theory of firm presentation

Theory of the Firm

Highlighting the concept of Firm ,Industry and Market

Bamoul’s Model of Sales Revenue Maximization

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Simon’s Satisficing Model

The Behavior Theory of Firm

Cyert and March Model

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The Economic Theory of firm

State the rationale of ‘Theory of Firm’

Objectives of Business under Economic Theory of Firm

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Traditional and Modern Views of Profit9

Learning Objectives :

• Concept of the Firm :

Firm, Industry and Market

A firm is a Business unit which owns,controls and manages a plant.Such a Business unit may be a sole Proprietor,a partnership,a company or a cooperative enterprise.The Firm is the owner of the plant and it controls the operation of plants.

A plant is an aggregate of the physical facilities like land and building,machines and equipment meant for production.The Plant owned by the firm may be engaged in the production of the same product or in the production of different goods and services.

• Concept of the Industry :


An Industry may be defined as a group of firms producing and distributing similar products and services.We can classify various firms into different industries on the basis of type of products,use of raw material,use of process of manufacture. The Concept of industry serves a lot of purposes.• Helps to group the firm in terms of specified criteria.• Makes it possible to derive a set of rules that constitute industry

behaviour of competing members.• Provides framework for the analysis of effect of entry on

behaviour,equilibrium price & output of the firm.• The Bussinessman design their strategy in view of industry they

belong to.• Government policy is designed with refernce to industry..

• Concept of the Market:


For understanding the concept of firm,understand the following kinds 0f market.

i. Perfect Competition:It refers to the market situation where there are many firms in the industry,producing homogeneous products,enjoying freedom of movement,having neither transportation cost nor information cost and selling product at a single price.

ii. Monopoly:Situation where single firm constitutes the entire industry.Entry of other firms is blocked.

iii. Oligopoly:It exist in the market with the small number of firms,grouped together ,producing either homogeneous or different products.Individual sellers are consious of their interdependance and therefore take care of rival’s actions and reaction in a variety of ways.

Objectives of Business Firms Profit Maximization

Sales MaximizationGrowth MaximizationMaximization Of Satisfaction Security ProfitsMaximization Of Managerial UtilityOutput MaximizationCyert & March's Behavioral TheorySatisfying Theory

According to classical theory of firms, principle objective of a firm is to maximize profit. Total Profit is defined as the excess of Total Revenue(TR) over Total Cost(TC). Symbolically it can be represented as: PROFIT=TR-TCA profit maximizing firm seeks to maximize the difference between the total revenue and total cost. If price for its products and its cost functions are given, the firm produces quantity that yields maximum profit.

Objectives of Profit Maximization

Condition for Profit Maximization

Rationale Behind Profit Maximization

1.Essential for survival of the firm.2.Greater relevance to competitive firm3. Based on Empirical Analysis.4.Strongest motive.

CRITICISM OF PROFIT MAXIMISATION• Traditional theory of profit maximization assumed stable demand and

stable supply conditions but in practise,the firm can't determine its demand and supply with certainty.

• Modern firms can't afford to follow profit maximization only. They have to follow multiple objectives and profit is one of them.

• In the modern era of globalization, survival of the business firm is the foremost goal. It may require cost reduction, generation of demand, fighting competition, enhancing public image through spending business funds on socially useful projects.

• The objective of profit maximization has been criticized by many economists saying that a firm may indulge in illegal and unfair trade practices when it is run with the sole objectives of profit maximization.

• In the present context the multinational companies are not run by their owners(share holders) but by the professional managers. Theses managers have their own different interests. So profit maximization may not be taken as the sole objective of the firm.

.Explain what exist .Explain what does not exist.Theory must have both Explanatory And Predictive values .Explanation – Logical Analysis for Analysis .Prediction – Forecasting Based on Observation

Purpose of any Theory

.Pred ict ive Power .Cons istency.Assumpt ion.Appl icat ion.S impl ic i ty

Validity of Any Theory

Rationale Theory Of Firm

› Theory which provide models for the Analysis of Decision- making in the Firm in various Market structure› Tell about the whole range of Price Output Decision› Tell about How Firm set the following decisions: .How Firm Set The Price .Decide Their Product-Line .Advertisement Expenses .Sales Promotion .Research And Development .Expenditure

Economic Theory of Firm

› Popular Due To Explanatory And Predictive value

› Build Around The Concept of “PROFIT MAXIMIZATION”

› Explain How Firm Adjust its Operation to Maximise its Profit


Firm Undertakes Transformation of input into products to create surplus values(profit)

Contd..

Firm is a Transformation Unit

Major propositions of Economic Theory of Firm:

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34 Guided by Profit MaximizationFollows Equi-marginal principle

5 Marginal Revenue = marginal Cost 6Market Environment is KnownCompletely

7Use Knowledge of market to Maximise Profit

1Came Because of limitation of Economic Theory

REVIEW…

Re-examine the concept of firm and Decision Making Process

3 Provide Tradition Thinking About the firm and its Activity

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Consider a Large Firm-productionMultiple Goals under Uncertainty in an Imperfect MarketContrast the Theory which Maximise Profit Does not Replace Traditional theory but Supplement it

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34 It Suggest firm Is not

a Single-goal Decision Making unit

It has multiple goals Operating unit (In addition to profit goal the firm has other goals like production goal inventory goal etc. )

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Behavioral Theory of Firm

Does Behavioral Theory Replace Traditional Economic Theory of Firm

Given by Herbert Simon


Review...

Herbert Simon in his satisficing model explains the behavior of practicing business managers. According to Simon, organizational behavior and individual behavior are comparable. Like an individual every organization or firm has its own aspiration, achievement, success or failure record and its aspiration level mechanism is set to work in view of its need, drive and attainment of goals. Firms make periodic review of their goals. They may face three alternative situations:

i. The actual performance is less than the aspirations.ii. The actual performance is equal to the aspirations.

iii. The actual performance is greater than the aspirations.

The first situation may be due to incomplete information about the future and the firms initiate the process of improving the quality of information. It is possible that the aspiration level has been pitched too high. The achievement level may lag behind the aspiration level because-

a) There are wide fluctuations in economic activity, orb) There is a qualitative deterioration in the performance

level.

Given by Herbert Simon


Contd...

Either way, there is a problem in information flow. The firm will have to organize ‘search activity’ and ‘choice’ to improve flow of information. It may even lower the aspiration level for the achievement of ‘satisfactory’ situation. The second situation, when achievement matches the aspiration(targets), the firm is more or less satisfied. No action will be taken except to review that the aspired targets have not been pegged too low and that the firm’s potential performance has been rightly estimated.The third situation speaks of commendable performance by the firm. The firm is satisfied but there is a need to ensure that the quantitative achievement is not the outcome of decreasing quality of performance. It is suggested that we should question success rather than failure; questioning failure is normal, but questioning success is rare. When the firm critically analyses its success, it is in a position to detect the quality of its performance; this may enable the firm to formulate its future policy more efficiently.

DrawbacksAppraisal


Simon has based his analysis on the study of individual psychology and organizational psychology. Simon’s theory seems plausible because it is consistent with psychological theory of motivation which suggests that human action stem from drives, and that these actions terminate once the drives are satisfied. Thus, Simon’s model envisages a marriage between economics and psychology. Secondly, Simon’s model is quite consistent with empirical observations of business behavior.

Simon Model has certain drawbacks also. Its main drawback is the difficulty of making an operational statement of what is to be regarded as a “satisfactory” level of performance. A firm has several stakeholders or groups such as shareholders, customers, workers, managers, suppliers, government, etc. It has to satisfy them all. For example, shareholders expect higher dividends, workers and managers want higher wages and perquisites and customers want lower prices. As a result, the firm has to choose a particular profit level which will satisfy all the stakeholders. However, this may not be practically feasible.

Cyert and March Model ∞ Cyert and March opined that a large-scale

corporate type of firm exists these days. ∞ Hence, entrepreneur cannot alone be a

decision maker.∞ The decision-making involves a complex group

or organization. ∞ It consists of various individuals whose

interest may conflict with each other.∞ The group is called ‘organizational coalition’

and includes managers, stockholders, workers, consumers and so on.

∞ All of these individuals participate in setting the goals of an organization.

Goals:

Production Goal: According to this goal, production should not fluctuate too much nor fall below an acceptable level.

Inventory Goal: This goal originates mainly from the inventory department, or from the sales and production departments.

Sales Goal: The sales goal is simply an aspirations with respect to the level of sales. Particularly, this goal arises from salesmen,

since their success depends on their ability to maintain or expand the sales. Market-share Goal: This goal is an alternative to the

sales goal and arises from the sales department. This department decides on the advertising campaigns, the market research programmes, and so on. Profit Goal: This goal is set by the top management in

order to satisfy the demands of shareholders and the expectations of bankers and

satisfy the other goals of the firm.

Cyert and March Model (contd..)The firm is a satisficing organization rather than a maximizing entrepreneur. The top management, accountable for the coordination of the activities of the various members of the firm, want:

-to attain a ‘satisfactory’ level of production,-to attain a ‘satisfactory’ share of the market,-to earn a ‘satisfactory’ level of profit-to divert a ‘satisfactory’ percentage of their total receipts to research and development or to advertising, -to acquire a ‘satisfactory’ public image, and so on.

Delegation of authority

decentralization of decision-making.

Monetary payments like wages, salary and dividend

slack payments – it is defined as payments to the various groups of the coalition above than the payments required for efficient working of the firm.

Budget determination

Side payment given to the scientist of research department in addition to regular salary

fulfilling demand according priority

Resolution of Conflicts:

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Of Sales Revenue Maximization

Bamoul’s Model

. The salaries and Perks of top executives closely related to sales profit then Profit..Financial Institution mainly look at the sales Revenue while financing the Firms..Trend in Sales revenue is most available indicator of Performance of firm..Manager prefers steady Performance with Satisfactory profit to high profit..Growing sales Strength Competitive position of the firm in the market. .Personal problem handled when sales growing by giving Higher wages, bonus and better work environment to employees.

Major Reasons for Manager Objective of Sales Revenue Maximisation :

W.J. Bamouls Suggested sales maximization as an alternative to the profit maximization objective.It is because of separation of ownership from management. It provide manager with an opportunity to set goals other than profit maximization which most owner of firm pursues.According to Bamoul's most factor in manager utility function is Maximization of Sales revenue.

Review..


Profit objective provide discipline to

the manager of firms.

Profit is a return for capital invested and

also Reward for Enterpreneur.

Economic Theory of firm is mostly based

on the concept of Profit Maximisation..

It guide all business planning and

decision-making.

Objectives of Business

• It play a significant role in a free enterprise economy.

• It provide resources for expansion andencourage entrepreneurs to increase production• Ensure that production is carried on

efficiency• Most important function to help

entrepreneurs to take risk of uncertainty.

Role of Profit:

Alternative Objectives of Firms

reasonable level profits ensures stable profits over long period more relevant under oligopoly

Secured profits

Intended to popularize the product and boost the morale of employee.

Sales maximisation

expansion of firm should be of balanced rate

Growth maximisation

maximisation of managerial utilities such as • better salaries • job security • reputation of firm etc.

Utility maximisation

Aimed to satisfactory profits rather than profit maximisation

Satisficing profits

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Traditional view Modern viewJ.B.Clark defined profit as an excess of market price of good produced over their cost.

He develop a Dynamic Theory of profit which have five generic changes:-• Change in size of

population;• Change in Stock of

capital;• Change in technique of

production;• Change in form of

business organisation and

• Change in consumer's wants and preference

The above changes affect cost, demand and supply.Thus profit according to clrk belongs to economic dynamics not economic statics.

Classical economist Adam smith and Ricardo Treat profit as a kind of Business incomeleft after paying for labour and Indestructible power of soil.according to this view there is no distinction b/w ownership capital and management of firmshe regard profit as "surplus value" according to him profit is socially not justifiable.

Neo-classic economist F.A. WALKER developed the marginal productivity theory of profitaccording to which factors of production paid by their respective marginal productivities.

Views Of Profit

Economic Profit:Accounting Profit:

Accounting vs. Economic Profit

Accounting profit figures consider realized or actual financial gains and losses. Accounting profit is the total of all the company's revenue minus cash payments for all explicit company costs and purchased resources. These resources include raw materials, materials transport, staff wages and benefits, rent paid on company property and interest on capital.

Unlike accounting profit, economic profit considers the cost of an organization's in-house resources that are utilized in their production of their goods or services. These items are also referred to in finance as implicit resources. Implicit or self-owned resources can include company-owned property, equipment, self-employment resources, company-owned vehicles and independently conducted staff training initiatives

Created By:Apoorv Pandey B.Tech (CSE)3rd yr Roll No.1150810015

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