocated based on ownership, taxable as personal income
• Advantages
• Easy to establish, decision with partners, business might survive with second partner, profits only taxed once
• Disadvantages
• Hard to reach consensus, owners' wealth at risk, could be capital shortfall if partner dies.  
• Still hard to raise capital.
• Corporation - owned by stockholders, liability legally limited to amount of money invested in the firm.  Firm is legal entity that pays corporate income taxes.
• Advantages
• Owners have limited liability, more capital readily available, more expertise, life not limited by owners, long-term labor contracts can reduce costs
• Disadvantages
• Complex management, corporate income is taxed twice

Market Concentration

• Markets with a few large firms are more concentrated than markets with many smaller firms
• Four Firm Concentration Ratio
• Percent of total sales made by four largest firms in industry
• Below 40% is considered competitive, above 60% is an oligopoly
• Herfindahl-Hirschman Index (HHI)
• Sum of the squared mkt share percentages of the 50 largest firms (or all firms if less than 50).
• Very low in highly competitive industries, and increases to 10,000 (100^2) for an industry with only one firm
• 1,000 to 1,800 = moderately competitive
• Greater than 1,800 = not competitive
• Limitations of measurements as a degree of competition
• Undefined geographical scope - e.g. newspapers
• Barriers to entry are not captured
• Relationship between market and industry is not always close - same industry does not mean same market (competition); large firms produce many products, all with different levels of competition; firms may switch (similar to barriers to entry argument)

Companies are often more efficient than markets in coordinating activity

• Market coordination - selling through various market channels
• Firm coordination - can be better because it leads to:
• Lower transaction costs
• Economies of scale/scope/team production

End of reading.

11:45 am

0.75 hrs