Transcript Document
Economics: Principles and Applications, 2e by Robert E. Hall & Marc Lieberman Chapter 7: How Firms Make Decisions: Profit Maximization The Goal of Profit Maximization We will view the firm as a single economic decision maker whose goal is to maximize its owner’s profit. Understanding Profit •Two Definitions of Profit •Why Are There Profits? Understanding Profit Accounting Profit Total revenue minus accounting costs. Understanding Profit Economic Profit Total revenue minus all costs of production, explicit and implicit. The Firm’s Constraints •The Demand Constraint •The Cost Constraint The Firm’s Constraints Demand Curve Facing the Firm A curve that indicates, for different prices, the quantity of output that customers will purchase from a particular firm. The Firm’s Constraints Total Revenue The total inflow of receipts from selling a given amount of output. The Nature of the Firm •Types of Business Firms •Why Employees? •The Limits to the Firm The Profit-Maximizing Output Level •The Total Revenue and Total Cost Approach •The Marginal Revenue and Marginal Cost Approach •Profit Maximization Using Graphs •What About Average Costs? The Profit-Maximizing Output Level Loss A negative profit--when total cost exceeds total revenue The Profit-Maximizing Output Level Marginal Revenue The change in total revenue from producing one more unit of output. The Importance of Marginal Decision Making: A Broader View Marginal Approach to Profit A firm maximized its profit by taking any action that adds more to its revenue than to its cost. Dealing with Losses •The Short Run and the Shutdown Rule •The Long Run: The Exit Decision Dealing With Losses Shutdown Rule In the short run, the firm should continue to produce if total revenue exceeds total variable costs; otherwise, it should shut down. Dealing With Losses Exit A permanent cessation of production when a firm leaves an industry. The Goal of the Firm Revisited •The Principal-Agent Problem •The Principal-Agent Problem at the Firm •The Assumption of Profit Maximization The Goal of the Firm Revisited Principal A person or group that hires someone to do a job. The Goal of the Firm Revisited Agent A person hired to do a job. The Goal of the Firm Revisited Principal-Agent Problem The situation that arises when an agent has interests that conflict with the principal’s, and has the ability to pursue those interests. The Goal of the Firm Revisited Stockholder Revolt When owners, dissatisfied with the profits they are earning, replace the firm’s management teams. The Goal of the Firm Revisited Hostile Takeover When outsiders buy up a firm’s shares with the goal of replacing the management team and increasing profits. The Goal of the Firm Revisited Friendly Takeover When a firm’s management arranges a takeover by another firm deemed unlikely to fire them. The Goal of the Firm Revisited White Knight A firm that undertakes a friendly takeover. The Goal of the Firm Revisited Stock Options Rights to purchase shares of stock at a prespecified price.