Chapter 7

Business organization and behaviour

David Begg, Stanley Fischer and Rudiger Dornbusch, Economics,

6th Edition, McGraw-Hill, 2000
Power Point presentation by Peter Smith
The theory of supply
Firms decisions about how much output to supply
depend upon the costs of production and the revenue
they receive from selling the output.

Costs of
production Revenues

Firm chooses
level of
output

7.2
Forms of business organization

Sole trader
owned by an individual entitled to income and
responsible for losses
Partnership
jointly owned by two or more people
unlimited liability
Company
ownership divided among shareholders
legal entitlement to produce and trade
limited liability
shares of public companies resold on the stock
exchange

7.3
Some key terms
Revenues
the amount a firm earns by selling goods
and services in a given period
Costs
the expenses incurred in producing
goods and services during the period
Profits
the excess of revenues over costs

7.4
A firms balance sheet
Assets
what the firm owns
Liabilities
what the firm owes
Balance sheet
lists a firms assets and liabilities at a
point in time

7.5
 Snark International balance sheet
31 December 2000

ASSETS LIABILITIES

Cash 40,000 Accounts payable 90,000

Accounts receivable 70,000 Salaries payable 50,000
Inventories 100,000 Mortgage from insurance
Factory building company 150,000
(original value 250,000) 200,000 Bank loan 60,000
Other equipment _______
(original value 300,000) 180,000 350,000

Net worth 240,000

590,000 590,000
======== =======

7.6
Costs and the economist
Accounting cost
actual payments made by a firm in a period
Opportunity cost
amount lost by not using a resource in its
best alternative use
Supernormal profit
profit over and above the return earned at
the market rate of interest
Economists include opportunity cost in
a firms total costs

7.7
The production decision
For any output level, the firm attempts to
mimimize costs
Assume the firm aims to maximize profits
Profits depend on both COSTS and REVENUE
each of which varies with the level of output
Marginal cost (MC) is the rise in total cost if
output increases by 1 unit.
Marginal revenue (MR) is the rise in total
revenue if output increases by 1 unit

7.8
 Maximizing profits
If MR > MC, an increase
in output will increase
MC, MR

profits.
MC If MR < MC, a decrease
in output will increase
profits.
E So profits are maximized
when MR = MC at Q1
MR
(so long as the firm
0 covers variable costs)
Q1 Output

7.9
Will firms try to maximize profits?

Large firms are not run by their owners

there is separation of ownership and control
Managers may pursue different objectives
e.g. size, growth
But firms not maximizing profits may be
vulnerable to takeover
or managers may be given share options to
influence their incentive to maximize profits

7.10