BUSINESS FIRMS Why D Business Firms Exist? Ecnmics Chapter 7: Business Operatins A business firm is an rganizatin that uses resurces t prduce gds and services that are sld t cnsumers, ther firms, r the gvernment. Mst businesses exist because a grup f peple wrking tgether can be mre effective than a grup f peple wrking individually. Three Types f Firms 1) SOLE PROPRIETORSHIP A sle prprietrship is a business that is wned by ne individual. This wner makes all the business decisins, receives all the prfits r lsses f the firm, and is legally respnsible fr the debts f the firm. Abut 18.3 millin prprietrships perate in the United States. Advantages Easy t frm and t disslve All decisin-making pwer resides with the sle prprietr The prfits are taxed nly nce Disadvantages Unlimited liability- The sle prprietr s persnal assets may be used t pay ff the debts f the firm There are challenges raising funds fr expansin Usually ends with the retirement r death f the wner 2) PARTNERSHIP A partnership is a business that is wned by tw r mre c-wners, called partners. The partners share prfits and are legally respnsible fr debts. Abut 2.3 millin partnerships perate in the United States. Advantages Disadvantages Specializatin - If ne partner has a talent that ges well with the ther partner s talent, the partners can separate the respnsibilities f the business. Taxes are assessed nly at the persnal level. Unlimited liability - If ne partner incurs a substantial business-related debt, all partners are respnsible fr the debt. One exceptin is the limited partnership. Limited partners d nt participate in the management f the firm r enter int cntracts s they are nly liable fr the amunt he r she invested in the firm. Decisin making can be cmplicated in a partnership. Each partner may want t take different risks r perate the business in a different way. 3) CORPORATION The crpratin is a business type familiar t mst peple. A crpratin is a legal entity that can cnduct business in its wn name in the same way that an individual des. A crpratin is wned by its stckhlders. Stckhlders are peple wh buy shares f stck in a crpratin. A share f stck represents a claim n the assets f a crpratin. Assets are anything f value t which the firm has a legal claim. All crpratins have a bard f directrs. The bard f directrs decides crprate plicies and gals, and much mre.
All firms can raise mney by brrwing frm banks and ther lending institutins. Crpratins can als raise mney frm the sale f bnds, f statements f debt, and f stcks. If yu buy a bnd frm a crpratin, yu are a lender. If yu buy stck, yu are an wner. Abut 5.1 millin crpratins perate in the United States and accunt fr abut 83 % f all business receipts. Advantages Limited liability - An wner can lse nly the amunt that she r he has invested in the firm. Suppse a persn spends $100 purchasing stck in a business firm. She is at risk f lsing nly her $100 investment, even if the firm perfrms prly and accumulates millins in debt. Any debts accumulated by a crpratin are the sle respnsibility f the crpratin. The crpratin will cntinue t exist even if ne r mre wners sell their shares r die. A crpratin is a legal entity, and its existence des nt depend n the existence f its wners. Crpratins are able t raise large amunts f mney by selling mre stck, prviding funding fr expansin. Disadvantage Duble taxatin - First, the crpratin is taxed n its earnings. Later, when the crpratin distributes prfits t stckhlders in the frm f dividends, the stckhlders are taxed n their dividends. Crpratins are mre cmplicated t set up than prprietrships r partnerships.
A Furth Type f Business Firm: The Franchise A franchise is a cntract that lets a persn r a grup use a firm s name and sell the firm s gds in exchange fr certain payments and requirements. A famus example is the franchises f the McDnald s Crpratin. The entity that ffers the franchise is the franchiser. In this case, McDnald s Crpratin is the franchiser. The persn r grup that buys the franchise is the franchisee. A franchise begins when a franchisee pays an initial fee t use the name and sell the gds (in 2005, the initial fee fr a McDnald s franchise was $45,000). The franchisee will pay a ryalty, r a percentage f prfits t the franchiser (in 2005, the McDnald s ryalty rate was 12.5%), and fllw guidelines established by the franchiser. In return, the franchisee receives help in training emplyees, advertising, and ther benefits. Advantages Use f natinal advertising helps all franchises. Cnsistency in the prduct (all Big Macs are made exactly the same). Less risk (the failure rate is abut 12 times higher fr independently wned businesses than fr franchises). Disadvantage Smetimes the financial and training supprt is nt effective fr success. The franchisee may nt prvide the quality f service and prduct that the franchiser expects. What Is the Ethical and Scial Respnsibility f Business? (Differing Pints f View) Ralph Nader, a cnsumer advcate, thinks that businesses have ethical and scial respnsibilities. He als believes that businesses shuld treat their emplyees well. And he believes that businesses shuld dnate funds t meet scial needs in the cmmunity. Miltn Friedman, winner f the 1976 Nbel Prize in Ecnmics, believes that a business has nly ne scial respnsibility: t use its resurces and increase its prfits withut deceptin r fraud. He believes that a business shuld earn as much as pssible by selling the public smething it wants t buy. Any ther use f resurces is utside the business s scial respnsibility.
Applying the Principles Chapter 7, Sectin 1 - Abut Business Firms Identify the type f firm (sle prprietrship, partnership r crpratin) that best answers the questin. 1. Which type f firm has limited liability? CORPORATION 2. Which type f firm is likely t have the greatest number f wners? CORPORATION 3. Which types f firms have unlimited liability? SOLE PROPRIETORSHIP and PARTNERSHIP 4. Which type f firm suffers frm duble taxatin? CORPORATION 5. Which type f firm has nly ne wner? SOLE PROPRIETORSHIP 6. Which type f firm is likely t have the shrtest life span? SOLE PROPRIETORSHIP 7. Which type f firm is the easiest t frm and t disslve? SOLE PROPRIETORSHIP 8. Which type f firm is wned by stckhlders? CORPORATION 9. In which type f firm des a bard f directrs make the imprtant decisins? CORPORATION 10. In which type f firm is decisin making ften the easiest? SOLE PROPRIETORSHIP 11. Barbershps and restaurants are examples f which type f firm? SOLE PROPRIETORSHIP 12. Law firms and medical ffices are examples f which type f firm? PARTNERSHIP 13. Wal-Mart, Best Buy and General Electric are examples f which type f firm? CORPORATION 14. Which type f firm accunts fr the greatest number f firms? SOLE PROPRIETORSHIP 15. Which type f firm accunts fr the greatest number f receipts (sales)? CORPORATION Duble taxatin is cnsidered t be a disadvantage f crpratins. Write yur answers t the next three questins in the space prvided. 16. Explain duble taxatin. The prfits f crpratins may be taxed twice. First, the crpratin pays a crprate incme tax n its prfits. Secnd, sharehlders pay a tax n the prtin f the prfits that are paid t them in the frm f dividends. 17. Is it fair t tax crprate prfits twice? Why r why nt? Answers will vary
18. Sme peple argue that either the crprate incme tax r the incme tax n dividends shuld be reduced r eliminated. What might be sme f the effects f reducing r eliminating ne r bth f these taxes? (Hint: Cnsider the circular flw diagram f ecnmic activity in the U.S. ecnmy n page 60 f yur textbk.) Answers will vary. If the tax n dividends were reduced r eliminated, cnsumers wuld have mre incme and wuld presumably buy mre gds and services. Hwever, the gvernment wuld have less revenue and might have t cut services. If the crprate incme tax were reduced r eliminated, crpratins wuld have mre incme t spend n resurces bught frm husehlds. But nce again, the gvernment wuld have less revenue and might have t cut services. Crpratins, like all firms, can raise mney by brrwing frm banks and ther lending institutins. Hwever, crpratins als can raise mney by selling bnds r issuing additinal shares f stck. Answer the fllwing questins by identifying the type f financing (stck r bnd) that best answers the questin. 19. In which frm f crprate financing is the investr a lender t the crpratin? BOND 20. In which frm f crprate financing is the investr als an wner? STOCK 21. Which frm f crprate financing invlves mre risk fr the investr? STOCK 22. Which frm f crprate financing invlves the ptential fr greater returns fr the investr? STOCK Franchises have becme mre cmmn in the last 25 years. What are the advantages and disadvantages f buying a franchise? 23. Advantages: The franchisee benefits frm natinal advertising and has a business that has prven itself. 24. Disadvantages: The franchisee may pay an initial fee and must ften pay a ryalty. The franchisee als cannt make decisins n many issues. Ethical and Scial Respnsibilities f Business 25. D yu agree r disagree with Miltn Friedman s ppsitin t businesses dnating funds t charitable rganizatins? Answer in the space belw and give reasns fr yur answer. Answers will vary but must include an effective explanatin.
COSTS Five types f csts are assciated with the prductin f gds: fixed cst, variable cst, ttal cst, average ttal cst, and marginal cst. A fixed cst is a cst, r expense, that is the same n matter hw many units f a gd are prduced. An example is building rent. A variable cst changes with the number f units f a gd prduced. Ttal cst is the sum f fixed cst plus variable cst: Ttal cst = Fixed cst + Variable cst. T determine hw much yu need t charge in rder t make a prfit, it helps t understand the cncept f average ttal cst. The average ttal cst is the ttal cst divided by the quantity f utput: Average ttal cst = Ttal cst Quantity. One cncept is very imprtant when deciding hw much f a gd t make marginal cst. Marginal cst is the cst f prducing an additinal unit f a gd that is, the change in ttal cst that results frm prducing an additinal unit f utput.
REVENUE AND ITS APPLICATIONS Ttal Revenue and Marginal Revenue Ttal revenue is defined as the price f a gd times the quantity sld. Marginal revenue is defined as the revenue frm selling an additinal unit f a gd that is, the change in ttal revenue that results frm selling an additinal unit f utput. Firms Have t Answer Questins Hw Much Will a Firm Prduce? A firm shuld cntinue t prduce as lng as marginal revenue is greater than marginal cst (MR > MC). In fact, sme ecnmists think that a firm shuld cntinue t prduce additinal units until marginal revenue is equal t marginal cst. What Price Shuld We Charge? (What Every Firm Wants: T Maximize Prfit) Maximizing prfit is the same as getting the largest pssible difference between ttal revenue and ttal cst. (Prfit is the difference between ttal revenue and ttal cst.) Cmputing Prfit r Lss A firm cmputes its prfits and lsses using three frmulas. Ttal cst = Fixed cst + Variable cst. Ttal revenue = Price x Quantity f gd sld. Prfit (r lss) = Ttal revenue - Ttal cst. The Law f Diminishing Returns The law f diminishing returns states that if additinal units f ne resurce are added t anther resurce in fixed supply, eventually the additinal utput will decrease. Suppse a firm wants t add wrkers. As lng as the additinal utput prduced by the additinal wrkers multiplied by the selling price f the gd is greater than the wage paid t the wrkers, it is a gd idea t hire the additinal emplyees.
Applying the Principles Chapter 7, Sectins 2 and 3 Csts and Revenue Fill in the blanks t be sure yu understand sme imprtant ecnmic terms. 26. A fixed cst IS THE SAME n matter hw many units f a gd are prduced. 27. An example f a fixed cst is RENT. 28. A variable cst CHANGES with the number f units f a gd prduced. 29. An example f a variable cst is WAGES. 30. In ecnmics, the wrd MARGINAL means additinal, s MARGINAL COST is the cst f prducing an additinal unit f a gd and MARGINAL REVENUE is the revenue frm selling an additinal unit f a gd. 31. Every firm wants t maximize PROFIT. Cmplete the cst and revenue frmulas belw. 32. Ttal cst (TC) = FIXED COST (FC) + VARIABLE COST (VC) 33. Average ttal cst (ATC) = TOTAL COST (TC) / QUANTITY (Q) 34. Marginal cst (MC) = CHANGE IN TOTAL COST (TC) / CHANGE IN QUANTITY (Q) 35. Ttal revenue (TR) = PRICE (P) x QUANTITY (Q) 36. Marginal revenue (MR) = CHANGE IN TOTAL REVENUE (TR) / CHANGE IN QUANTITY (Q) 37. Prfit (r lss) = TOTAL REVENUE (TR) TOTAL COST (TC) Use the frmulas abve t fill in the missing numbers in the fllwing table. Fr this firm, marginal revenue is the same as price. (10 pints fr the chart being cmplete) Gadgets/ hur Fixed Cst Variable Cst Ttal Cst Marginal Cst Marginal Revenue Ttal Revenue Prfit r (lss) 0 $ 0 $0 $0 () 1 $8 $32 $8 ($8) 2 $12 $36 $4 $48 $12 3 $15 $39 $3 $72 $33 4 $20 $44 $5 $96 $52 5 $27 $51 $7 $120 $69 6 $36 $60 $9 $144 $84 7 $48 $72 $12 $168 $96 8 $63 $87 $15 $192 $105 9 $82 $106 $19 $216 $110 10 $106 $130 0 $110 11 $136 $160 $30 $264 $104 12 $173 $197 $37 $288 $91
Ttal Revenue and Marginal Revenue Every firm must answer certain questins. One questin is: Hw much shuld the firm prduce? Fill in the blank fr questi47 t answer this questin and then use the table t answer the ther three questins. 47. Accrding t ecnmists, a business shuld cntinue t prduce additinal units f its gd until MARGINAL REVENUE is equal t MARGINAL COST. 48. S, the firm in the table shuld prduce 10 gadgets at current prices. 49. If the price (marginal revenue) f gadgets rises t $37, the firm shuld prduce 12 gadgets. 50. If the price (marginal revenue) f gadgets drps t $15, the firm shuld prduce 8 gadgets. A firm als needs t decide hw many wrkers t hire. T see hw a firm makes this decisin, yu need t understand the law f diminishing marginal returns. Fill in the blanks fr questins 51 and 52 with the crrect answers. 51. Accrding t the law f diminishing marginal returns, if additinal units f ne RESOURCE, such as labr, are added t anther RESOURCE in fixed supply, such as capital, eventually the additinal utput (prduced as a result f hiring an additinal wrker) will DECREASE. 52. If a firm adds wrkers t increase prductin, mre CAPITAL must be added t minimize the effects f the law f diminishing marginal returns. A firm decides hw many wrkers t hire by lking at bth the csts and the benefits f an additinal wrker. The benefits are the additinal utput prduced as a result f hiring an additinal wrker and the revenue generated by that additinal utput (price f gd prduced x additinal utput). The csts are the wages paid t an additinal wrker. Based n the infrmatin abve, answer questins 53 and 54. 53. Accrding t ecnmists, a firm shuld hire additinal wrkers until the additinal utput prduced by the additinal wrker multiplied by the price f the gd is GREATER THAN the wage the firm must pay the wrker. 54. Fill in the missing numbers in the fllwing table. (5 pints pssible) Number f wrkers 0 1 2 3 4 5 6 7 8 Quantity f utput per hur 0 4 10 17 23 28 31 32 31 Additinal utput prduced by hiring an additinal wrker 59. The law f diminishing marginal returns sets in with wrker # 4. 60. If the firm pays wrkers $15 an hur, it shuld hire 6 wrkers. 0 4 6 7 6 5 3 1-1 Additinal revenue generated if the price f the gd is $5 $0 $20 $30 $35 $30 $25 $15 $5 -$5