Theory of the Firm

• Combines and organizes resources for the

purpose of producing goods and/or services
for sale.
• Internalizes transactions, reducing
transactions costs.
• Primary goal is to maximize the wealth or
value of the firm.
• The primary goal of the firm is to maximise
the wealth/value of the firm
• It is given by the present value of all expected
future profits of the firm
• Future profits must be discounted to the
present because a rupee of profit in the
future is worth less trhan a rupee of profit
today
 TYPE OF FIRMS
Private Ltd Company
•A private company has the following features:
Restricts the right of the shareholders to transfer their shares.
•Has a minimum of 2 and maximum of 50 members.
•does not invite public to subscribe to its share capital
Public Ltd Company :
•A public Ltd company has the following characteristics:
It allows the shareholders to transfer their shares.
•Has a minimum of 7 members, and for maximum there is no limit.
Unlimited Company
•Unlimited Company is a form of business organization under which the
liability of all its members is unlimited. The personal assets of the members
can be used to settle the debts
Sole proprietorship
•Sole proprietorship is a form of business entity where a single individual
handles the entire business organization. He is the sole recipient of all profits
and bearer of all loses.
Joint Hindu Family
•Joint Hindu Family is a form of business organization wherein the members
of a family can only own and manage the business.
Partnership
Partnership is “the relation between persons who have agreed to share the profits of the
business carried on by all or any one of them acting for all”.
Co-operatives
Co-operatives is a form of voluntary organization, wherein the members work together
for the promotion of the interests of its members. There is no restriction to the entry or
exit of any member.
Limited Liability Partnership
Under LLP (Limited Liability Partnership) the liability of at least one member is unlimited
whereas rest all the other members have limited liability, limited to the extent of their
contribution in the LLP.
Liaison Office
Liaison Office is a kind of representative office which is set up to understand the business
and investment environment. It is barred from taking up any
commercial/industrial/trading activity and its role is limited to aggregation of information
and promotion of exports/imports.
Branch Office
Foreign companies which are into manufacturing and trading activities abroad are
permitted to set up branch offices in India for various purposes like rendering of
professional and consultancy services, export/import of goods etc.
Project Office
Foreign companies can set up temporary project offices in India for carrying out
activities related to that specific project.

Subsidiary Company
•In India the sectors where 100% foreign direct investment is permitted there foreign
companies can set up wholly-owned subsidiary. The wholly-owned subsidiary can be
either of the following business entities: Private Ltd Company
•Public Ltd Company
•Unlimited Company
•Sole Proprietorship
 Alternative Theories
• Sales maximization
Adequate rate of profit
• Management utility maximization
• Principal-Agent problem-Manager may be more
interested in maximizing his own benefits(fringe) than
maximizing the owner’s interest
• Satisficing behavior-Satisfying the share holders&
managers
• Because of greater complexity of running the large
modern cooperation-a task often complicated by
uncertainty and a lack of adequate data
• Managers are not able to maximize profits but
can only strive for some satisfactory goal in
terms of sales, profits ,growth, market share
and so on
• Simon called this satisfying behavior
 CONSTRAINTS OF THE FIRMS
• Lack of Availability of raw materials &other
inputs in the short run
• Scarcity of skilled laborers to hire up to its
requirement level
• Lack of space in ware housing facility
• Lack of adequate capital funds
• Legal constraints-minimum wage act,health
and safety standards
 Constrained optimization
• Maximization of wealth or the value of the
firm subject to the constraints if faces
• Optimization –In order to allow for these
cases where the firm wants to minimize costs
and other objectives ,subject to the
constraints it faces
The nature and function of profits
• Business profits refers to the revenue of the firm-
the explicit or accounting costs of the firms
• Explicit costs are the actual out of pocket
expectations of the firm to purchase/hire the
inputs if requires in production
• Economic Profits=Revenue-Explicit Costs
• Implicit costs refer to the value of the inputs
owned and used by the firm in its own
production process
 Definitions of Profit
• Business Profit: Total revenue minus the
explicit or accounting costs of production.
• Economic Profit: Total revenue minus the
explicit and implicit costs of production.
• Opportunity Cost: Implicit value of a resource
in its best alternative use.
• Gross profit
• Net profit
• Value of output
• Value of inputs
 Theories of Profit
• Risk-Bearing Theories of Profit
• Frictional Theory of Profit-In short run firms
may get abnormal profits, but in long run only
normal profits can be made
• Monopoly Theory of Profit
• Innovation Theory of Profit
• Managerial Efficiency Theory of Profit
 Function of Profit
• Profit is a signal that guides the allocation of
society’s resources.
• High profits in an industry are a signal that
buyers want more of what the industry
produces.
• Low (or negative) profits in an industry are a
signal that buyers want less of what the
industry produces.
 Business Ethics
• Identifies types of behavior that businesses
and their employees should not engage in.
• Source of guidance that goes beyond
enforceable laws.
• Business and management ethics goes beyond
the law to provide guidelines as to what is
applicable behavior in business transactions