Lecture 9
BUSINESS ORGANIZATION

1. What is a firm?

An institution that hires factors of production and organizes those factors to produce and sell goods and services

2. Why firms?

• Lower transaction costs
• Economies of scale
• Economies of team production: Each team specializes (accounting, production etc.)

3. How are businesses organized?

• Proprietorships
• Partnerships
• Corporations

3.1 Proprietorships

Pros:
• Easy to set up
• Owner makes all decisions
• Profits taxed once
Cons:
• Unlimited liability
• Limited capital
• Firm dies with owner

Pros:
• Easy to set up
• Diversified decision making
• Profits taxed once
Cons:
• Achieving consensus may be slow
• Unlimited liability
• Limited capital
• Withdrawal of a partner could create problems

3.3 Corporations

Pros:
• Limited liabilities for owners
• Greater access to capital
  • Issue of stocks and bonds
• Professional management
• Perpetual life
Cons:
• Profits taxed twice
• Complex management structure can make decisions slow and expensive
• Conflicting goals for owners and managers:
  • The Principal-Agent Problem
  • What steps do shareholders take to resolve the problem?

4. The Profit Motive