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58 Cards in this Set
- Front
- Back
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A firm brings together the factors of production _________to produce a product or service it hopes can be sold at a profit
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labor, physical capital, human capital and entrepreneurial skill
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Firm
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A business organization that employs resources to produce goods or services for profit
A firm normally owns and operates at least one “plant” or facility in order to produce. |
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The legal organization of firms
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Proprietorship
Partnership Corporation |
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Accounting Profit
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Total revenue minus total explicit costs
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Explicit Costs
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Costs that business managers must take account of because they must be paid
Examples are wages, taxes and rent |
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Implicit Costs
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Expenses that managers do not have to pay out of pocket and hence do not normally explicitly calculate
Opportunity cost of factors of production that are owned Owner-provided capital and owner-provided labor |
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Normal Rate of Return
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The amount that must be paid to an investor to induce investment in a business
Also known as the opportunity cost of capital |
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Opportunity Cost of Capital
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The normal rate of return, or the available return on the next-best alternative investment
Economists consider this a cost of production, and it is included in our cost examples. |
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Opportunity cost of owner-provided land and capital
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Single-owner proprietorships often exaggerate profit as they understate their opportunity cost of capital.
Consider a simple example of a skilled auto mechanic working at his/her own service station, six days a week. |
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Accounting profits versus economic profits
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The term profits in economics means the income entrepreneurs earn.
Over and above all costs including their own opportunity cost of time. Plus the opportunity cost of capital they have invested in their business. |
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Economic Profits
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Total revenues minus total opportunity costs of all inputs used
The total of implicit and explicit costs |
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The goal of the firm
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profit maximization
Theory of consumer demand: utility (or satisfaction) maximization Theory of the firm: profit maximization is the underlying hypotheses of our predictive theory |
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____ is the price paid from debtors to creditors for the use of loanable funds.
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Interest
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Businesses use _______in order to invest in physical capital
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financial capital
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Financial Capital
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Funds used to purchase physical capital goods, such as buildings and equipment
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Interest
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The payment for current rather than future command over resources; the cost of obtaining credit
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Variations in the rate of annual interest that must be paid for credit depend on
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Length of loan
Risk Handing charges |
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Nominal Rate of Interest
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The market rate of interest expressed in today’s dollars
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Real Rate of Interest
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The nominal rate of interest minus the anticipated rate of inflation
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We can say that the nominal, or market, rate of interest is approximately equal to the ______ plus _________
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real rate of interest plus anticipated inflation
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Interest is a ____ that allocates loanable funds (credit) to consumers and businesses
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price
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Interest is a ____ that allocates loanable funds (credit) to consumers and businesses
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price
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Investment, or capital, projects with rates of _________ of interest will be undertaken
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return higher than the market rate
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Investment, or capital, projects with rates of _________ of interest will be undertaken
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return higher than the market rate
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The interest rate performs the function of _________ thus ultimately allocating physical capital.
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allocating financial capital
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The interest rate performs the function of _________ thus ultimately allocating physical capital.
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allocating financial capital
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Businesses make investments which often incur large costs.
They need to compare their investment cost today with a stream of future profits. They must relate present costs to future benefits. Interest rates are used to link the ________. |
present with the future.
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Businesses make investments which often incur large costs.
They need to compare their investment cost today with a stream of future profits. They must relate present costs to future benefits. Interest rates are used to link the ________. |
present with the future.
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Present Value
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The value of a future amount expressed in today’s dollars
The most that someone would pay today to receive a certain sum at some point in the future |
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Present Value
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The value of a future amount expressed in today’s dollars
The most that someone would pay today to receive a certain sum at some point in the future |
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PV1 =
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PV1 = FV1 / 1 + i
where PV1 = Present value of a sum one year hence FV1 = Future sum paid or received one year hence i = Market rate of interest |
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PV1 =
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PV1 = FV1 / 1 + i
where PV1 = Present value of a sum one year hence FV1 = Future sum paid or received one year hence i = Market rate of interest |
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Present value of $105 to be received one year from now, if the interest rate is 5%
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PV = 105/(1.05) = $100
The present value is $100 |
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Present value of $105 to be received one year from now, if the interest rate is 5%
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PV = 105/(1.05) = $100
The present value is $100 |
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How much would have to be put in a savings account today to have $105 two years from now if the account pays 5% per year compounded annually?
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PV2 x (1.05)2 = $105
PV2 x $105 = $95.24 (105)2 |
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How much would have to be put in a savings account today to have $105 two years from now if the account pays 5% per year compounded annually?
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PV2 x (1.05)2 = $105
PV2 x $105 = $95.24 (105)2 |
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Discounting
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The method by which the present value of a future sum or a future stream of sums is obtained
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Discounting
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The method by which the present value of a future sum or a future stream of sums is obtained
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Rate of Discount
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The rate of interest used to discount future sums back to present value
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Rate of Discount
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The rate of interest used to discount future sums back to present value
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________ will determine how willing you are to save and to borrow.
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Your own personal discount rate
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The_______ lies between the upper and lower ranges of personal rates of discount.
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market interest rate
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When it all began—1602
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Dutch East India Company raised financial capital by
Selling ownership shares (stock) Using notes of indebtedness (bonds) Some profits were retained for reinvestment |
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Share of Stock
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A legal claim to a share of a corporation’s future profits
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Common stock
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Incorporates certain voting rights regarding major policy decisions of the corporation
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Preferred stock
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Owners are accorded preferential treatment in the payment of dividends
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Bond
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A legal claim against a firm
Usually entitling the owner of the bond to receive a fixed annual coupon payment, plus a lump-sum payment at the bond’s maturity date Bonds are issued in return for funds lent to the firm. |
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Reinvestment
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Profits (or depreciation reserves) used to purchase new capital equipment
Sales of stock are an important source of financing for new firms. Reinvestment and borrowing are the primary means of financing for existing ones. |
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Stock vs Bonds
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Stocks
Stocks represent ownership. Common stocks do not have a fixed dividend rate. Stockholders can elect a board of directors, which controls the corporation. Stocks do not have a maturity date; the corporation does not usually repay the stockholder. All corporations issue or offer to sell stocks. This is the usual definition of a corporation. Stockholders have a claim against the property and income of a corporation after all creditors’ claims have been met Bonds Bonds represent debt. Interest on bonds must always be paid, whether or not any profit is earned. Bondholders usually have no voice in or over management of the corporation. Bonds have a maturity date on which the bondholder is to be repaid the face value of the bond. Corporations need not issue bonds. Bondholders have a claim against the property and income of a corporation that must be met before the claims of stockholders |
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The Markets for Stocks and Bonds
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Economists often refer to the “market for wheat” or the “market for labor.”
These are more conceptual places rather than actual ones. For securities there really are markets—physical locations. |
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Securities
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Stocks and bonds
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Examples of Markets for Stocks and Bonds
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New York Stock Exchange (NYSE)
Nasdaq London Stock Exchange (FTSE) Tokyo Stock Exchange Bombay Stock Exchange (BSE) Shanghai Stock Exchange |
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Economic rent serves an efficient allocative function for ...
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resources that are fixed in supply
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The main types of business organization
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Proprietorship
Partnership Corporation |
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Accounting profit is the...
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excess of total revenue over explicit costs.
To arrive at economic profit, we must subtract implicit costs as well. |
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Interest is a payment for the ability to use...
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resources today instead of in the future
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The present value of a sum to be received in the future can be calculated through ______.
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discounting
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The three main sources of corporate funds are ....
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stocks, bonds, and reinvestment of profits.
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