ME Ch2 Wosabi

8/13/2019 ME Ch2 Wosabi

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HAPTER TW

THE FIRM AND ITS GOALS

Dr. Mohammed Alwosabi 1


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The Firm ,

resources together to produce a good or.

The firm bears costs of production. These

technology e amoun o pro uce an e pr ce o

charge are affected by the market

s ruc ure n w c e rm opera es.

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Dealing with others in the market, the firm

incurs transaction costs Transaction costs are the costs incurred

selling). This includes the costs of,

(2)negotiation, and(3)enforcement of contracts and coordinating

transactions.

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Transaction costs are influenced by. ,know the future perfectly, particularly in

.2.Frequency of recurrence , which refers to

repeated.. ,extent to which the parties are " tied in" in

- -relationship. This might lead to an,

seeks to take advantage of the other. 4


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Managers of profit maximizing firmsalways face the question of whether it is

components (goods and services)internall or to order some of arts from

other firms, through what is known asoutsourcing . rms usua y ou source e per p era ,

non-core activities.

so total cost is minimum

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There is a tradeoff between the cost of

external transactions and the cost ofinternal operations of the firm.

item is higher than its internal operation, the.

The opposite is true. n erne as cause e ransac on cos s o

decrease drastically, making it easier for the

rm o ou source some o e r o ospecialized and more efficient companies

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The Economic Goal of the Firm and Optimal

Decision Makin : Profit Maximization (or loss minimization ,

to be the ultimate goal of the firm.

received and costs incurred. =

To maximize profit , the firm should produce

e quan y o ou pu w c equa es erevenue generated with the cost incurred of

e as un pro uce .MR = MC 7


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For public sector or not-for-profit,

that the organization wants to use its

benefits that this organization was.

Whether the firm wants to maximize profitor ac eve o er goa s, e op madecision is the one that brings the firm

c oses o s goa s.

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Along with the discussion of the firms goal

it is im ortant to distin uish between short-run and long-run.

do directly with months or years-

amount of some resources but not others ong-run : w en e rm can vary e

amount of all resources The firms goal is to maximize profit in SR

and LR, However, at times short-run profitability will

be sacrificed for long-run purposes 9


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Goals Other than Profit Maximization:

other targets as well, according to the

. Different goals may lead to different

amount of resources.conom c oa s

If maximizing profit is the firm goal, howcould the manager be sure that the actionstaken in the present will result in the largestpossible profit?

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Manager of the firm has to break down the

overall oal of rofit maximization into someintermediate targets to be adopted byvarious divisions or de artment of the firm.

The manager has to define production, ,

growth rate, required growth in R&D,,

needed increase in advertising budget.

,be accountable, and incentives will be

their targets. 11


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Some of economic goals that, at the end,

results in maximizin rofit mi ht include:Firms Goal Managerial Decision

x u u ,advertising, promotions

level of output

value

value of profits

Customer satisfaction Quality product at low

12Maximum earning per Higher leverage (debt


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Nevertheless, all of the above goals result,

directl or indirectl , in maximizin the rofitof the firm. , ,

profit-maximization hypothesis, which

long run if it is not profitable .

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Non-Economic Objectives

In toda s world firms are concern withworkers and customers satisfaction , andhow to be sociall res onsible more than in

the past. ,

adoption of objectives that apparently not

maximization such as:

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1. Corporate citizenship and socialresponsibility

2. Firms programs for pollution abatement.3. Labor lifetime contracts.

4. Firms guarantee of none-geneticen ineered roduct

5. Good work environment and higher safetystandards

6. Quality products and services

these objectives would in some way oranother support firms efforts toward theirgoals of profit maximization.

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Do Companies Maximize Profits?

- Problem)

-problem or agency problem

g - eve managers w o are respons e or

major decision making may own very little ofe company s s oc an may e moreinterested in maximizing their own income

an per s, no o max m ze pro ecausethey know that:

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1.Medium-sized or large corporations are

owned b thousands of shareholders whohave no time or resources to follow closelythe firms erformance.

2.Shareholders, usually, hold portfolios of

normally own a small number of any firms. ,

performance of their entire portfolio and not

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3.Most stockholders are not well informed on

how well a cor oration can do and thus arenot capable of determining the effectivenessof mana ement.

4.Shareholders will be satisfied with an

will not likely to take any action as long as

their investment.

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For these reasons, managers act in

accordance with their own interest, savetheir jobs, protect their benefits, while,shareholders are uite ha as lon as

they receive some reasonable return on theirca ital.

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Second Argument: With the profit

maximization h othesis Managers objective is to maximize profit

1.Financial institutes mostly hold the largest .

on managerial performance with the help of,

external auditors.

. n e presence o e c en nanc amarkets, managers misconducts would bere ec e on s oc pr ces n e mar e .

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This will have a negative effect on

stockholders wealth.3.Competition between firms secures thatinefficient mana ers will soon be discovered

and forced out of their jobs.4.The com ensation of man executives istied in a way or another to stock price

performance in terms of attained profits. For the abovementioned reasons, managers

objectives coincide shareholders

o ec ves; managers wou o e r es omaximize firms profits.

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Economic Profit:

statements according to GAAP recording,

because there are different ways of

amortization of such items as goodwill and

When it comes to calculating costs, two

accounting and economics:

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1. Accountants base their assessments of

ca ital de reciation and inventories onhistorical costs , while economists, on theother hand, ne lect historical costs and call

it sunk costs that should not affectdecisions. Instead, the considerreplacement cost .

.explicit costs , while economists are

include both explicit and implicit costs.

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Implicit costs include the value of resources

owned b owners of the firm even if thereare no monetary payments. Part of the economic cost art of im licit

cost) is the normal profit. Normal rofit is the avera e return that

could be obtained from running another

business. It is an amount equal to what theowners of a business could have earned iftheir resources including entrepreneurial

a es an a en a een emp oyeelsewhere.

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Normal profit covers the opportunity cost ofrunning the firm.

Normal profit is the minimum return a firm'sowner must earn in order to stay inoperat on. ower rate wou cause some othe established firms to leave; a higher one

.

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Economic profit represents an extra profit

over and above all costs includin normalprofit.

the entrepreneur for taking the risk of

suffer loss..

Economic Profit = TR - TEC

= TR Opp. Cost= TR (Explicit Cost + Implicit cost)

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A firm earns an economic profit only if it

earns more than its o ortunit cost. If economic profit is zero firm earns

If economic profit is positive firm earns

If economic profit is negative firm earnsess an norma pro econom c oss

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ME Ch2 Wosabi

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