American Public University
In this paper, I will analyze the advantages of creating a business in the form of corporation and cost structures of companies. Companies develop some strategies to have the possible least cost of production and gain an advantage in competition. Preference for forming an organization is the first step. Corporation legal structure presents some advantages to companies. Also, companies need to have full knowledge of costs to be able to manage costs to maximize their profits. Eventually, this paper will give some insights about these subjects.
Corporation is a legal form of building an organization for a company. Operating a business in corporate form has some legal and financial advantages compared to the other business organization forms. The benefits of corporate form as follows:
1- Protection of personal assets: The legal framework for corporates, personal assets is legally protected under some certain conditions, 2- Easy to create financial resources: In corporations, there are relatively more and easier ways of raising funding, 3- Transferring shareholders' rights: In corporations, shareholders can transfer their rights to other people outside the corporation, 4- Easier to build prestige and credibility for company: Corporations have an advantage for building prestige and credibility compared to the other forms of organizations, 5- Longer lifespan: Existence of corporations is not dependent on a particular group of people or one individual (Brue, McConnell, & Flynn, 2010). These features of corporations make this form of organization relatively more advantages for companies (Butler, 1989).
While a company makes a decision related to running a business, the economic cost has an essential place. Many people are confused about economic cost. The economic cost is different from accounting cost, and it is more inclusive than accounting cost. Economic cost includes explicit and implicit costs. Explicit cost part is relatively easier to define and detect while implicit cost is hard to define and determine. While making an economic decision, an individual has to take all possibilities and alternatives into account while making his decision. When a person makes a decision, he gives up on other alternatives, and he picks one among all possibilities. Subsequently, he cannot receive benefits from the choices. Let us give an example. For instance, a company is making a decision of producing a set of various products. When the decision is made, then the company cannot make a profit on the other products not selected. This cost is implicit, and it is called “alternative cost” or sometimes “shadow cost.” Economic decision making requires taking all possibilities into account while making a final determination. It is a strategic decision making by caring economic benefits and costs of each choice (Brue, McConnell, & Flynn, 2010).
Another important factor determining cost structure of companies is the law of diminishing returns. Law of diminishing returns is an essential factor that influences costs of companies in the short run. When a company increases the amount of production without changing capacity production scale, the company faces decreasing the productivity of labor and machinery. In the short run, the company is in a time interval not allowing the company to change the scale of production. Therefore, the law of diminishing returns to scale is the main determinant of short-run production costs.
In the short-term, when a company starts producing, in the beginning, the productivity of company increases because the company has an available not used capacity of production at the beginning. However, the increasing production with a given capacity of production in the short-run decreases the productivity. Subsequently, the marginal cost of production starts increasing. If the scale stays unchanged, and the amount of production continues raising, then the marginal cost and the average cost starts might increase more and more, and the increase in the total cost might be more rapid (Brue, McConnell, & Flynn, 2010).
For monitoring and controlling costs of production, academicians have developed some terms such fixed cost and variable cost. These costs are measured at different time intervals: short-run and long-run. The total fixed cost is constant because the fixed cost includes the buildings, vehicles, and other things purchased only once in the short-term. Therefore, the fixed total cost does not change. The average fixed cost is decreasing because it is the ratio of fixed cost per production. The marginal cost equal to 0 because there is no change and marginal cost is derivative of fixed cost subject to increasing production.
The variable cost is costs of inputs and labor in the production. The total variable cost is always increasing because the increasing production increases the number of inputs and labor. The average variable cost decreases and then starts increasing because at the beginning in the short-run the productivity increases and after a certain amount of production the productivity starts decreasing. The marginal variable cost similar to average variable cost decreases up to a certain amount of production thanks to increasing productivity at the beginning. However, it starts rising after a certain amount of production more rapidly than the average variable cost (Butler, 1989).
The long-run average cost includes the average costs in the short-run. The long-run includes much short-run, and therefore, the long-run average cost consists of many short-run average costs. In the long run, a company might change the scale of production by increasing or decreasing production capacity of the company. When the scale is changed, the short-run average cost changes its position because the scale change causes a structural change in the production. The long-run average cost is shaped very similar to the short-run average cost. Therefore, many short-run average costs are spread on a curve first decreasing then increasing. The company tries to decrease the costs mainly in the long-run and then in the short-run. Therefore, only one short-run average cost will be the preferred scale of production for the company (Brue, McConnell, & Flynn, 2010).
Consequently, companies spend the effort to maximize their profit and mainly depend on increasing their sale volume while having a possible lowest level of production costs. Businesses have different alternatives in markets, and making preferences among different preferences determine their cost structure, and subsequently their profits. In this paper, I have given some insights how a company can monitor its costs in the short-run and the long-run (Butler, 1989).
Reference
Brue, S., McConnell, C., & Flynn, S. (2010). Essentials of economics. Boston: McGraw-Hill Irwin.
Butler, H. (1989). The Contractual Theory of the Corporation. George Mason University, School of Law Review. Retrieved 8 August 2016, from http://www.law.gmu.edu/assets/files/publications/working_papers/1219ContractualTheory.pdf
