The company and its economic efficiency

The company is the institution or economic agent that makes the decisions on the use of factors of production to obtain the goods and services offered in the market. The productive activity consists of the transformation of intermediate goods (raw materials and semi-finished products) into final goods, through the use of productive factors (basically labor and capital).

In order to carry out its activity, the company needs to have a technology that specifies what type of productive factors it needs and how they are combined. Likewise, you must adopt an organization and legal form that allows you to make contracts, obtain financial resources, if you do not have them, and exercise your rights over the goods that you produce.

The company is the universally used instrument to produce and put in the hands of the public most of the goods and services in the economy. To try to achieve its objectives, the company obtains from the environment the factors it uses in production, such as raw materials, machinery and equipment, labor, capital, etc… Given a priority objective or objectives, it is necessary to define the way to achieve them and adapt the available means to the desired result. Every business encompasses a wide range of people and interests linked together through contractual relationships that reflect a promise of collaboration. From this perspective, the figure of the businessman appears as a basic piece, since it is the conciliatory element of the different interests.

The employer is the person who contributes the capital and performs at the same time the functions of the management: organize, plan and control. In many cases the origin of the company is in an innovative idea about the processes and products, so that the entrepreneur acts as a disseminating agent of economic development. In this case, the entrepreneur-administrator, the entrepreneur who assumes the risk and the innovative entrepreneur are united in a single figure. This situation is characteristic of family businesses and, in general, of small businesses.

On the other hand, and as large companies emerge, there is a separation between the classic functions of the entrepreneur. On the one hand, there is the figure of the investor, who assumes the risks linked to promotion and innovation through the contribution of capital. On the other hand, the role of the professional manager, specialized in business management and administration, is consolidated. In this way, there is a clear separation between ownership and the effective management of the company.

The current entrepreneur is an individual or collegiate body that makes the appropriate decisions to achieve certain objectives present in companies and the surrounding circumstances. The individual or collegiate entrepreneur is the one who coordinates the internal fabric of the company with its economic and social environment.

2. The company and production in the short term

• The company and production

The company is the economic unit of production in charge of combining the factors or productive resources, labor, capital and natural resources, to produce goods and services that are later sold in the market.

• Types of business organization

There are three fundamental forms of business organization: individual property, partnership, and corporation. An individually owned company is one that is owned by an individual, who logically has the full right to receive the benefits generated by the business and is fully responsible for the losses incurred.

Individual ownership is the simplest way to establish a business. Although individual ownership is simple and flexible, it has serious drawbacks, as a person's financial and work capacity is limited.

A jointly-owned company is one whose owners are a small number of people who participate jointly in the benefits.

The theories of the organization are based on analysis of the behavior of the different individuals and groups that make up the company. In large companies, there is a dissociation between ownership - in the hands of shareholders - and those who effectively control, the management team. Furthermore, the management team frequently delegates the management of some of the company's activities to units with autonomous decision-making power, such as divisions. The behavior of the company becomes the result of the forecasts of groups with executive power and different objectives. Under this model, the company does not respond to a single criterion, but this will be the result of a negotiation process developed within the company.

• The control mechanisms

The company creates control mechanisms and incentives for managers with managerial autonomy that reduces losses due to behaviors unconscious of their objectives. Among the elements that contribute to exercising control are:

a) The control of results and the internal audit, that is, the periodic investigation of the activities carried out by the company or its divisions in order to identify deviations from the behavior considered optimal and, where appropriate, penalize them.

b) The use of incentive systems, monetary or otherwise, that stimulate the achievement of the global objectives of the company.

c) Competition within the company by comparing the results of the different divisions.

d) The use of the information that, in private companies, provides the capital market through the price of shares.

• Decision making

In any case, it is interesting to study how the decision-making process develops in this type of model.

a) Senior management levels. The top management or direction decides the distribution of resources between the different departments and this is carried out by the budget.

When deciding, when a problem is detected is when some alternatives are analyzed. Detailed cost-benefit studies or marginalist rules are not usually carried out, but two simple criteria are established:

1. the financial or budgetary criteria, which tells us if funds are available for the proposal, and

2. the criterion of improvement of the starting situation without any doubt.

b) Lower levels of administration. Simple and almost mechanical rules are followed, based on experience. Staff learn from past mistakes and successes.

The company only deals with a short-term time horizon. Faced with the uncertainty posed by the actions of its competitors, it is assumed that some kind of tacit solution will be reached. This is what is called a negotiated environment.

Each of the owners or partners is responsible for the losses incurred by the company. These companies, as all their partners have unlimited liability and since people are reluctant to expose their personal fortune, they are usually reduced to personal or family companies, and generally small.

Every time a partner dies, or resigns, a new partnership must be formed. Likewise, the admission of a new partner raises certain problems, as all partners must agree, before any of them can sell their share to a third party.

• The corporation

In a public limited company, the capital is divided into small aliquots called shares, which facilitates the gathering of large capital. Each shareholder has a limited liability, specifically only responsible for the capital they have contributed, but is not responsible for the company's social debts.

In these companies there is a clear separation between ownership, which belongs to the shareholders, and management, which is held by the Board of Directors, which usually hires specialized technicians in the various areas of the company.

The public limited company does not pose problems of continuity. Being legally a "legal person" when one of its shareholders dies, the company survives, as the shares are transferred to their heirs without causing any disturbance. Also, if one of the shareholders decides to go out of business, they only have to sell their shares and there is no need to reorganize the company.

• The company and benefits

The production function is the relationship that exists between the product obtained and the combination of factors used to obtain it.

The production function tells us that the quantity of product Q that a company can obtain is a function of the quantities of factors used; Let's say capital (K), labor (L), land (T) and entrepreneurship (H), so that:

Profits are defined as the difference between income and costs. Income is the amounts that the company obtains from the sale of its goods or services during a specified period. The costs are the expenses linked to the production of the goods or services sold during the period considered.

A first explanation of why companies really intend to achieve this objective would be that competition forces them to behave trying to minimize costs, which implies maximizing the difference between income and costs.

• The production function

Given a fixed number of factors, the amount of product that can be obtained depends on the state of the technology.

The relationship between the quantity of productive factors required: labor (L), capital (K), land and natural resources (T) and entrepreneurship (H) and the quantity of product (Q) that can be obtained is called the production function. Analytically:

There are thousands of different production functions in the Spanish economy. At least one for each company and product.

• The production function and the short term

Many of the factors used in production are capital goods, such as machinery, buildings, etc.

The short term is a period of time over which some of the factors cannot vary, which are called fixed factors. The company can adjust the variable factors, even in the short term.

To facilitate the analysis, we consider that we are studying the evolution of the wheat production of an agricultural company and that variations can only occur in the amounts of labor used while the other productive factors remain constant.

Table 7.1, in the first column, shows the amount of work used in wheat production. The second column shows the product or total productivity (PT), that is, the amount of production that is obtained for different levels of work. Likewise, the third column collects the values ​​of the product or marginal productivity of labor (PMaL), which is defined as the increase in product obtained when the amount of labor used is increased by one unit.

As can be seen, the total product of labor starts from the origin of coordinates, since if 0 units of labor are used, 0 units of product are obtained and it is increasing. It increases continuously as the amount of work employed increases, doing so at an increasing rate until the fourth worker is hired.

As a consequence of the shape of the total product curve, the marginal product curve initially rises to a maximum, at the inflection point of the total product curve, and then decreases.

The total product curve shows the relationship between the amount of a variable factor (labor) and the amount of product obtained. The marginal product curve of a variable factor (labor) shows the increase in product obtained using an additional unit of that factor.

• The law of diminishing returns

The justification for the behavior observed in figure 7.1 rests on the so-called law of diminishing returns outlined in Chapter 2, which refers to the amount of additional product that is obtained when additional equal units of a variable factor are successively added to a fixed amount of one or more factors.

The law of diminishing returns establishes that the marginal product of a variable factor of production decreases, beyond a certain level, as the quantity of that factor used increases.

This law constitutes an important technical regularity generally observed, but it is not universally valid. It is often only fulfilled after adding a considerable number of equal doses of the variable factor.

• The average product

The last column of Table 7.1 shows the average product or average productivity (PMeL) of labor corresponding to each level of employment of the labor factor.

The average product of labor is the quotient between the total level of production and the amount of labor used.

In the economic literature the average product of labor is usually called labor productivity, and indicates the level of production obtained by the company per unit of work employed.

The graphical representation of the values ​​of the average product (PMeL) contained in table 7.1 shows that, like the marginal product (PMaL), the average product initially increases when the quantity of labor increases, and, from a certain level In the example considered the fifth worker, it begins to decrease. The maximum product or average productivity is called the technical optimum.

• The relationship between the total product, the average product and the marginal product

Since the average product of labor has been defined as the ratio between the total product and the amount of labor employed PMeL _q, L

in geometric terms it is equivalent to the slope of the radius vector drawn from the origin of coordinates to each of the points of the total product curve. This slope in a first phase increases to the level of application of the work factor Lo, where it reaches a maximum, and subsequently decreases.

On the other hand, we have defined the marginal product of labor as the increase in the product used per additional unit of labor:

If the product that a company launches on the market experiences increasing demand, it will want to expand production. The company can immediately make the existing workforce work overtime, and it can also increase the number of employees hired.

In the long term, therefore, companies have the possibility of altering the quantity of any of all the factors they use in production.

The technical properties of long-term production are established around the concept of returns to scale, and this applies only to the case where all factors vary simultaneously in the same proportion.

Looking at the behavior of the quantity produced of a good we will say that there are increasing returns or economies of scale when by varying the quantity used of all the factors, in a certain proportion, the quantity obtained from the product varies in a greater proportion.

In the example considered (Table 7.2), the amounts of capital and labor used go from 2 units and 16 physical units to double, respectively, that is, 4 and 32, respectively, and production, from 1000 to 2200.

Also, there are constant returns to scale when the amount of all the factors used and the amount of product obtained vary in the same proportion. Finally, we will say that there are decreasing returns to scale when by varying the amount used of all the factors in a certain proportion, the quantity obtained of product varies in a smaller proportion.

• Technical efficiency

Knowledge of technology is a first step in this choice, since the company will seek technical efficiency and discard those combinations of factors that, in order to obtain a given quantity of product, require the use of greater quantities of said factors.

Suppose that three different techniques or methods can be used to obtain a unit of output using two factors of production, capital and labor. (Table 7.3):

• Technique A uses 2 units of capital and 16 units of labor.

• Technique B uses 4 units of capital and 8 units of labor.

• Technique C uses 3 units of capital and 17 units of labor.

A production method is technically efficient if the output obtained is the maximum possible with the specified quantities of factors.

• Economic efficiency

From an economic efficiency point of view, the chosen production technique or method will be the one that is cheapest for a set of factor prices. Table 7.4 evaluates the costs of the two efficient production techniques or methods, A and B, under the assumption that the price of capital is 5000 pesetas a day per machine and that the price of labor is 1000 pesetas. per day per worker.

According to these factor prices, the total cost incurred is lower for technique A than for technique B, so the company will opt for the former. Note, however, that if the prices of capital and labor vary, the method chosen for production may vary. Thus, for example, if now the price of labor is 2000 pesetas per worker per day and that of capital does not change, the cheapest method will be B, with a total cost of 36000 pesetas.

• The substitution in the use of some factors for others

The example that has been considered the incidence of the relative price of the factors in the use of the same. Thus, when the price of labor is 1,000 pesetas and that of capital 5,000 pesetas a day, the method of production that turns out to be economically efficient is A.

The economically efficient method of production minimizes the opportunity cost of the factors used to obtain a given level of production.