INDUS ECON - FIRM AND COST

An entity that draws various types of factors of production in different amounts from the economy, and converts them into desirable output/s, through a process with the help of suitable technology.

Firm

Person (or group of persons) who decide/s to undertake the responsibility of the inherent risks in starting a business.

Entrepreneur

Objective of business is generation of the largest amount of profit.

Profit Maximization Theory

Traditionally efficiency of a firm measured in terms of its profit generating capacity.

Profit Maximization Theory

Criticisms:

• Confusion on measure of profit

• Confusion on period of time

• Validity questioned in competitive markets

Profit Maximization Theory

In competitive markets, firms aim at maximizing revenue through maximization of sales.

Baumol’s Theory of Sales Revenue Maximization

Sales volumes determine market leadership in competition.

Baumol’s Theory of Sales Revenue Maximization

Criticism:

• Insufficient empirical evidence

Baumol’s Theory of Sales Revenue Maximization

Two sets of goals:

• Owners (shareholders) aim at profits and market share

• Managers aim at better salary, job security, and growth

Marris’ Hypothesis of Maximization of Growth Rate

Both achieved by maximizing balanced growth rate of the firm, dependent on:

• Growth rate of demand for the firm’s products

• Growth rate of capital supply to the firm

Marris’ Hypothesis of Maximization of Growth Rate

Constraints in the objective of maximization of balanced growth:

• Managerial Constraint

• Financial Constraint

Marris’ Hypothesis of Maximization of Growth Rate

Managers apply their discretionary power to maximize their own utility function

• Constraint of maintaining minimum profit to satisfy shareholders.

Williamson’s Model of Managerial Utility Function

Firms have to incur costs in acquiring information in the present

Simon’s Satisficing Model

Objective of maximizing either profit, or sales, or growth act as constraints to rational decision making.

Simon’s Satisficing Model

“Bounded rationality”, Satisfactory level of profit, sales, and growth

Simon’s Satisficing Model

Stakeholders have different and oft conflicting goals.

Model by Cyert and March

‘Satisficing behavior’ aiming at satisfying all stakeholders.

Model by Cyert and March

Aspiration level on basis of past experience, past performance of the firm, performance of other similar firms, and future expectations.

Model by Cyert and March

When a party whose actions are unobserved can affect the probability or magnitude of a payment associated with an event.

Moral hazard

Problem arising when agents pursue their own goals rather than the goals of principals

Principal-agent problem

An individual employed by a principal to achieve the principal’s objective.

Agent

An individual who employs one or more agents to achieve an objective.

Principal

It refers to actual or real expenses incurred in the production of goods and services.

Cost