Unit 6 Objectives Of Firms

Structure 6.1 Introduction Objectives 6.2 Profit Maximization model 6.3 Economist Theory of firm 6.4 Cyert and Marchs behavior theory 6.5 Marris growth maximization model 6.6 Boumals static and dynamic models 6.7 Williamsons managerial discretionary theory 6.1. Introduction A business firm is an economic unit. It is a producing unit. It converts inputs in to outputs. It is a legal entity on the basis of ownership and contractual relationship organized for pr oduction and sale of goods and services. All business units are set up and managed by people and a re called by various names like shops, firms, enterprise, production and business concerns etc. They can take several forms like sole trader, partnership concern, Joint Stock Company, cooperat ives or even public utilities. They produce and supply different goods and services for the dire ct satisfaction of consumers for producing other final goods and services. Each firm lays down its own objectives. They are fundamental to the very existen ce of a firm. They are the endpoint towards rational activity. They indicate the very existence of a firm and guid e the actions of a firm. They indicate how a firm has to organize its activities and perfor m its functions. A modem business unit has multiple objectives and they are multidimensional in the ir nature. Some of them are competitive while others are supplementary in nature. A few other obje ctives are mutually interconnected and a few others are opposing in nature. These objectives are det ermined by various factors and forces like corporate environment, socioeconomic conditions, and the nature of power in the organization and extraneous conditions, and constraints under which a firm op erates. Each business unit defines its own objectives which may have to satisfy the needs of th ose groups whose cooperation makes the continued existence of the business possiblethe share hold ers, management, employees, suppliers and consumers etc. Thus, we come across mu ltiple and diversified objectives. 6.2 Profit Maximization Model

Profitmaking is one of the most traditional, basic and major objectives of a firm. Profitmotive is the drivingforce behind all business activities of a company. It is the primary measure of suc cess or failure of a firm in the market. Profit earning capacity indicates the position, perfo rmance and status of a firm in the market. It is an acid test of economic ability and performance of an individual firm. There is no place for a firm unless it earns a reasonable amount of profit in the bu siness. It is necessary to stay in business and maintain in tact the wealth producing agents. It is a widely accepted goal and there is nothing bad or immoral about it. Earlier profit maximiz ation was the sole objective of a firm. This assumption has a long history in economic literature and the conventional price theory was based on this very assumption about profit making. In spite of se veral changes and development of several alternative objectives, profit maximization has remained a s one of the single most important objectives of the firm even today. Both small and large firms consi stently make an attempt to maximize their profit by adopting novel techniques in business. Specifi c efforts have been made to maximize output and minimize production and other operating costs. Co t reduction, cost cutting and cost minimization has become the slogan of a modern firm. It helps to predict the priceoutput behavior of a firm under changing market conditions like tax rates, wages and salaries, bonus, the degree of availability of resources, technology, fas hions, tastes and preferences of consumers etc. It is a very simple and unambiguous model. It is th e single most ideal model that can explain the normal behavior of a firm. It is often argued that no ot her alternative hypothesis can explain and predict the behavior of business firms better than profi tmaximization hypothesis. This model gives a proper insight in to the working behavior of a firm. There are well developed mathematical models to explain this hypothesis in a systematic and sci entific manner. Main propositions of the profitmaximization model.

The model is based on the assumption that each firm seeks to maximize its profit given certain technical and market constraints. The following are the main propositions of the m odel. 1. A firm is a producing unit and as such it converts various inputs into outputs of higher value under a given technique of production. 2. The basic objective of each firm is to earn maximum profit. 3. A firm operates under a given market condition. 4. A firm will select that alternative course of action which helps to maximize cons istent profits 5. A firm makes an attempt to change its prices, input and output quantity to maxi mize its profit. The model Profitmaximization implies earning highest possible amount of profits during a giv en period of time. A firm has to generate largest amount of profits by building optimum prod uctive capacity both in the short run and long run depending upon various internal and external fa ctors and forces. There should be proper balance between short run and long run objectives. In the short run a firm is able to make only slight or minor adjustments in the production process as well as in business conditions. The plant capacity in the short run is fixed and as such, it can increas e its production and sales by intensive utilization of existing plants and machineries, having over time work for the existing staff etc. Thus, in the short run, a firm has its own technical and managerial constr aints. But in the long run, as there is plenty of time at the disposal of a firm, it can expand and ad d to the existing capacities, build up new plants, employ additional workers etc to meet the rising demand in the market. Thus, in the long run, a firm will have adequate time and ample opportuni ty to make all kinds of adjustments and readjustments in production process and in its marketing strat egies. It is to be noted with great care that a firm has to maximize its profits after taking in to consideration of various factors in to account. They are as follows 1. Pricing and business strategies of rival firms and its impact on the working of th e given firm.

2. Aggressive sales promotion policies adopted by rival firms in the market. 3. Without inducing the workers to demand higher wages and salaries leading to ri se in operation costs 4. Without resorting to monopolistic and exploitative practices inviting governmen t controls and takeovers. 5. Maintaining the quality of the product and services to the customers. 6. Taking various kinds of risks and uncertainties in the changing business environ ment. 7. Adopting a stable business policy. 8. Avoiding any sort of clash between short run and long run profits in the busines s policy and maintaining proper balance between them. 9. Maintaining its reputation, name, fame and image in the market. 10.Profit maximization is necessary in both perfect and imperfect markets.In a per fect market, a firm is a pricetaker and under imperfect market it becomes a pricesearcher. Assumptions of the model The profit maximization model is based on tree important assumptions. They are as follows 1. Profit maximization is the main goal of the firm. 2. Rational behavior on the part of the firm to achieve its goal of profit maximizati on. 3. The firm is managed by ownerentrepreneur. Determination of profit maximizing price and output Profit maximization of a firm can be explained in two different ways. a. Total Revenue and Total Cost approach. b. Marginal Revenue and Marginal Cost approach. Profits of a firm are estimated by making comparison between total revenue and t otal costs. Profit is the difference between TR and TC. In other words, excess of revenue over costs is the profits. Profit = TR TC. If TR is equal to TC in that case, there will be break even point. If TR is less than TC, in that case, a firm will be incurring losses. In this case, we take in to account of total cost and total revenue of the firm while measuring profits. It is clear from the following diagram how profit arises when TR is greater than tha t of TC

2. MR and MC approach In this case, we take in to account of revenue earned from one unit and cost incurr ed to produce only one unit of output. A firm will be maximizing its profits when MR= MC and MC curv e cuts MR curve from below. If MC curve cuts MR curve from above either under perfect market or under imperfect market, no doubt MR equals MC but total output will not be maximized and hence total profits also will not be maximized. Hence, two conditions are necessary for profit maximizatio n 1. MR = MC. 2. MC curve cut MR curve from below. It is clear form the following di agram.

Justification for profit maximization 1. Basic objective of traditional economic theory. The traditional economic theory assumes that a firm is owned and managed by the entrepreneur himself and as such he always aims at maximum return on his capital invested in the business. Hence profitmaximization becomes the natural principle of a firm. 2. A firm is not a charitable institution. A firm is a business unit. It is organized on commercial principles. A firm is not a charitable institution. Hence, it has to earn reasonable amount of profits. 3. To predict most realistic priceoutput behavior. This model helps to predict usual and general behavior of business firms in the real world as it provides a practical guidance. It a lso helps in

predicting the reasonable behavior of a firm with more accuracy. Thus, it is a very simple, plain, realistic, pragmatic and most useful hypothesis in forecasting price output behavi or of a firm. 4. Necessary for survival It is to be noted that the very existence and survival of a firm depends on its capacity to earn maximum profits. It is a timehonored hypothesis and there is common agreement among businessmen to make highest possible profits both in the short run and long run. 5. To achieve other objectives. In recent years several other objectives have beco me much more popular and all these objectives have become highly relevant in the context of mo dern business set up. But it is to be remembered that they can be achieved only when a firm is making maximum profits.

A firm is formed, run and managed by an owner, employer or an entrepreneur wh o has the following characteristics. 1. He has the legal permission to run an enterprise. 2. He can enter in to contract with any group of people who supply productive res ources. 3. He can take his own decisions to maximize his economic gains. 4. He is entitled to enjoy the residual income after making payments to all product ive resources in the form of rent, wages and salaries and interest. 5. He can transfer his rights and obligations to other individuals on the basis of co ntracts. 6. He can direct and dictate the suppliers of productive resources in the manner h e likes of course on the basis of legal contracts. 7. He can change the nature of management according to his convenience. 8. He has all the rights to make changes in his organization which he feels the bes t. He can consult others or he can take his own final decisions. Thus, a firm is managed by a private person who centralizes all his decisions on th e basis of legal contracts and makes enough profits. He has his own personal interests to run the business unit. Such a type of business unit has emerged as a dominant form of business organiz ation over a period of time. It has its won advantages as the firm is managed by an individual.

A firm managed by an individual has several advantages over other forms of orga nization. 1. He can take immediate and quick decisions to maximize his economic gains. 2. Direct control over the firm will ensure higher productivity, efficiency, better su pervision, better performance etc. Better control and management helps him to have timebound pr ograms 3. He can reward factor inputs on the basis of their performance and get best serv ices from them. 4. He adopts a flexible business policy to suit the changing conditions without any of loss of time. Thus, this form of business organization has emerged as the classical entrepreneu rial firm and has become most popular over a period of time. The above mentioned features of the classical firm have been described as the theory of firm by various economists. The traditional or classical firm basically engages itself in various kinds of economi c activities which help in maximizing its profits. It concentrates on wealthcreation and through it surplus creation. Surplus value is nothing but the difference between the value of the final product and the value of various inputs employed in the production process. Surplus generation is possible when the firm produces maximum output with minimum costs. Hence, a firm works out the most ideal factor combinations to avoid all kinds of wastages, cut down costs and maximize its outp ut. When the firm produces maximum output with minimum costs then it will reach the equilibrium p osition. This is possible when total revenue is equal to total cost or marginal revenue is equal to marginal cost. At the equilibrium point, it is said that a firm will be maximizing its profits. The natur e of working of a firmdepends on several factors like number of firms in the market, size of the firm, volume of p roductionentry and exit if firms, degree of competition, existence of alternative su bstitutes, prices of goods etc. Thus, the traditional or classical firm aims at profit maximization and over the yea rs this objective has been replaced by profit optimization.
6.8. Summary Units 6 enlighten us about the various alternative objectives of a firm. The traditional obj ective is that

of profit maximization. But in recent years, economists have developed various alternativ e objectives to suit to modern business environment. The theory of firm highlights on wealthmaximization or creation of maximum assets through which it can generate economic surpluses. The profi t maximization theory stresses on earning maximum amount of profits by a firm. Cyert and March theory concentrates on the behavior of various coalition partners in an organization and e xplain how opposite goals of different groups would affect the decision making of a firm. Marris mode l analyses the rate of growth of a firm via maximizing managers powers and status. Boumal analyse s the impact of advertisement expenditures incurred by a firm on sales promotion and its impa ct on total sales revenue of a firm. Williamson studies the impact of managerial utility functions on t he performance of a firm. Thus, a firm has several alternative goals and the selection of parti cular goals depends on the management of a firm. It is to be remembered that all other objectives of a firm can be realized only when a firm is making reasonable amount of profits. Any organization ha s to earn adequate profits to please the shareholders. In order to make more profits, a firm has to c reate more wealth, assets, and surpluses, satisfy the expectations of top managers, workers, and ach ieve a high growth rate of the firm. All objectives are inter connected and supplement one another. R ealization of one objective would depend on other objectives. Hence, there should be a proper balanc e between different objectives.