The Firm and its Goals
The Firm
Ø A firm is a collection of resources that is
transformed into products demanded by consumers
Ø Profit is the difference between revenue received and costs incurred
Ø Transaction costs are incurred when entering into a contract
Types of
transaction costs: investigation, negotiation, enforcing
contracts.
Ø Transaction costs are incurred when entering into a
contract
Influences : Uncertainty , frequency
of recurrence , asset specificity
Ø Limits to firm size
-
tradeoff
between external transactions and the cost of internal operations
-
company
chooses to allocate resources so total cost is minimum
-
outsourcing
of peripheral, non-core activities
Economic goal of
the firm
Ø Profit maximization hypothesis: the primary objective of the firm (to economists) is
to maximize profits
Other goals include market share, revenue
growth, and shareholder value
Ø Optimal decision is the one that brings the firm closest to its goal
Ø Short-run versus Long-run
·
nothing
to do directly with calendar time
·
short-run:
firm can vary amount of some resources but not others
·
long-run:
firm can vary amount of all resources
·
at
times short-run profitability will be sacrificed for long-run purposes
Goals other than
profit
Ø Economic goals
·
market
share, growth rate
·
profit
margin
·
return
on investment, Return on assets
·
technological
advancement
·
customer
satisfaction
·
shareholder
value
Ø Non-economic objectives
·
good
work environment
·
quality
products and services
·
corporate
citizenship, social responsibility
Do companies maximize
profit?
Ø Criticism: companies do not maximize profits but
instead merely aim to satisfice, which means to achieve a satisfactory
goal, one that may not require the firm to ‘do its best’
Ø Position and power of stockholders
Ø Position and power of management
Ø Counter-arguments which support the profit
maximization hypothesis
Two
major types of risk:
Ø
Business risk involves
variation in returns due to the ups and downs of the economy, the industry, and
the firm
All firms
face business risk to varying degrees
Ø
Financial risk concerns the
variation in returns that is induced by ‘leverage’
Leverage is the proportion of a company
financed by debt
o
the higher the leverage, the greater the
potential fluctuations in stockholder earnings
o
financial risk is directly related to the
degree of leverage
