Discussion Questions

1. Why do firms exist? Who benefits from their existence?

2. How does the theory of the firm differ from short-term profit maximization? Why is the former superior to the latter?

3. What effect would each of the following have on the value of the firm?

a. A new advertising campaign increases the sales of the firm substantially.

b. A new competitor enters the market.

c. The production department achieves a technological breakthrough that reduces production costs.

d. The firm is required to install pollution-control equipment.

e. The workforce votes to unionize.

f. The rate of interest rises.

g. The rate of inflation changes.

4. According to Milton Friedman, "Business has only one social responsibility - to make profits (as long as it stays within the legal and moral rules of the game established by society). Few trends could so thoroughly undermine the very foundation of our society as the acceptance by corporate officials of a social responsibility other than to make as much money for their stockholders as possible." Explain why you agree or disagree with such statement.

Problems

1. The cost of attending a private college for one year is $6,000 for tuition, $2,000 for the room, $1,500 for meals, and $500 for books and supplies. The student could also have earned $15,000 by getting a job instead of going to college and 10% interest on expenses he incurs at the beginning of the year. Calculate the explicit, implicit, and the total economic costs of attending college.

2. A woman managing a duplicating (photocopying) establishment for $25,000 per year decides to open her own duplicating place. Her revenue during the first year of operation is $120,000, and her expenses are as follows:

Salaries to hired help $45,000

Supplies 15,000

Rent 10,000

Utilities 1,000

Interest on bank loan 10,000

Calculate (a) the explicit costs, (b) the implicit costs, (c) the business profit, (d) the economic profit, and (e) the normal return on investment in this business.

Integrated Case

Samantha Jones has a job as a pharmacist earning $30,000 per year and she is deciding whether to take another job as the manager of another pharmacy for $40,000 per year or to purchase a pharmacy that generates revenue of $200,000 per year. To purchase the pharmacy, Samantha would have to use her $20,000 savings and borrow another $80,000 at an interest rate of 10% per year. The pharmacy that Samantha is contemplating purchasing has additional expenses of $80,000 for supplies, $40,000 for hired help, $10,000 for rent, and $5,000 for utilities. Assume that income and business taxes are zero and that the repayment of the principal of the loan does not start before three years. (a) What would be the business and economic profit if Samantha purchased the pharmacy? Should Samantha purchase the pharmacy? (b) Suppose that

Samantha expects that another pharmacy will open nearby at the end of three years and that this will drive the economic profit of the pharmacy to zero. What would the revenue of the pharmacy be in three years? (c) What theory of profit would account for profits being earned by the pharmacy during the first three years of its operation? (d) Suppose that Samantha expects to sell the pharmacy at the end of three years for $50,000 more than the price she paid for it and that she requires a 15% return on her investment. Should she still purchase the pharmacy?