Business Organization and Market Structures

Business Firm- an organization that brings together the factors of production for the purpose of producing and/or distributing goods and services

  • Specialization and division of labor (define)
  • Workers trained in specific tasks, why is this more efficient than everyone making a complete product?
  • Specialization result in increased efficiency in production process
  • Results in economies of scaleoccurs when a large volume of output can be produced at a lower cost per unit than can a small volume
  • Economies of scale are experienced by a firm when long-run average cost declines as the firm expands its output
  • RISK
  • Possibility that a business will fail and money will be lost; people still invest b/c they think they can make a successful business
  • UGLY MONKEY/TAILGATORS

Forms of Business Organization (can group them by industry or legal form of organization)

  • Individual Proprietorshipbusiness firm is owned by a single individual who makes all of the decisions and receives all of the profits
  • Most common type, yet corporations are the most profitable
  • Advantages
  • Ease with which it can be started
  • Owner gets all the profits
  • Owner is his/her own boss
  • Disadvantages
  • Unlimited liabilitypotential for a business owner to incur and have to pay unlimited business debts
  • Limited fundraising ability
  • Limited life
  • Partnershipform of business organization that is collectively owned by two or more people who jointly make the business decisions, share the profits and bear financial responsibility for the loss
  • Only 8% of all businesses, 4% of all business receipts
  • Advantages
  • Relatively easy to start up
  • Opportunity for some specialization in management
  • Better fund-raising ability than the individual proprietorship
  • Disadvantages
  • Limited lifeonly as long as partnership agreement is in force
  • Unlimited liability, each partner can stand to lose substantial personal wealth if the business fails
  • Corporationsform of business organization that is collectively owned by a number of individuals but has the legal status to act a s a single fictitious person
  • Less than 25% of business firms but 90% of all receipts
  • Structure
  • Set up through a corporate charterlegal document granted by a state government that gives a business the authority to operate in that state; corporation as a legal entity avoids problem of unlimited liability
  • Stock
  • Share of ownership in a corporation
  • Way of raising money
  • Preferred stock(prior claim on dividends but no voting privileges)
  • Common stockvoting privileges but usually given to a proxy, last to get paid if corporation fails
  • Can make money from stock in 2 ways
  • Capital gains
  • Dividends
  • Bonds
  • Another fundraising methods
  • An IOU of the corporation to pay fixed sum of money when bond matures
  • Corporate board of directors is responsible for management and board can hire a president and other officers to run the company; stockholders can vote on board and other matters concerning the company, usually vote by proxy
  • Advantages
  • Limited liability
  • Ability to raise large sums of money
  • Unlimited life
  • Disadvantages
  • Separation of ownership and managementsince these are two different groups of people there can be conflict between their views of what is best for the company, may have different strategies for maximizing profits
  • Double taxationcorporations have to pay taxes on their profits even though stockholders later pay a tax on some of these same profits when they are distributed as dividends that are subject to personal income taxes; to what extent do corporations pass their corporate income tax on to customers

Importance of Competition

  • Advantages of competition
  • economic efficiency (products produced at lowest possible cost/unit) Because of competition, no one firm could take advantage of customers b/c customers could always purchase their products from another firm; thus prices would stay at a fair, equilibrium
  • firms do not make excessive profits (price=per unit cost of production)
  • good allocation of productive resources (if waste occurs, firm loses part of profits)
  • Adam Smith if individuals were allowed to pursue their own self-interests without the interference by the government, the y would be led to achieve what is best for society (this force=invisible hand)
  • Wealth of Nations

Market Structures and Competition

  • Number of firms selling in the market
  • Type of product sold
  • Ease of entry and exit
  • Artificial restrictions (minimum wage, labor unions, price controls)
  • Does pure competition exist? No, but some industries come close
  • Pure Competitionidentical product, many sellers, very free entry and exit
  • Monopolyno close substitutes (distribution of electricity, government grants a single company to distribute electricity in each community, if 3-4 companies, it would be more expensive b/c the costs to each firm great and they would pass the cost to customers)barrier to entry in this case is the government, other barriers to entry could include a single company controlling all of the essential raw materials needed for production, patents, size of community may limit the # of firms, a town may be large enough only to have 1 bank, if another entered, eventually one of the two banks would be driven out of the market
  • Oligopolymost large corporations, few sellers, substantial barriers to entry, standardized or differentiated products, substantial nonprice competition
  • Number of firms has to be small enough so that the actions of any one firm will affect the other firms in the market, a firm wouldn’t change the price, quality etc of its product without considering the response of other firms; American auto industry
  • Barriershigh cost of acquiring resources necessary, inability to begin producing on a sufficiently large scale to take advantage of the economies of scale; look at auto industry, if new firm enters market its production costs per unit will be higher and so it will have to charge a higher price per car so it will be hard for the firm to be competitive unless it can differentiate its product somehow
  • Standardized vs. differentiated products
  • Nonprice competition has to do with advertising
  • Monopolistic competition
  • Government efforts to promote and maintain competitionhistorically firms have attempted to reduce competition in an effort to increase profits
  • Have entered into secret agreements with each other (collusion) to charge a fixed price
  • Price fixing is illegal in the United States
  • The larger the number of firms In an industry the harder to price fix
  • Mergers and acquisitionsanother way to reduce competition, enter a trusta device that converted a grou of firms into a single monopoly, Rockefeller and standard Oil trust (40 companies, 1880s and 1890s)
  • Sherman Antitrust Act (1890)made it illegal to monopolize or even attempt to monopolize trade; vague language gave room for loopholes, no enforcement agency
  • Clayton Antitrust Act (1914)
  • Clarified Sherman, can’t do the following things if the effect is to substantially lessen competition
  • Price discrimination
  • Exclusive dealing arrangements (making buyers agree to not purchase from a particular company)
  • Interlocking directorates
  • Acquisition of the stock of one company by competing companies
  • Federal Trade Commission Act 1914
  • Enforcement mechanism for Clayton to investigate and hold hearings and issue orders
  • Robinson-Patman Act (1936)
  • Cellar-Kefauver Antimerger Act (1950)