MICROECONOMICS 05/09/2019

Forms of Business Organization

Sole Proprietorship
Definition A form of organization where
there is only one owner – the
proprietor.
Partnership
An association of two or
more persons who bind
themselves to contribute
money, property, or industry
to a common fund with the
intention of dividing the
profit among themselves.
Corporation
An artificial being created by
operation of law, having the
right of succession and
powers, attributes and
properties expressly
authorized by law or incident
to its existence.

Advantages 1. Easiest to organize. 1. Easy to form. 1. Capacity to act as a legal

2. Owner is entitled to all the
profits of the business.
3. Owner runs the business.
4. Subject to lower tax rate.
5. Financial operations are
not complicated.
2. More specialization than unit.
sole proprietorship. 2. It has continuity of
3. Operated more efficiently existence.
than sole proprietorship. 3. Professional management
(BODs).
4. Limited liability.
5. Ability to raise more
capital.

Disadvantages 1. Unlimited liability. 1. Unlimited liability. 1. Complicated formation and

2. Limited ability to raise
capital.
3. Limited ability to expand.
4. Limited life of business.
2. Limited ability to raise
capital.
3. Limited life since it can be
easily dissolved.
4. Subject to corporate tax
rate except for GPPs (General
Professional Partnerships).
management.
2. Subject to greater degree
of governmental supervision
and control.
3. Owners (shareholders)
have limited powers.
4. Subject to higher income
tax rate.

Co-operative Business Syndicate

Definition A co-operative is a member-owned business Temporary association of two or more
structure with at least five members, all of individuals or firms to carry out a specific
whom have equal voting rights regardless of business venture or project such as large-
their level of involvement or investment. scale real estate development.

Advantages 1. Generally inexpensive to register. 1. Potential for great opportunities and

2. All members must be active in the co- increased profit while minimizing risk.
operative.
3. Members have an equal vote at general
meetings regardless of their level of
investment or involvement.
4. Other than directors, members can be
aged under 18 years. These members cannot
stand for office and don’t have voting rights.

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Disadvantages 1. Difficult to attract potential members 1. The largest drawback of syndication is the
seeking a financial return. aspect of group mentality and decision-
2. There is usually limited distribution of making.
profits to members and some co-operatives 2. Syndicates are commonly treated as
may prohibit the distribution of any surplus. corporations or partnerships for tax purposes.
3. Members providing greater involvement or
investment than others will still only get one
vote.
4. Requires ongoing education programs for
members.

Cost Concepts
A firm maintains a stock of assets that it can spend for production. Assets are in real and monetary
forms. These resources are transformed into unsold goods which become part of the firm’s stock assets
called inventories.
1. Real Assets – physical assets that have an intrinsic worth due to their substance and properties. It has a
tangible form, and its value derives from its physical qualities. It can be a natural substance, like gold or
oil, or a man-made one, like machinery or a building. Real assets include precious metals, commodities,
real estate, land, equipment and natural resources.

Pros Cons
1. Portfolio diversification 1. Illiquidity
2. Inflation hedge 2. Storage fees
3. Income stream 3. Transport costs

2. Monetary Assets – carry a fixed value in terms of currency units (e.g., Dollars, Euros, Yen). Its values do
not fluctuate in dollar terms and it carry an obligation to deliver a certain amount of currency units. In
short, they are static. However, their purchasing power may change upon a change in the prices of goods
and services in general. A monetary asset cannot become obsolete or gain more value (appreciate) in the
market over time.

Characteristics Examples of Monetary Assets

1. Change in real terms: Monetary assets 1. Cash

are fixed in their dollar terms but are 2. Bank deposits
subject to changes in real terms, i.e., a 3. Trade receivables
relative change in buying power. 4. Other receivables meant for settlement
2. Restatements in financial statements: through cash
They are not subject to a restatement of 5. Investments in debt capital market
their recorded value in financial instruments
statements. 6. Lease investments

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3. Inventories – the term for the goods available for sale and raw materials used to produce goods available
for sale. It represents one of the most important assets of a business because the turnover of inventory
represents one of the primary sources of revenue generation and subsequent earnings for the company's
shareholders.

Types of Inventory
Inventory is generally categorized as raw materials, work-in-progress, and finished goods.

a. Raw materials are unprocessed materials used to produce a good. Examples of raw materials include
aluminum and steel for the manufacture of cars, flour for bakeries production of bread, and crude oil held
by refineries.
b. Work-in-progress inventory is the partially finished goods waiting for completion and resale; work-in-
progress inventory is otherwise known as inventory on the production floor. For example, a half-
assembled airliner or a partially completed yacht would be work-in-process.
c. Finished goods are products that have completed production and are ready for sale. Retailers typically
refer to this inventory as "merchandise". Common examples of merchandise include electronics, clothes,
and cars held by retailers.
d. Consignment inventory is the inventory owned by the supplier/producer but held by a customer. The
customer purchases the inventory once it has resold or once they consume it (e.g. to produce their own
products).

Benefit to Supplier Benefit to Customer

The product is promoted by the customer and
readily accessible to end-users.
The customer does not expend capital until it
proves profitable to them, meaning they only
purchase it when the end-user purchases it
from them or until they consume the inventory
for their operations.

Valuing Inventory
Inventory can be valued in three ways:

FIFO Method (first-in, first-out) The cost of goods sold is based on the cost of the earliest
purchased materials, while the carrying cost of remaining
inventory is based on the cost of the latest purchased
materials.
LIFO Method (last-in, first out) The cost of goods sold is valued using the cost of the latest
purchased materials, while the value of the remaining
inventory is based on the earliest purchased materials.
Weighted Average Method Requires valuing both inventory and the cost of goods sold
based on the average cost of all materials bought during the
period.

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Opportunity Cost – represent the benefits an individual, investor or business misses out on when choosing one
alternative over another. While financial reports do not show opportunity cost, business owners can use it to
make educated decisions when they have multiple options before them.

The formula for opportunity cost is:

𝑂𝑝𝑝𝑜𝑟𝑡𝑢𝑛𝑖𝑡𝑦 𝐶𝑜𝑠𝑡 = 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑏𝑒𝑠𝑡 𝑓𝑜𝑟𝑒𝑔𝑜𝑛𝑒 𝑜𝑝𝑡𝑖𝑜𝑛 − 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑓 𝑐ℎ𝑜𝑠𝑒𝑛 𝑜𝑝𝑡𝑖𝑜𝑛

Imputed Cost – incurred by virtue of using an asset instead of All opportunity costs are imputed costs
investing it or undertaking an alternative course of action. It is an but not all imputed costs are opportunity
invisible cost that is not incurred directly. It is any imaginary cost costs.
that have been included in the cost for decision making purposes.

Fixed and Variable Costs 𝑇𝐶 = 𝑇𝐹𝐶 + 𝑇𝑉𝐶

Total Cost (TC) has two basic components, namely Fixed and where:
Variable Costs. Fixed Cost does not vary with output; whereas TC = Total Cost
Variable Cost does in direct proportion. TFC = Total Fixed Cost
TVC = Total Variable Cost
Fixed cost often include rent, building, machinery, etc., while
variable cost may include wages, utilities, materials used in production, etc.

Consider the following hypothetical example of a boat building firm. The total fixed costs, TFC, include premises,
machinery and equipment needed to construct boats, and are $100,000, irrespective of how many boats are
produced. Total variable costs (TVC) will increase as output increases.

TOTAL
TOTAL FIXED
OUTPUT VARIABLE TOTAL COST
COST
COST
1 100 50 150
2 100 80 180

3 100 100 200

4 100 110 210

5 100 150 250

6 100 220 320

7 100 350 450

8 100 640 740

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Average Fixed Costs – AFC are found by dividing total fixed costs by output. As fixed cost is divided by an
increasing output, average fixed costs will continue to fall.

TOTAL FIXED AVERAGE

OUTPUT
COST FIXED COST
1 100 100

2 100 50

3 100 33.3

4 100 25

5 100 20
6 100 16.6

7 100 14.3
8 100 12.5

The average fixed cost (AFC) curve will slope down continuously, from left to right.

Average Variable Costs – AVC are found by dividing total fixed variable costs by output.
TOTAL AVERAGE
OUTPUT
VARIABLE COST VARIABLE COST
1 50 50
2 80 40

3 100 33.3

4 110 27.5

5 150 30
6 220 36.7

7 350 50

8 640 80

The average variable cost (AVC) curve will at first slope down from left to right, then reach a minimum point, and
rise again.

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AVC is ‘U’ shaped because of the Principle of Variable Proportions, which explains the three phases of the curve:

1. Increasing returns to the variable factors, which cause average costs to fall, followed by:
2. Constant returns, followed by:
3. Diminishing returns, which cause costs to rise.

Average Total Costs – ATC is also called average cost or unit cost. Average total costs are a key cost in the theory
of the firm because they indicate how efficiently scarce resources are being used. Average variable costs are
found by dividing total fixed variable costs by output.

TOTAL AVERAGE
OUTPUT VARIABLE VARIABLE OUTPUT
COST COST
1 50 50 1
2 80 40 2
3 100 33.3 3

4 110 27.5 4

5 150 30 5

6 220 36.7 6
7 350 50 7

8 640 80 8

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