THE OBJECTIVE OF FIRMS

*DEFINE PUBLIC SECTOR.

The public sector refers to the organizations that are owned and controlled by the
government. The activity of this organization is to provide services to the public.

The composition of the public sector varies by country but in most countries the
public sector includes government department such as: education, health care, law
and order, defense local and central government bodies and their departments.

There are also a range of more commercially oriented public sector organization,
such as transport postal services and utilities.

*DEFINE PRIVATE SECTOR:

The segment of national economy that is controlled and managed by private

individuals or enterprises is known as private sector.

There are two types of private sector:

a) For profit organizations: Profit seeking firms such as Google aim to maximize
the financial benefits of its shareholders by targeting for profit maximization.
b) Non-profit organization: Private sector also includes not for profit
organization which have the goal to meet certain social objectives. They can
make profits but they cannot be used for anything a part from this goal and the
operation of this organization. Example: charitable organization like American
Red Cross.
o CO-OPERATIVE: Co-operatives are owned, control and operated for the
benefit of their members. They are normally form so that individuals and small
business can be benefited from being part of a larger group allowing greater
bargaining and buying power. Cooperatives are likely to place a greater
emphasis on meeting the needs of its member such as improving living
conditions for farmers rather than making profit.
They may also give a higher priority to social responsibility. Ex:
environmental concerns, community needs, providing employment
opportunities.
*Types of cooperative:

Consumer cooperative: Consumer cooperatives are owned by the people who by

the goods or use the services of the cooperative. They operate worldwide in areas
of retailing etc.

Producer (workers) cooperatives: Producer or workers cooperative are owned by

farm commodities of crafts. Producer cooperatives often group together in order to
gain economies of scale and improve their access to financial services.

Retail cooperative: Retail cooperatives involved small retailers grouping together

to be more competitive with large retailers by sharing marketing expenses and
buying as group manufactures for high volume discount.

EVALUATION:

o Cooperatives may find it difficult to raise finance since breaks are not willing to
lend them money because their main aim not to make a profit.

o In many countries cooperatives often have to comply with more regulations

than other private sector organizations. For example: Setting up a cooperative
enterprise typically involves more paper work and bureaucracy leading to high
start up cost.

o Mutual: A mutual company is a private company whose ownership based is

made of his clients or policy holders since its customers are also its owners;
they are entitled to receive profit or income generated by mutual company.
Profits are typically distributed as dividends in position to the amount of
business that each customer conducts with the mutual company. Example:
Mutual insurance companies.

*KEY DIFFERENCES BETWEEN PUBLIC AND PRIVATE SECTOR:

1) Public sector is a part of the country’s economy where the control and
maintenance are in the hands of government whereas if we talked about private
sector, it is owned and managed by the private individuals and corporations.
2) The aim of public sector is to provide service for general public. They do not
work with profit motive. Whereas private sector enterprises are established with
the profit motive.
3) The employees of the public sector have the security of the job along with that
they are given the benefits of the allowances, per quests and retirement like
gratuity, pension, super annotation fund etc. Which are absent in the case of the
private sector.
4) In the public sector the government has full control over the organizations.
Conversely, private sector companies enjoy less government interference.
5) In the private sector working environment is quite competition which is missing
in the public sector because they are not established to meet commercial
objectives.

*Advantages of public sector:

a) They base their decisions on the full cost and benefits involved. It means,
before taking any decision to invest in a new project, Public Corporation
compare their full cost and benefit to see whether the in investment will be
fruitful. Unlike private sector, public sector focuses mainly on maximizing
consumer welfare but also make some profits, if not as much as that off private
sector. It is important for public sector to make profit to continue to provide
better quality services to consumers in the future.
b) They can be used to influence economic activity. To boost country’s output,
public corporations can be directly encouraged to increase their output.

c) State owned firms like, rail infrastructure are natural monopoly firm. It means
there is only one firm in the market, so in that case , if the state owned firm
wants then they can exploit consumer but they do not do this because their main
objective is to work for consumer and social welfare.
d) Owner ship of a whole industry by the government makes planning and
coordination easier. For insistence (example): If the state ruins the train system,
it can ensure that train timetables are coordinated.

e) It is important that basic industries, such as electricity, gas and transport

company, are owned by government because these are consumers basic
necessity so, if public sector owned it then consumer may be able to pay higher
price for services.

*DISADVANTAGE OF PUBLIC CORPORATION or PUBLIC SECTOR:

 It is difficult to manage and control the large size of the organizations may
mean that firm has to be spent on meeting and communicating with staff
slowing down decision making.
 They may become inefficient, produce low quality products and change
relatively high prices, due to lack of competition and the knowledge they
cannot go bankrupt.
 They will need to be subsidized if they are loss making. The use of tax revenue
to support them has an opportunity cost it could be used to spend on, say,
training more teaches and nurses.

*Advantages of private sector:

o Profit incentive: Private firms have a profit incentive to cut costs and develop
products demanded by consumers. In the government sector this profit motive
is often absent. Therefore, government bodies have a greater tendency to be
overstaffed and inefficient.
o Bureaucracy: For political reasons, it is sometimes more difficult to get rid of
surplus workers in the public sector than private sector. Private businessman do
not have to worry about political popularity and so are more willing to make
people redundant if it helps efficiency. The public sector on the other hand are
more likely to employ surplus on the other hand are likely to employ surplus
worker in unproductive jobs.
o Improve efficiency: The main argument for privatization is that private
companies have a profit incentive to cut cost and be more efficient. If you work
for a government run industry, managers do not usually share in any profits.
Since privatization companies such as British Airways have shown degree of
efficiency and higher profitability.
o Lack of political interference: It is argued governments make economic
managers. They are motivated by political resources rather than sound
economic and business sense. For example: A state enterprise may employ
surplus workers because of negative publicity involved in job losses. Therefore,
state owned enterprises often employ too many workers increasing inefficiency.
o Shot run view: A government may think only in terms of the next election.
Therefore, they may be unwilling to invest in infrastructure improvements
which benefit the firm in the long term because they are more concerned about
projects that give a benefit before the election.
o Share holders: It is argued that a private firm shareholders to perform
efficiently. If the firm is inefficient then the firm could be subject to take over.
A state owned firm does not have this pressure and so it is easier for them to
inefficient.
o Increased competition: Often privatization of state owned monopolies occurs
alongside deregulation i.e. (that is) policies to allow more firms to enter the
industry and increase the competitiveness of the market. It is this increase in
competition that can be the greatest spur (Anything that motivate, inspire)
improvements in efficiency. For example- There is now more competition in
telecoms and distribution of gas and electricity.
However, privatization does not necessarily increase
competition. It demands on the nature of the market.
Example: There is no competition in tap water because it
is a natural monopoly. There is also very little
competition within the rail industry.
o Government will raise revenue from the sale: Selling state owned assets to
the private sector raised significant sums for the UK government in 1980s.
However, this is one off benefit. It also means we lose out on future dividends
from the profit public companies.

*DISADVANTAGES OF PRIVATISATION/PRIVATE SECTOR:

a) Natural monopoly: A natural monopoly occurs when the most efficient
number of firms in the industry is one. For example- tap water has very
significant fixed cost; therefore there is no scope for having competition
amongst several firms. Therefore, in this case, privatization would just create a
private monopoly which might seek to set higher prices which exploit
consumers. Therefore it is better to have a public monopoly rather than a
private monopoly which can exploit the consumer.
b) Public interest: There are many industries which perform important public
services, such as health care, education and public transport. In these industries,
the profit motive should not be the primary objective of firms and industry. For
example: In the case of health care, it is feared privatizing health care, arguably
we do not need a profit motive to improve standards. When doctors treat
patients they are unlikely to try harder if they get a bonus.
c) Government loses out on potential dividends: Many of the privatized
companies in the UK are quite profitable. This means the government misses
out on their dividends, instead going to wealthy share holders.

d) Problem of regulating private monopolies: Privatization creates private

monopolies, such as the water companies and rail companies. These need
regulating to prevent abuse of monopoly power. Therefore, there is still need
for government regulation, similar to under state ownership.
e) Fragmentation of industries: In the UK, rail privatization led to breaking up
the rail network to infrastructure and train operating companies. This leads to
areas where it was unclear who had responsibility. For example: The hat field
rail crash was blamed on no one taking responsibility for safety. Different Rail
Company has increased the complexity of rail tickets.
f) Short-termism of firms: As well as the government being motivated by short
term pressures this is something private firms may do as well. To please
shareholders they may seek to increase short-term profit avoid investing in long
term projects. For example: The UK is suffering from a lack of investment in
new energy sources; the privatized companies are trying to make use of existing
plants rather invest in new ones.

EVALUATION OF PRIVATISATION:
 It depends on the industry in question. An industry like telecoms is a typical
industry where the incentive of profit can help increase efficiency. However, if
you apply it to industries like health care or public you apply it to industries
like health care or public transport the profit motive is less important.
 It depends on the quality of regulation.
 Creating a private monopoly may harm consumer interests, but if the market is
highly competitive there is a greater scope for efficiency savings.

*SIGNIFICANCE OF THE DIVORCE OF OWNERSHIP FROM

CONTROL-( PRICNCIPLE AGENT PROBLEM ):

The divorce of ownership from control refers to a situation where the owners of a
firm (share holders) are not involved in the day to day running off a business
which is rather control by managers/ directors.

The principal agent problem can be linked to the theory of asymmetric

information. It occurs when the agent (managers) makes decisions for the
principals (shareholder). The agent is inclined (have a tendency to do
something) to act in their owned interest rather than those of the principal. For
example: Share holders and mangers have different objectives which might
conflict.

Share holders are more likely to desire profit maximization. They want to achieve
a good returns in the form of dividend payments and arising share price. On the
other hand managers may be focused on more growth objectives, building a power
base, increasing revenue which leads to higher bonuses prestige and status rather
than maximize the dividends of the shareholders.

*EVALUATION:

1. Share holders may also prefer to see short term company growth rather than
short term profit gains.
2. The larger the firm the more significant will be the present of the principle
agent’s problem.
3. In the long run all parties are likely to seek profit as an objective as it
determines organizations survival. (Except in the case of not for organization)
4. Firms may use incentive for manager such as profit – related pay, share seams,
bonuses in order to focus on achieving profit maximization.
5. Directors and senior managers may be major shareholders and so there may
not necessarily be a divorce between ownership from control.
6. The private sector also includes cooperatives and non-profit organizations.
Here the divorce between ownership and control may not be as significant as
the shareholders are not likely to seek high profit levels and have more social
profit objectives.

*OBJECTIVES OF PRIVATE SECTOR FIRMS [PROFIT

ORGANIZATION]:

The prime objective of most private sector organizations is to make a profit. This
may be achieved through:

Profit maximization /profit satisfying.

Profit maximization:

OUTPUT MARGINAL MARGINAL MARGINAL TOTAL

REVENUE COST PROFIT PROFIT
1 10 10 0 0
2 10 6 4 4
3 10 3 7 11
4 10 6 4 15
5 10 10 0 15
6 10 13 -3 12

Explanation of profit maximization:

To maximize supernormal profit a firm must produce at MC=MR. Below the

output level MR is greater than MC, MR>MC. So adding an extra unit of output
will increase profit as marginal profit MP is positive above output level. So adding
an extra unit of output will diminish profit as MP becomes negative.

1. Profit maximizing occurs at output level where MC=MR

2. At this level of output marginal profit is zero.
3. Profit maximizing output is not affected by changes in fixed costs.