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Profit and Objective of the Firm

Profit and Objective of the Firm

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Published by tanvir09

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Categories:Types, Business/Law
Published by: tanvir09 on Apr 14, 2009
Copyright:Attribution Non-commercial


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Profit and Objective of the firm
Profit: Basic concept
• Profit: Revenue – Cost• Revenue: Sales volume
Unit price• Cost: Accounting costs
Economic cost• Role of profit:– Determines types of goods and services to be sold– Determines demand for various factors of production
Theory of profit
• Dynamic equilibrium (friction) theory• Monopoly theory• Innovation theory• Managerial efficiency theory
Dynamic equilibrium theory
• Normal profit: Rate of return that the firms in a particular industry earn over a longperiod of time• All the firms want to earn at least a normal profit• A firm or firms in a industry may earn profit above or below normal profit• Temporary dislocation of various sectors of economy is responsible• In case of higher than normal profit – many firms are attracted that ultimately reducesprofit• In case of lower than normal profit – many producers leave the industry that ultimatelyenhance profit by reducing supply• Little time is taken for this adjustment• Firms earn higher or lower than normal profit in the interim period
Monopoly theory
• Sometimes above normal profit is possible due to sole or significance dominance in themarket• Source of monopoly power• Law• Economies of scale• Control of natural resource• Patent right
Innovation theory
• Innovation: New idea about product, place, price and promotion• above normal profit is possible due to unique and successful innovation• Example– Microsoft– Nokia– Square food
Managerial efficiency theory
• Managerial efficiency – enables firm to come up with better idea, reduce cost andwastage and prepare better to cope with the changes in business environment• Firms can earn above normal profit is due to exceptional managerial skill• Most of the firms now a days invest a lot in training and development for improvingmanagerial skills of their managers
Objectives of the firm
• Profit maximization objective• Share holders wealth maximization objective• Efficiency objective• Non profit objective– Maximization of quantity and quality of output– Utility Maximization of the Administrator– Cash Flow Maximization– Satisfaction Maximization of the Stake holders
Profit maximization objective
• Commonly set objective• Three different decisions regarding this objective– Increase revenue more than the cost– By reducing some of the costs more than it increases other costs (holding revenueremains same)– By Increasing some revenue more than it decreases other revenue (holding costs remainsame)– By reducing the costs more than the revenue• Each three decision has different implications resource allocation decisions
Shareholders’ wealth maximization Objective
 • Takes two major factors into consideration:– risk – discounting money value• This goal states that firm should maximize present value of expected future return to theowners (shareholders)• Shareholders’ wealth is the product of market price per share and the number of outstanding shares
Efficiency objective
• Efficiency =
• Three different approaches:– Maximizing out for given input (cost)– Minimizing cost at given level of out put– Maximizing net benefit• Appropriate for public services, utility etc

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