6 objectives of firms

7/28/2019 6 Objectives of Firms

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Unit 6 Objectives Of Firms

Structure6.1 Introduction Objectives 6.2 Profit Maximization model6.3 Economist Theory of firm 6.4 Cyert and Marchs behavior theory6.5 Marris growth maximization model 6.6 Boumals static and dynamic models6.7 Williamsons managerial discretionary theory

6.1. Introduction

A business firm is an economic unit. It is a producing unit. It converts inputs in tooutputs. It is alegal entity on the basis of ownership and contractual relationship organized for production and saleof goods and services. All business units are set up and managed by people and are called by

various names like shops, firms, enterprise, production and business concerns etc.They can takeseveral forms like sole trader, partnership concern, Joint Stock Company, cooperatives or evenpublic utilities. They produce and supply different goods and services for the direct satisfaction of consumers for producing other final goods and services.

Each firm lays down its own objectives. They are fundamental to the very existence of a firm. They are the end-point towards rational activity. They indicate the very existence of a firm and guide the

actions of a firm. They indicate how a firm has to organize its activities and perform its functions. Amodem business unit has multiple objectives and they are multidimensional in their nature. Some ofthem are competitive while others are supplementary in nature. A few other objectives are mutuallyinterconnected and a few others are opposing in nature. These objectives are determined by various factors and forces like corporate environment, socio-economic conditions, and the nature of power inthe organization and extraneous conditions, and constraints under which a firm operates. Each

business unit defines its own objectives which may have to satisfy the needs of those groups whosecooperation makes the continued existence of the business possiblethe share holders,management, employees, suppliers and consumers etc. Thus, we come across multiple and diversifiedobjectives.

6.2 Profit Maximization Model


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Profit-making is one of the most traditional, basic and major objectives of a firm. Profit-motive is the driving-force behind all business activities of a company. It is the primary measure of success orfailure of a firm in the market. Profit earning capacity indicates the position, perfo

rmance and statusof a firm in the market. It is an acid test of economic ability and performance of anindividual firm.

There is no place for a firm unless it earns a reasonable amount of profit in the business. It isnecessary to stay in business and maintain in tact the wealth producing agents. Itis a widelyaccepted goal and there is nothing bad or immoral about it. Earlier profit maximization was the sole

objective of a firm. This assumption has a long history in economic literature andthe conventionalprice theory was based on this very assumption about profit making. In spite of several changes anddevelopment of several alternative objectives, profit maximization has remained as one of the singlemost important objectives of the firm even today. Both small and large firms consistently make anattempt to maximize their profit by adopting novel techniques in business. Specific efforts have beenmade to maximize output and minimize production and other operating costs. Co

t reduction, costcutting and cost minimization has become the slogan of a modern firm.

It helps to predict the price-output behavior of a firm under changing market conditions like tax rates,wages and salaries, bonus, the degree of availability of resources, technology, fashions, tastes andpreferences of consumers etc. It is a very simple and unambiguous model. It is the single most idealmodel that can explain the normal behavior of a firm. It is often argued that no other alternative

hypothesis can explain and predict the behavior of business firms better than profitmaximizationhypothesis. This model gives a proper insight in to the working behavior of a firm.There are welldeveloped mathematical models to explain this hypothesis in a systematic and scientific manner.

Main propositions of the profitmaximization model.


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The model is based on the assumption that each firm seeks to maximize its profitgiven certaintechnical and market constraints. The following are the main propositions of the model.

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 consistent profits5. A firm makes an attempt to change its prices, input and output quantity to maximize its profit.

The model

Profitmaximization implies earning highest possible amount of profits during a given periodof time. A firm has to generate largest amount of profits by building optimum productive capacityboth in the short run and long run depending upon various internal and external factors and forces.

There should be proper balance between short run and long run objectives. In theshort run a firm isable to make only slight or minor adjustments in the production process as well asin business

conditions. The plant capacity in the short run is fixed and as such, it can increase its production andsales by intensive utilization of existing plants and machineries, having over timework for the existingstaff etc. Thus, in the short run, a firm has its own technical and managerial constraints. But in thelong run, as there is plenty of time at the disposal of a firm, it can expand and add to the existingcapacities, build up new plants, employ additional workers etc to meet the risingdemand in themarket. Thus, in the long run, a firm will have adequate time and ample opportuni

ty to make all kindsof adjustments and readjustments in production process and in its marketing strategies.

It is to be noted with great care that a firm has to maximize its profits after takingin 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 the given firm.


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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 rise in operation costs4. Without resorting to monopolistic and exploitative practices inviting government controls andtakeovers.

5. Maintaining the quality of the product and services to the customers.6. Taking various kinds of risks and uncertainties in the changing business environment.7. Adopting a stable business policy.8. Avoiding any sort of clash between short run and long run profits in the business 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 perfect market, a firm is a price-taker and under imperfect market it becomes a pricesearcher.

Assumptions of the model

The profit maximization model is based on tree important assumptions. They areas 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 maximization.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 total costs. Profit isthe difference between TR and TC. In other words, excess of revenue over costs isthe profits. Profit

= TR TC. If TR is equal to TC in that case, there will be break even point. If TR isless than TC, inthat case, a firm will be incurring losses. In this case, we take in to account of totalcost and total revenue of the firm while measuring profits.

It is clear from the following diagram how profit arises when TR is greater than that of TC


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2. MR and MC approach

In this case, we take in to account of revenue earned from one unit and cost incurred to produce onlyone unit of output. A firm will be maximizing its profits when MR= MC and MC curve cuts MR curvefrom below. If MC curve cuts MR curve from above either under perfect market orunder imperfectmarket, no doubt MR equals MC but total output will not be maximized and hencetotal profits alsowill 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 diagram.


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Justification for profit maximization

1. Basic objective of traditional economic theory. The traditional economic theoryassumes thata firm is owned and managed by the entrepreneur himself and as such he alwaysaims atmaximum return on his capital invested in the business. Hence profitmaximizationbecomes the natural principle of a firm.

2. A firm is not a charitable institution. A firm is a business unit. It is organized oncommercialprinciples. A firm is not a charitable institution. Hence, it has to earn reasonableamount of profits.

3. To predict most realistic priceoutput behavior. This model helps to predict usualand generalbehavior of business firms in the real world as it provides a practical guidance. It also helps in


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predicting the reasonable behavior of a firm with more accuracy. Thus, it is a verysimple, plain,realistic, pragmatic and most useful hypothesis in forecasting price output behavior of a firm.

4. Necessary for survival It is to be noted that the very existence and survival of afirm depends on its capacity to earn maximum profits. It is a time-honored hypothesis and there is commonagreement among businessmen to make highest possible profits both in the shortrun and long run.

5. To achieve other objectives. In recent years several other objectives have become much morepopular and all these objectives have become highly relevant in the context of modern businessset up. But it is to be remembered that they can be achieved only when a firm is

making maximumprofits.

A firm is formed, run and managed by an owner, employer or an entrepreneur who 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 resources.

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 productive 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 contracts.6. He can direct and dictate the suppliers of productive resources in the manner he 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 best. 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 the basis of legalcontracts and makes enough profits. He has his own personal interests to run thebusiness unit.

Such a type of business unit has emerged as a dominant form of business organization over a periodof time. It has its won advantages as the firm is managed by an individual.


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A firm managed by an individual has several advantages over other forms of organization.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 supervision, betterperformance etc. Better control and management helps him to have timebound pr

ograms3. He can reward factor inputs on the basis of their performance and get best services from them.4. He adopts a flexible business policy to suit the changing conditions without anyof loss of time.

Thus, this form of business organization has emerged as the classical entrepreneurial firm and hasbecome most popular over a period of time. The above mentioned features of theclassical firm have been described as the theory of firm by various economists.

The traditional or classical firm basically engages itself in various kinds of economic activities which help in maximizing its profits. It concentrates on wealth-creation and through it surplus creation.Surplus value is nothing but the difference between the value of the final productand the value ofvarious inputs employed in the production process. Surplus generation is possiblewhen the firmproduces maximum output with minimum costs. Hence, a firm works out the mostideal factorcombinations to avoid all kinds of wastages, cut down costs and maximize its output. When the firm

produces maximum output with minimum costs then it will reach the equilibrium position. This ispossible when total revenue is equal to total cost or marginal revenue is equal tomarginal cost. Atthe equilibrium point, it is said that a firm will be maximizing its profits. The nature of working of afirmdepends on several factors like number of firms in the market, size of the firm,volume of productionentry and exit if firms, degree of competition, existence of alternative substitutes, prices of goods etc.

Thus, the traditional or classical firm aims at profit maximization and over the years 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 objective is that


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of profit maximization. But in recent years, economists have developed various alternative objectivesto suit to modern business environment. The theory of firm highlights on wealth-maximization orcreation of maximum assets through which it can generate economic surpluses. The profitmaximization theory stresses on earning maximum amount of profits by a firm. Cyert and

Marchtheory concentrates on the behavior of various coalition partners in an organization and explain howopposite goals of different groups would affect the decision making of a firm. Marris model analysesthe rate of growth of a firm via maximizing managers powers and status. Boumal analyses theimpact of advertisement expenditures incurred by a firm on sales promotion and its impact on totalsales revenue of a firm. Williamson studies the impact of managerial utility functions on theperformance of a firm. Thus, a firm has several alternative goals and the selection of parti

cular goalsdepends on the management of a firm. It is to be remembered that all other objectives ofa firm canbe realized only when a firm is making reasonable amount of profits. Any organization has to earnadequate profits to please the shareholders. In order to make more profits, a firm has to create morewealth, assets, and surpluses, satisfy the expectations of top managers, workers, and achieve a highgrowth rate of the firm. All objectives are inter connected and supplement one another. Realization ofone objective would depend on other objectives. Hence, there should be a proper balanc

e between different objectives.

6 objectives of firms

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