1 Busines Economics - Theory of Firm and WTO

WTO
& International Framework

of Business Economics
Prof. Dr. Qais Aslam
Professor of Economics
SAF, UCP, Lahore
Former Chairman
Department of Economics, GCU,
Lahore
Business Economics
Course Outline (18 Lectures)
1.Theory of A Firm
2.Marginal Cost and Benefit 12 Things an Economist should Know
3.Demand Analysis and Supply and Demand, Elasticity
4.Supply Analysis & Market Price
5.Cost of Production
6. Iso-quants
7.Factor Pricing
8.Revenue Curves under:
9.Perfect Competition
10.
Monopoly
11.
Oligopoly - Cournot
12.
Oligopoly Stackelberg
13.
Oligopoly Bertrand
14.
Game Theory, Nash Equilibrium & Prisoner's Dilemma
15.
Advanced Pricing Strategies
16.
Horizontal and Vertical Integration
17.
Macro Economics, & Policy Decisions Effecting Market Decisions
18.
International Trade & Business Practices in the new Global Environment
Scope of Business
Economics
Definition: refers to the application
of economic theory and the tools of
analysis of decision making as a
science to examine how an
organization (firm) can achieve its
aims and objectives most efficiently
Economic Theory of Micro & Macro
Economics
Theory of A Firm
Firms are business entities that exist in the

market only and only to make profits.
Sometimes these firms take short term losses
for long term gains
Profits are also called wealth or value of a firm
A firm is a business organization that organizes
resources cost effectively for purpose of
increasing output of goods and services for
maximizing sales and therefore profit margins
Firms exist because it would be very inefficient
and costly for entrepreneurs to enter into and
enforce contracts with workers and owners of
capital, banks, land, energy, information, and
other resources (Factors of production)
Kinds of Firms
There are:
Single proprietor firms (Entrepreneurs)
Partnerships between two or more persons
And there are large Corporations (MNCs)
that sell their shares on the stock market
and therefore dilute the ownership with
the stock holders
Small and Medium Firms (SMEs) are
usually run by Entrepreneurs
Large Corporations (Organizations ) are
run by BODs
Function of a Firm
Is to purchase resources or inputs (Factors

of Production) in order to transform them
into goods and services for sale.
Resource owners (factors of production)
use the income earned from sale of their
resource in order to buy goods and services
and other resources from the market from
these firms
Therefore firms help the economy
transform in an efficient way to redistribute
resources from producers to consumers,
from sellers to buyers through the market
Circular Flow of income in a Two Sector

Economy
EmploymentFactors
of
of
production
Production of Goods and
Services (GDP)
House
Hold
Firms
Expenditure on Goods &
Services
Income
(Y)
Objective and Value of the

Firm
Apart from maximizing of profits the
objective of Modern firms is to
sacrifice short term profits for
increasing future long-term value of
the firm
This is done by calculating the future
value into present money value of
the investments and functions of the
Firm
Formula for calculating future value

into Present Value
Present Value of the Firm (PV)
=
Where PV = the present value of all expected future

profits of the firm
= represents the expanding expected profits in 1, 2,
3 . n years
r = appropriate discount rate used to find the present
value of future profits
TR is Total Revenue of the firm in t number of years
TC is the total costs of the firm in t number of years
(1 + r)t = results from substituting the value of 1 to n
in t number of years
Constraints on the Operations of the Firm

1. Limitations on the Availability of Essential Inputs
(Resource Constraints):
Enough Labor Force or
Enough skilled labor or
essential to productive process specialized labor;
quality and specific raw material;
better and cost-effective machines;
enough storage facilities (where house space)
and
transport facilities (logistics) befitting the
transportation of the produce of the firm;
Financial Constraints
lack of Qualified and innovative managers etc.
2.
Legal Constraints:
Minimum Wage Law

Unfair businesses Practice
law
Quality Standards
Environmental Standards
Anti-Monopoly &
Cartelization laws
Health and safety
Constraint Optimization
The existence of these
constraints limit the capacity of
the firm to maximize their profit
margins freely and unhindered
Therefore Business Economics
teaches techniques that allow
managers to maximize value of
the firm under the constraints :
Constraint optimization: best
possible outcome under the
Limitations on the Theory of the Firm

Theory 1. Profit Maximizing Theory - Firm
Exists to Maximize Profits
Theory 2. Sale maximizing Theory -Firms
exist to maximize is to maximize sales,
Theory 3. Management Utility maximization
theory - maximize management utilities
and maximize satisfying behaviors or
Principle (Stock Holder)- Agent (Managers
& BOD) Problem
The Principle wants to maximize profits
while the Agent wants to maximize sales
Theories of Profit
Profits rate differ among firms and among
different industries.
Some industries need more expensive
technologies, machines and inputs with
specialized labor which are expensive , while
other industries are not that specialized
therefore can run on simpler technologies
and less skilled labor, therefore profit margins
(TR-TC = Profit) differ among industries
Also competition tends to bring down prices
therefore profit margins are less under
competition than under monopoly
Nature & Theories of Profit

Business Versus Economic Profit:
Business Profit: refers to Revenue of a
Firm (from sale of a quantity of produce
in the market) minus the explicit
(Accounting) costs of the firm
Economic profit: refers to Revenue of
the firm minus explicit and implicit costs
(Implicit costs refer to the value of
inputs owned and used by the firm in its
own production process)
1. Risk bearing Theories of Profit
Risk bearing Theories of Profit:

Above normal Economic Profits ()
are required by the firms to enter
and remain in such fields as
petroleum exploration which also
include above-normal Risks.
(Higher the risk, higher the profit,
lower the risk, lower the profit)
2. Frictional Theory of Profit

Frictional Theory of Profit: Profit arises as a result of
friction or disturbances from long-run equilibrium
Firms tend to earn only a normal returns adjusted
for risk or zero economic profit on their
investments. However in the long-run equilibriums
extra-ordinary profits or losses might occur
With Higher Profit margins new firms might be
attracted to enter the industry which would reduce
profit margins for older firms.
At time of losses, firms might leave the industry,
leaving room for those that survive to enhance
their profits in the long run
3. Monopoly Theory of Profit

Monopoly Theory of Profit:
Some firms with monopoly
power can restrict output and
charge higher prices than
under perfect competition,
thereby earning a higher
profit
4. Innovation Theory of
Profit
Innovation Theory of Profit:
Economic Profit is the reward for
the introduction of a successful
innovation
In the long run competitors
imitate the innovation thereby
reducing the monopoly power of
the firm and referring back to the
competitive prices in the market
5. Business Efficiency Theory of Profit
Business Efficiency Theory of

Profit: Observes that if an
average firm tends to earn only
normal profits (Costs of the firm)
or returns on its investments in
the long run
Only firms that are more efficient
(cost effective) than the average
firm would earn above-normal
All the above theories of Profit

have some elements of truth
Each may be applicable to
some industries
Profit often arises from a
combination of factors,
including differential risk,
market disequilibrium,
monopoly power, innovations,
and above-average Business
Function of Profit
High profits are a signal that consumers
want more of the output of the industry
High Profits provide the incentive for
firms to expand output and for more
firms to enter the market
High Profit is a reward for greater
efficiency
Profits are a crucial signal for reallocation
of resources to reflect the changes in
consumers tastes and demand over time
International Framework of Business

Economics
Many of the commodities that are
purchased by us are imported or if
produced domestically, their inputs
wholly, or partially are imported in
the form of raw materials, finance
or machines and technology.
Sometimes even skilled labor or
knowhow is also imported.
Many a times, firms outsource to other

countries some or a part of their
products to be produced elsewhere
and then assembled at home for
domestic consumption or for exports.
There are often mergers and
cooperation between different firms for
establishing a market niche or cartel
This means that there is a rapid
movement towards globalization of
production, consumption and
distribution as well as competition.
Business Economics & the Internet

The Internet (the NET) is a collection of more than
100,000 computers throughout the world, linked
together in the service of the World called the
World Wide Web (WWW). Half of the online
community is outside the USA.
This cyber connection between people of the world
is also called a Unified Information Superhighway
through the internet
This means that individuals, researchers, firms and
consumers can hook up with libraries, databases
and marketing information from around the world,
very quickly, on their fingertips, and information
about past, present and future that they could not
get ever before, quickly, cheaply and immediately.
What is WTO
WTO or the World Trade Organization was

established in 1995 in result of the
extensive trade negotiations under
Uruguay Round
WTO is a forum that has replaced GATT and
serves as a forum for negotiations relating
to multilateral trade matters
Under WTO agreements, trade disputes
between states can be settled and nations
would have to abide by WTO Dispute
Settlement Understandings and regime
WTO would conduct review of Trade
Policies of its members
The WTO
Is based in Geneva,
is made up of 146 member countries, one-fourth of
which are developing countries.
WTO was founded in 1995 as a successor to the
General Agreement of Tariffs and Trade (GATT), as a
result of Uruguay Round of multilateral trade
negotiations, which took place between 1986 and 1994.
The WTO establishes the rules governing the
international trading system, which have a major impact
n peoples livelihoods.
These rules often require that member countries
change their intellectual property legislations, industrial
and agricultural policies, basic service provisions and
sometimes even their constitutions.
Objectives of WTO
To contribute to the Development of a
fairer & a more open multilateral trading
system in the World
To strive for greater global coherence of
policies relating to trade, money and
finance
To ensure differential & more favorable
treatment for developing countries
To assist the least developed & net-food
importing countries to cope with their
predicaments
Principles of WTO
1. Non-discrimination or to give the
most favored nation treatment to all
member countries
2. Legal, institutional and procedural
Transparency
3. Prohibition of Quantitative
Restrictions
4. Reduction, & ultimately elimination
of trade distortions & trade
restrictions by individual nations
5. Reciprocity among Members
WTO AGREEMENT
WTO agreement consists of the
following instruments:
Multilateral Agreements on Trade in
Goods
General Agreement on Trade in
Services
Agreement on Trade-related Aspects
of Intellectual Property Rights
Understanding on rules & Procedures
Governing the Settlement Disputes
WTO AGREEMENT
WTO agreement consists of the
following instruments:
Multilateral Agreements on Trade in
Goods
General Agreement on Trade in
Services
Agreement on Trade-related Aspects
of Intellectual Property Rights
Understanding on rules & Procedures
Governing the Settlement Disputes

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WTO

& International Framework

Firms are business entities that exist in the

Is to purchase resources or inputs (Factors

Circular Flow of income in a Two Sector

Objective and Value of the

Formula for calculating future value

Where PV = the present value of all expected future

Constraints on the Operations of the Firm

Minimum Wage Law

Limitations on the Theory of the Firm

Nature & Theories of Profit

1. Risk bearing Theories of Profit

Risk bearing Theories of Profit:

2. Frictional Theory of Profit

3. Monopoly Theory of Profit

5. Business Efficiency Theory of Profit

Business Efficiency Theory of

All the above theories of Profit

International Framework of Business

Many a times, firms outsource to other

Business Economics & the Internet

WTO or the World Trade Organization was

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