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The Firm and Costs

The document outlines the structure and objectives of firms, emphasizing that most are for-profit organizations aiming to maximize profits. It discusses various forms of ownership, including sole proprietorships, partnerships, and corporations, highlighting the implications of liability and control. Additionally, it covers market structures, including perfect competition and monopolies, and explains the concepts of mergers, economies of scale, and the dynamics of monopsony and dominant firms.

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Kamanzi Ammi Beni
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6 views7 pages

The Firm and Costs

The document outlines the structure and objectives of firms, emphasizing that most are for-profit organizations aiming to maximize profits. It discusses various forms of ownership, including sole proprietorships, partnerships, and corporations, highlighting the implications of liability and control. Additionally, it covers market structures, including perfect competition and monopolies, and explains the concepts of mergers, economies of scale, and the dynamics of monopsony and dominant firms.

Uploaded by

Kamanzi Ammi Beni
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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The Firm and Costs

A firm is an organization that transforms inputs (resources it purchases)


into outputs (valued products that it sells). It earns the difference
between what it receives as revenue and what it spends on inputs,
which are used in manufacturing and selling.

The Objective of a Firm


Most firms are for-profit firms: They exist to make money. Unless we
state otherwise, when we refer to a firm we mean a for-profit firm and
not a firm that exists for charitable or other nonprofit reasons.
And profit maximization is a reasonable approximation of a firm’s
objectives
Ownership and Control
Firms are owned and controlled in a variety of ways. A firm must raise
money to finance itself, decide how its business is to be managed, and
distribute its revenues to those who have contributed to its activity

Forms of Ownership.

The three basic business forms in are


sole proprietorships (single owner),
partnerships (multiple owners), and
corporations

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Sole proprietors and partners are personally liable for the debts of
their business. All the owners’ assets, not just those invested in the
business, are at risk. For example, a partner bears full personal liability
for the debts of a failed business if the other partners have no assets,
even if the business fails through no fault of the partner with the
assets. Partnerships have a second problem as well. If one member of a
partnership leaves, the entire partnership is automatically dissolved. To
continue, the business must form a new partnership

Corporations are companies whose capital is divided into shares that


are held by individuals who have only limited responsibility for the
debts of the company. That is, a shareholder has
limited liability: If the corporation fails (is unable to pay its bills), the
stockholders need not pay for the debt using their personal assets. A
shareholder’s losses are limited to the price paid for the stock.

Shareholders (also called equity owners because they own rights to the
capital or equity of the firm) are entitled to receive dividend payments,
which come out of the corporation’s profits

Separation of Ownership and Control.

With separation of ownership and control, the owners of a corporation,


the shareholders, are typically not the managers, who are employees of
the corporation. In contrast, single proprietorships and partnerships are
run by the owners.

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When control is separated from ownership, managers may not attempt
to maximize profits and may pursue other objectives, like maximizing
their own incomes, not working hard, and having plush offices.

Size of Firms. A firm may expand because it wants to produce more of


its basic output or because it chooses to also produce inputs or
distribute its output. The market and the firm are alternative means of
providing goods and services. The higher the costs of doing business
with other firms, the more tasks a firm performs itself

Mergers and acquisitions


A firm may increase its size by expanding through investment, such as
by building new factories, or by means of a merger: a transaction in
which the assets of one or! More firms are combined in a new firm. We
use the term merger to include acquisitions. There are three types of
mergers:
Vertical merger: A firm combines with its supplier.
Horizontal merger: Firms that compete within the same market
combine.
Conglomerate merger: Firms in unrelated lines of businesses combine

Reasons for Mergers and Acquisitions


There are many explanations for mergers. The main motive is usually to
increase profitability. Unfortunately for firms, not all mergers result in
greater profitability. Moreover, some mergers may be profitable for the
firm yet harm society by reducing efficiency.

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Mergers That Increase Efficiency. Acquisitions and other mergers that
increase efficiency are desirable for society. There are a number of
reasons why takeovers of existing firms may promote efficiency,
including increasing scale to an optimal level, creating synergies, and
improving management

Mergers That Reduce Efficiency. Some mergers are disastrous: They


reduce both efficiency 0and profitability.1 Here, we focus on mergers
where the new owners of a firm profit from the merger, yet production
efficiency is reduced or other efficiency losses occur. Although the
owners of the new firm may benefit, society loses. Such mergers may
occur to take advantage of tax codes, for reasons of short-run ex-
ploitation, or to extend market or political power.

ECONOMIES OF SCALE
A firm’s average costs may remain constant, rise, or fall as its output
expands. If average cost falls as output increases, the firm is said
to have economies of scale (or increasing returns to scale); if
average costs do not vary with output, it has constant returns to
scale; and if average cost rises with output, the firm is said to have
diseconomies of scale (or decreasing returns to scale).

MULTIPRODUCT FIRMS

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Most firms do not produce a single product; it is typical for a firm to
make several different, perhaps related, products. A firm that produces
many different products is called a multiproduct firm

MARKET STRUCURES
COMPETITION

Perfect competition
Even though perfect competition is rarely, if ever, encountered in the
real world, we study the perfect competition model because it provides
an ideal against which to compare other models and markets.
Assumptions
We define perfect competition as a market outcome in which all firms
produce homogeneous, perfectly divisible output and face no barriers
to entry or exit; producers and consumers have full information, incur
no transaction costs, and are price takers: and there are no
externalities. That is, the main assumptions of perfect competition are:

Homogeneous Good. All firms sell an identical product.


Perfect Information. Buyers and sellers have all relevant information
about the market, including the price and quality of the product.

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■ Price Taking. Buyers and sellers cannot individually influence the
price at which the product can be purchased or sold. Price is
determined by the market. So each buyer and seller takes the price as
given.
No Transaction Costs. Neither buyers nor sellers incur costs or fees to
participate in the market.
No Externalities. Each firm bears the full costs of its production
process. That is, the firm does not impose externalities—
uncompensated costs—on others. For example, pollution produced by
a firm is an externality because the firm does not recompense the
victims.
Free Entry and Exit. Firms can enter and exit the market quickly at any
time without having to incur special expense. That is, firms do not face
barriers to entry or exit.
Perfect Divisibility of Output. Firms can produce and consumers can
buy a small fraction of a unit of output. As a result, the amount of
output demanded or supplied varies continuously with price. This
technical assumption avoids problems caused by large discrete changes
in either supply or demand in response to small price changes.

Monopolies, Monopsony, and Dominant Firms


Firm is a monopoly if it is the only supplier of a product for which there
is no close substitute. A monopoly sets its price without fear that it will
be undercut by a rival firm.
A firm’s behavior and government regulations influence the firm's
ability to become and remain a monopoly.
Monopoly Power

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In contrast to a price-taking competitive firm, a monopoly knows that it
can set its own price and that the price chosen affects the quantity it
sells. Whenever a firm can influence the price it receives for its product,
the firm is said to have monopoly power or market power. The terms
monopoly power and market power typically are used interchangeably
to mean die ability to profitably set price above competitive levels
(marginal cost)
CREATING AND MAINTAINING A MONOPOLY
There are several ways in which a firm may become and remain a
monopoly. One possibility is that the firm takes a strategic action that
prevents entry by other firms. Another possibility is that all the firms
merge (combine into a single firm) or act in concert as a monopoly
would.
MONOPSONY
A single buyer in a market is called a monopsony. A monopsony’s
decision on how much to buy affects the price it must pay (just as a
monopoly’s choice of output affects the price it receives). The
monopsony decides how much to purchase by; ‘noosing a price-
quantity pair on the market supply curve. Monopsony is the flip? Ide of
monopoly. Both a monopoly and a monopsony recognize that their
actions affect the market price.

A dominant firm. It typically has a large market share. The smaller,


price-taking firms, called fringe firms, each have a very small share of
the market, though collectively they may have a substantial share of
the market.
Industries in which one firm has a large share of the industry sales are
common.

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