Scribd
Upload
72 views17 pages

Rents, Profits, and The Financial Environment of Business

This chapter discusses economic rents, business organizational forms, profits, costs, interest rates, and corporate financing methods. It defines economic rent and distinguishes between accounting and economic profits. The chapter outlines proprietorships, partnerships, and corporations as the main business forms and their key advantages and disadvantages. It also covers explicit and implicit costs, how interest rates allocate resources, and the main sources of corporate funds including stocks, bonds, and reinvestment of profits.

Uploaded by

Jeries Lama
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
72 views17 pages

Rents, Profits, and The Financial Environment of Business

This chapter discusses economic rents, business organizational forms, profits, costs, interest rates, and corporate financing methods. It defines economic rent and distinguishes between accounting and economic profits. The chapter outlines proprietorships, partnerships, and corporations as the main business forms and their key advantages and disadvantages. It also covers explicit and implicit costs, how interest rates allocate resources, and the main sources of corporate funds including stocks, bonds, and reinvestment of profits.

Uploaded by

Jeries Lama
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 17

Chapter 21

Rents, Profits,
and the Financial
Environment of Business
Learning Objectives
1. Understand the concept of economic rent.
2. Distinguish among the main organizational forms of
business and explain the chief advantages and
disadvantages of each.
3. Explain the difference between accounting profits and
economic profits.
4. Discuss how the interest rate plays a key role in allocating
resources
5. Calculate the present discounted value of a payment to be received at
a future date.
6. Identify the three main sources of corporate funds and differentiate
between stocks and bonds

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-2
Economic Rent
• Economic rent allocates resources to their highest valued use

• Economic Rent
– A payment for the use of any resource over and above its opportunity cost.
– Thus, rent has a different meaning in economics.

• Supply - Three Positions


1. Completely/ perfectly Inelastic
2. Completely / perfectly Elastic
3. Elastic

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-3
Economic Rent

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-4
Firms and Profits
• The legal organization of firms --- Profit making organizations
1. Proprietorship / Sole trader / sole owner / Entrepreneur
2. Partnership
3. Corporation

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-5
Firms and Profits Proprietorship
– A business owned by one individual who
• Makes the business decisions.
• Receives all the profits
• Is legally responsible for all the debts of the firm

• Advantages of proprietorships
– Easy to form and dissolve
– All decision-making power resides with the sole proprietor
– Profit is taxed only once.( Income tax)
• Disadvantages of proprietorships
– Unlimited Liability
• The owner of the firm is personally responsible for all of the firm’s debts.
– Limited ability to raise funds
– Proprietorship normally ends with the death of the proprietor
Issa Ghrayeb ECON 101 / issa Ghrayeb
21-6
Firms and Profits- Partnership
– A business owned and managed by two or more co-owners, or partners, who
– Share the responsibilities and the profits of the firm
– Are individually liable for all the debts of the partnership

• Advantages of partnerships
– Easy to form and dissolve
– Partners retain decision-making power
– Permits more effective specialization
– Profit is taxed only once.
• Disadvantages of partnerships
– Unlimited liability
– Decision making more costly
– Dissolution often occurs when a partner dies or leaves the firm.

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-7
Firms and Profits - Corporation
• Corporation
– A legal entity that may conduct business in its own name just
as an individual does
– The owners of a corporation, called shareholders
• Own shares of the firm’s profits
• Enjoy the protection of limited liability

• Limited Liability
– A legal concept whereby the responsibility, or liability, of the
owners of a corporation is limited to the value of the shares
in the firm that they own

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-8
Firms and Profits - Corporations
• Advantages of corporations
– Limited liability
– Continues to exist when owner leaves the business
– Raising large sums of financial capital

• Disadvantages of corporations
– Double taxation .
• Dividends
• Portion of corporation’s profits paid to its owners (shareholders).
• Separation of ownership and control

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-9
Types of Costs ( Explicit & Implicit )
• Explicit costs
– Expenses that business managers must take account of because they must be
paid
– Examples are wages, taxes and rent

• Implicit Costs
– 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.

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-10
Accounting profits versus economic profits
– 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

• Accounting Profit
– Total revenue minus total explicit costs

• Economic Profits
– Total revenues minus total opportunity costs of all inputs used
– The total of implicit and explicit costs

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-11
Interest
Interest is the price paid from debtors to creditors for
the use of loanable funds.
• Several types of interest rates .
• Businesses use financial capital in order to invest
in physical capital.
• Economists consider this a cost of production,
production
and it is included in our cost examples

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-12
Interest (cont'd)
• Financial Capital
– Funds used to purchase physical capital goods, such as buildings and
equipment

• Variations in the rate of annual interest that must be paid for


credit depend on
– Length of loan.
– Risk.
– Handing charges – Handling charges.

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-13
Interest important to know
• Nominal Rate of Interest
– The market rate of interest expressed in today’s dollars

• Real Rate of Interest


– The nominal rate of interest minus the anticipated rate of inflation

• We can say that the nominal, or market, rate of interest is


approximately equal to the real rate of interest plus
anticipated inflation, or
in = ir + anticipated inflation rate

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-14
Interest (cont'd)
• Interest is a price that allocates loanable funds (credit) to
consumers and businesses
• Investment, or capital, projects with rates of return higher
than the market rate of interest will be undertaken.
• The interest rate performs the function of allocating
financial capital thus ultimately allocating physical capital.

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-15
Corporate Financing Methods (cont'd)
• Share of Stock
– A legal claim to a share of a corporation’s future profits.
– Ownership
• Common stock
– Incorporates certain voting rights regarding major policy decisions of the
corporation
• Preferred stock
– Owners are accorded preferential treatment in the payment of dividends

• Bond
– A legal claim against a firm ( lending to the company).
– 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.

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-16
Corporate Financing Methods (cont'd)

• Reinvestment
– 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

Issa Ghrayeb ECON 101 / issa Ghrayeb


21-17

You might also like