Changes

== The "Firm" ==

== The "Firm" ==

On the CLEP exam that some of you will take to earn college credit, 10–15% of the questions are devoted to decisions by a "Firm".  That term refers to the seller, which is alternatively describes as a "supplier", a "company", a "producer", a "manufacturer", a "store", or, mostly simply, a "firm".  A Firm makes decisions about how much to produce and how to try to earn a profit, such that revenue is in excess of costs.

On the CLEP exam that some of you will take to earn college credit, 10–15% of the questions are devoted to decisions by a "Firm".  That term refers to the seller, which is alternatively described as a "supplier", a "company", a "producer", a "manufacturer", a "store", or, mostly simply, a "firm".  A Firm makes decisions about how much to produce and how to try to earn a profit, such that revenue is in excess of costs.

We are on the "supply side" when we discuss companies or firms.  It is on this side (rather than the demand or consumer side) where we have to decide how much you would produce if you were the president of a company.  Recall that microeconomics is about supply and demand.  When we are on the demand side, then we are discussing what you would buy as a consumer, and how much you would pay.  When we are on the supply side, we are considering what you would produce in managing a company.  Keep these concepts separate in your mind.

We are on the "supply side" when we discuss companies or firms.  It is on this side (rather than the demand or consumer side) where we have to decide how much you would produce if you were the president of a company.  Recall that microeconomics is about supply and demand.  When we are on the demand side, then we are discussing what you would buy as a consumer, and how much you would pay.  When we are on the supply side, we are considering what you would produce in managing a company.  Keep these concepts separate in your mind.

This leads us to the second point above.  Essential to microeconomics are the two concepts of  “marginal ____” and “average ____.”  For example, we have “marginal cost” and “average cost.”  The “marginal cost” is how much it costs to make one more widget (a "widget" in an economics course is an imaginary good).  The “average cost” is the overall average per-unit cost for all the widgets you make.   

This leads us to the second point above.  Essential to microeconomics are the two concepts of  “marginal ____” and “average ____.”  For example, we have “marginal cost” and “average cost.”  The “marginal cost” is how much it costs to make one more widget (a "widget" in an economics course is an imaginary good).  The “average cost” is the overall average per-unit cost for all the widgets you make.   

And now the third point above is as follows.  The “marginal product” is the increase in supply due to one more unit of input (typically labor).  If you hire one more laborer (e.g., employee or worker), how much will your output of widgets increase?  “Marginal product,” or MP, gives you that answer.  Your overall product output (Q) is the sum of all your marginal products (MP).  You could then take the average of that, defining “average product” as your total output Q divided by your total labor (L).  Expressed as an equation, this is AP = Q/L.

And now the third point above is as follows.  The “marginal product” is the increase in supply due to one more unit of input (typically one more unit of labor).  If you hire one more laborer (e.g., employee or worker), how much will your output of widgets increase?  “Marginal product,” or MP, gives you that answer.  Your overall product output (Q) is the sum of all your marginal products (MP).  You could then take the average of that, defining “average product” as your total output Q divided by your total labor (L).  Expressed as an equation, this is AP = Q/L.

The average _____ always moves towards the marginal _____ as the relevant activity increases.  Average cost approaches marginal cost, and average product approaches marginal product.  Think about that, providing your own examples to convince yourself.

The average _____ always moves towards the marginal _____ as the relevant activity increases.  Average cost approaches marginal cost, and average product approaches marginal product.  Think about that, providing your own examples to convince yourself.

Think of a baking some bread.  It requires some time and effort to bake one loaf of bread, and the expense of heating the oven.  But there is not as much extra effort and expense to stick a second loaf in the oven at the same time.  After all, the oven expense is the same for two loaves as it is for one.

Think of a baking some bread.  It requires some time and effort to bake one loaf of bread, and the expense of heating the oven.  But there is not as much extra effort and expense to stick a second loaf in the oven at the same time.  After all, the oven expense is the same for two loaves as it is for one.

Or imagine going to a baseball game.  The cost for one person to go is the ticket price plus the cost of gas and parking and wear and tear on the car.  The cost for a second person to go with the first person is just the price of the ticket.  There is no extra gas or parking or wear and tear on the car for a second person to ride along.  So the marginal cost for the second person is less than for the first person.

Or imagine going to a baseball game.  The cost for one person to go is the ticket price plus the cost of gas and parking and wear and tear on the car.  The cost for a second person to go with the first person is just the price of the extra ticket.  There is no extra gas or parking or wear and tear on the car for a second person to ride along.  So the marginal cost for the second person is less than for the first person.

Let’s return to your role as President of the widget company.  You are deciding how many employees to hire.  You have an assembly line that needs workers.  Each additional employee whom you hire to work on that assembly line increases the '''''“marginal product of labor,” which is the increase in output for each additional unit of labor.  It is often called “MP”'''''.   

Now let’s return to your role as President of the widget company.  You are deciding how many employees to hire.  You have an assembly line that needs workers.  Each additional employee whom you hire to work on that assembly line increases the '''''“marginal product of labor,” which is the increase in output for each additional unit of labor.  It is often called “MP”'''''.   

Let’s explain MP in a different way to make sure you understand it.  The more workers you hire, the more goods your company can produce.  Suppose you can make 1000 widgets a week with 10 employees.  Then you hire one more employee, and your output increases to 1015 widgets.  What is the “marginal product of labor,” or MP, for your 11th employee?  It is 1015-1000=15.  Note that this is less than the '''''average''''' product of labor, which 1015/11 = 92.3 for 11 employees.   

Let’s explain MP in a different way to make sure you understand it.  The more workers you hire, the more goods your company can produce.  Suppose you can make 1000 widgets a week with 10 employees.  Then you hire one more employee, and your output increases to 1015 widgets.  What is the “marginal product of labor,” or MP, for your 11th employee?  It is 1015-1000=15.  Note that this is less than the '''''average''''' product of labor, which 1015/11 = 92.3 for 11 employees.   

There is a concept for the long run known as “scale”.  '''''"Scale" refers to the total amount of inputs (workers, facilities, equipment, etc.) that a company has.'''''  The “large scale” means large facilities and number of workers.  The “small scale” means small facilities and number of workers.

There is a concept for the long run known as “scale”.  '''''"Scale" refers to the total amount of inputs (workers, facilities, equipment, etc.) that a company has.'''''  The “large scale” means large facilities and number of workers.  The “small scale” means small facilities and number of workers.

We expect the output of a firm to increase in proportion to an increase in scale.  As President, you may think that doubling everything (facilities, workers, etc.) will double your output.  Often that is true.  '''''When output increases on a one-to-one basis with input, this is called “constant returns to scale.”'''''  When scale increases by a factor of ‘x’, then output also increases by the same factor of ‘x’.

We expect the output of a firm to increase in proportion to an increase in scale.  As President of your company, you may think that doubling everything (facilities, workers, etc.) will double your output.  Often that is true.  '''''When output increases on a one-to-one basis with input, this is called “constant returns to scale.”'''''  When scale increases by a factor of ‘x’, then output also increases by the same factor of ‘x’.

An assembly line is perhaps the best example of this.  Suppose one assembly line produces 1000 widgets a month.  How much would two assembly lines, with double the workers, produce?  We would expect about twice the output, or 2000 widgets a month.

An assembly line is perhaps the best example of this.  Suppose one assembly line produces 1000 widgets a month.  How much would two assembly lines, with double the workers, produce?  We would expect about twice the output, or 2000 widgets a month.

==Costs: Long Run Is Cheaper than Short Run==

==Costs: Long Run Is Cheaper than Short Run==

Well-planned long-run changes should always be more efficient than short-run adjustments.  For example, it should always be cheaper to hire a new employee at the basic wage than to pay time-and-a-half for existing employees to work overtime.  It should always be more efficient to build a facility the way you need it than to pay someone else to rent a facility that is not exactly what you need.  There may be reasons why you do not want to take a risk on a new facility, but efficiency is always on the side of long-run expenses.

Well-planned long-run changes are more efficient than short-run adjustments.  For example, it is cheaper to hire a new employee at the basic wage than to pay time-and-a-half for existing employees to work overtime.  It should always be more efficient to build a facility the way you need it than to pay someone else to rent a facility that is not exactly what you need.  There may be reasons why you do not want to take a risk on a new facility, but efficiency is always on the side of long-run expenses.

That is true in life also.  When you make decisions, you are better off thinking about the long-run consequences.  Many mistakes are caused by short-term thinking.  If drug addicts considered the long-run impact of their decision to take drugs, then they would never try drugs in the first place.  By avoiding drugs they would save themselves from dying in a gutter some day or ending up homeless.

That is true in life also.  When you make decisions, you are better off thinking about the long-run consequences.  Many mistakes are caused by short-term thinking.  If drug addicts considered the long-run impact of their decision to take drugs, then they would never try drugs in the first place.  By avoiding drugs they would save themselves from dying in a gutter some day or ending up homeless.

Exercise is not always the most pleasant activity in the short run.  But its benefit is substantial for the long run.

Exercise is not always the most pleasant activity in the short run.  But its benefit is substantial for the long run.

Jesus focused on the long run in many ways.  Christianity talks in terms of eternity, while anti-Christians talk in terms of the short run, or even the past.

Jesus focused on the long run in many ways.  Christianity talks in terms of eternity, while anti-Christians talk in terms of the short run, or even the past.

==Accounting==

==Accounting==

Keeping track of all the revenue, expenses and profits of a firm is the task of “accountants”.  This is its own profession: like doctors, lawyers, ministers, teachers, and so on, there is the profession of “accounting”.  You take courses in this in college, and can pass exams to become a certified public accountant (CPA).  They provide services to businesses and earn a fine living.  It involves numbers, but is never more complicated than ordinary arithmetic.  A personality that likes to keep track of financial matters and likes the stability of steady work, with little conflict, is often well suited to becoming an accountant.

"Accountants" keep track of all the revenue, expenses and profits of a firm.  They take courses in this in college, and pass exams to become a certified public accountant (CPA).  The math is never more complicated than ordinary arithmetic.  A personality that likes to keep track of financial matters and likes the stability of steady work, with little conflict, may be well-suited to becoming an accountant.

It is the job of accountants to calculate the profits of a business.  A special term, "accounting profits," is defined as follows: '''''Accounting profits equal total revenue minus explicit costs.'''''  The explicit costs are the expenses of the inputs, such as workers’ wages, cost of materials, and the cost of maintenance and depreciation on facilities like plants and equipment.  ("Depreciation" is the predictable wear and tear on something that makes it gradually less valuable and useful, such as depreciation of your car's tires every time you drive somewhere, because the tire tread wears down with every ride.)

It is the job of accountants to calculate the profits of a business.  A special term, "accounting profits," is defined as follows: '''''Accounting profits equal total revenue minus explicit costs.'''''  The explicit costs are the expenses of the inputs, such as workers’ wages, cost of materials, and the cost of maintenance and depreciation on facilities like plants and equipment.  ("Depreciation" is the predictable wear and tear on something that makes it gradually less valuable and useful, such as depreciation of your car's tires every time you drive somewhere, because the tire tread wears down with every ride.)

There are tricks of accounting to overstate the profitability of a company, and that has led to huge scandals and bankruptcies for firms like Enron.  If you ever consider investing in a firm, you should be aware of the distortions that are possible in accounting.  The rule “caveat emptor” (buyer beware) applies to investors just as much as consumers.

There are tricks of accounting to overstate the profitability of a company, and that has led to huge scandals and bankruptcies for firms like Enron.  If you ever consider investing in a firm, you should be aware of the distortions that are possible in accounting.  The rule “caveat emptor” (buyer beware) applies to investors just as much as consumers.

It is easy to overstate sales projections.  It is easy to overstate the value of a firm’s inventory (goods in its warehouse and store).  Something about money makes everyone want to exaggerate.  That’s because nobody can ever obtain enough money to satisfy themselves or their expectations.  Take all assertions about money with a grain of salt.  Even if there is a great deal of money somewhere, it is almost never as much as people claim and never as meaningful as people pretend.

It is easy to overstate sales projections.  It is easy to overstate the value of a firm’s inventory (goods in its warehouse and store).  Firms also have a tendency to understate depreciation (wear and tear) and future liabilities.

 

Firms also find it easy to understate depreciation (wear and tear) and future liabilities.  Some companies, like Ford Motor Company, may actually be bankrupt once the true costs of their pensions for retired workers are taken into account.

Occasionally a major firm will suddenly declare itself to be broke and will ask the government for a “bailout” to save its jobs, as General Motors recently did.  The car maker Chrysler also did this about 25 years ago.  The federal government, despite substantial criticism, provided cheap loans to Chrysler to keep it out of bankruptcy.  So many jobs were at stake that there was political benefit to some officials for doing this.  But don’t expect the government ever to save '''''your firm''''' from going bankrupt.   

Occasionally a major firm will suddenly declare itself to be broke and will ask the government for a “bailout” to save its jobs, as General Motors has done.  The car maker Chrysler also did this about 30 years ago.  The federal government, despite substantial criticism, provided cheap loans to Chrysler to keep it out of bankruptcy.  So many jobs were at stake that there was political benefit to some officials for doing this.  But don’t expect the government ever to save '''''your firm''''' from going bankrupt.   

Debate question: Should the government bail out a company to keep it from going bankrupt?

Debate question: Should the government bail out a company to keep it from going bankrupt?

1.  Fixed costs can be easily identified by seeing what the total costs are when output is _______.  Separately, give an example of a variable cost.

1.  Fixed costs can be easily identified by seeing what the total costs are when output is _______.  Separately, give an example of a variable cost.

2.  The Lecture mentioned how a prior student in this course is paying her way through college by working as a waitress in a fancy Manhattan restaurant.  Suppose her boss told her one day, "We were profitable last month.  To increase our profits next month, I'm going to double our number of waitresses so that we can serve more people!"  But our former economics student told him that his plan would fail because there is _____________ returns of scale in the restaurant, because more waitresses would result in more wasted time talking to each other and waitresses getting in the way of each other.

2.  Suppose the owner of a restaurant decides, "We were profitable last month.  To increase our profits next month, I'm going to double our number of waitresses so that we can serve more people!"  But an economics student told him that his plan would fail because there is _____________ returns of scale in the restaurant: more waitresses would result in more wasted time talking to each other and waitresses getting in the way of each other.

3.  Give an example of a "short run" cost for a firm, and give an example of a "long run" cost.  This can refer to any type of firm, from a grocery store to a baseball team to homeschooling.

3.  Give an example of a "short run" cost for a firm, and give an example of a "long run" cost.  This can refer to any type of firm, from a grocery store to a baseball team to homeschooling.