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The Theories of Firm
The Theories of Firm
Meaning of firm:
A firm is an organization that combines and organizes resources for the
purpose of producing goods and services for sale. In economics, the
term firm refers to a unit. The form is a producing unit. It is a business
unit which undertakes production activity. The firm buys and co-
ordinates the services of productive factors such as land, labor and
capital along with its organization for producing a commodity and sells
it in the market to the households or other firm.
A firm as to take decisions regarding:
The products to be produced
The nature of the product
Quantity and quality of the product
Methods of production
Whom to sell and at what price?
The motive behind all these decisions is maximizing the projects of the
firm. The firm hires factors of production and pays them remuneration
for the productive services they render. In short, the firm organizes the
business and bears the risks. Thus a firm earns profits as the reward.
Firm owns and organizes a plant. It may be a factory or plant as a
productive unit containing building, machineries, equipment’s etc. A
plant is a place or arrangement for a production process whereas a firm
is a decision making unit.
MARRIS THEORY:
A coherent and integrated theory of the growth of the firm has been
developed by Marris. His theory is applicable to corporate firm owned
by shareholders but controlled by managers. Shareholder’s being
owners of the firm, are assumed to have the objective of maximizing
the return on their investment in the firm. Managers of the firm, on the
other hand aspire to maximize their own interests which are taken care
of by higher pay, perks, power, prestige etc. All such things are
postulated to be positively correlated with the growth of the firm in
Marris model. It implies that managers of the firm are assumed to have
the rate of growth of the firm as their objective. The return on
shareholder’s investment is realized in the form of dividend and capital
gains throughout the life of the firm. The present value of the future
stream of such earnings of current share capital determines the value
of the firm in stock market. Higher the expectation of the earnings by
shareholders from a firm, greater will be its value in stock market and
vice-verse. In view of this relationship, one may take the growth in
market value of equity shares of a firm as a proxy variable to specify the
profit maximization goal of its shareholders. Marris used this approach
in his model. He specified maximization of the rate of growth as the
overall goal of the firm subject to stock market constraints. The
constraints takes care of the objective of the shareholders. They have
to be assured a minimum level of earnings on their investment,
otherwise the job security of the managers will be in danger. If
profitability or market value of the firm shares declines there will be a
danger of its being taken over by other firms. In this situation also, the
jobs or importance of the managers of the firm will be adversely
affected.
The mechanism of the growth of the firm in Marris frame work can best
be explained with the help of a few relationships which Marris himself
specified. They are as follows:
The steady growth condition:
To simplify the analysis of the growth of the firm Marris made the
assumption of steady state growth under which all characteristics of
the firm such as assets, employment, sales, profits etc. grow at the
same rate over time. There will be several ratios of any two of these
characteristics which will of course be constant under the steady state
of growth of the firm. E.g. the profit margin, the rate of return on
capital, the capital-output ratio etc. which Marris called as the “state
variable”. The implication of the steady state growth rate is that both
supply and demand sides of the firm grow over time at the same rate. If
this is not so, there will be either ever growing spare capacity when
supply grows at a faster rate than demand or ever growing excess
demand when demand grows at faster rate than supply. Both these
situation would be empirically unsound and so the management of the
firm will be maintaining a balance between them over time.