Business Organization Quiz

Chapter 6: A Firm's Production Decisions and Costs in the Short Run

• Firm: A business organization that hires and organizes factors of production to sell goods and services. Also known as a company or business. It includes various types of organizations like sole proprietorships, partnerships, corporations, state-owned enterprises, and non-profit organizations.

The Role of the Firm

• Sole Proprietorship: The owner/manager is responsible for all the firm's activities.
• Partnership: Has two or more joint owners. In a limited partnership, some partners have no role in running the firm and aren't liable for its debts.
• Corporation: Owners are not personally responsible for debts or involved in operations.
• State-owned enterprise: Owned by the government and usually managed by appointed officials (also known as Crown corporations in Canada).
• Non-profit organization: Organized to achieve certain goals by providing goods and services, not to make a profit.

Production

• Production: The process of a business/firm using inputs to produce outputs.
  • Inputs: Examples include sand, gravel, cement, water, machinery, and labor.
  • Process: The transformation of inputs into outputs.
  • Outputs: The products created, such as concrete.
  • Costs: Payments for the inputs; the costs of production.

Explicit and Implicit Costs

• Explicit Costs: Actual payments in money (usually to non-owners).
• Implicit Costs: Opportunity cost of using owner-provided resources; no direct money payment.

Profit and Loss Statement (Example)

• Total Revenue: $250,000 (cash sales, excluding sales tax)
• Explicit Costs:
  • Rent: $18,000
  • Materials/Supplies: $50,000
  • Utilities: $12,000
  • Hired Labor: $120,000
• Total Explicit Costs: $200,000
• Accounting Profit: $50,000
• Implicit Costs:
  • Opportunity cost of $150,000 invested into business
  • Owners' labor contribution worth $80,000
• Total Implicit Costs: $95,000
• Total Explicit and Implicit Costs: $295,000
• Economic Profit/Loss: -$45,000

Accounting vs. Economic Profit

• Accounting Profit: Total Revenue – Total Explicit Costs
• Economic Profit: Total Revenue – Total Costs (including explicit and implicit costs)
• Normal Profit: Minimum profit needed to keep entrepreneurs in that type of business.

Theory of Production

• Short Run: A period where at least one input is fixed.
• Total Product (TP): The total output from a given process.
• Marginal Product (MP): The increase in total product from adding one more unit of input (labor).
• Average Product (AP): Total product divided by the quantity of inputs.

Division of Labour

• Division of Labour: The division of a production process into specialized tasks. Each task is performed by a different worker.
• Benefits of Division of Labour:
  • Assigns the right person to the proper task.
  • Workers become more adept at a specific task.
  • Saves time by avoiding the need to switch and adjust tools/machines.
  • Enables specialization in machines to specific tasks

Law of Diminishing Returns

• Law of Diminishing Returns: As a variable input is added to a fixed input, the resulting increase in total output will eventually diminish.

Total, Marginal, and Average Product Curves

• Average product will rise if marginal product is above it, and fall if marginal product is below it.
• Marginal product is minimum when marginal product is maximum.

Marginal and Variable Costs

• Total Variable Cost (TVC): All costs that change with output.
• Marginal Cost (MC): Increase in total variable cost when producing one more unit of output.
• Average Variable Cost (AVC): TVC divided by total output.

Cost Data for a Firm

• Cost data charts detailing units of labor, total product, marginal product, average product, total variable cost, marginal cost, and average variable cost.

The Marginal Cost and Average Variable Cost Curves

• MC is at its minimum when MP (marginal product) is at its maximum.
• MP intersects AP at its maximum.
• MC intersects AVC at its minimum.

Total and Average Total Costs

• Total Fixed Cost (TFC): Costs that do not vary with the level of output.
• Average Fixed Cost (AFC): TFC divided by the quantity of output.
• Total Cost (TC): The sum of TFC and TVC.
• Average Total Cost (ATC): TC divided by the quantity of output.

Cutting Costs

• Cutting costs means reducing average cost, not necessarily total cost.
• Average cost falls if input prices fall or technology improves.
• Firms operate at excess capacity if output could increase without significant extra cost.

Key Concepts to Remember

• Distinction between implicit and explicit costs.
• Difference between normal and economic profit.
• Total, average, and marginal product.
• Division of labor and law of diminishing returns.
• Total, variable, and fixed costs.
• Relationship between different product and cost curves.