Mic ie 14 H OF A BUSINESS FIRM oR COPTIMUM SIZE OF THE FIRM ™@ 1. Introduction ; ‘The business firm isa unit engaged in production of goods and ser business firm includes all those enterprises which produce and sell goods and firm may be an individual proprietorship, or partnership or Joint Stock ¢ © DEFINITION a — According to Edwin Mansfield, "Firms a unit that produces a goo sale." — Inthe words of Salvatore, "A sirmis an organisation that cor resources for the purpose of producing goods and services for : : — According to Michael Parkin, “Firm is an institution that buys or h ; t! production and organises them to produce and sell goods and ( ‘Thus, afirm is an organisation that uses resources to produce goods producers are called firms, no matter how big they are or what they pro farmrs, banks and insurance companies are all firms. All firms are alike one primary objective. They are in business to make a profit, 2. Objectives of a Business Firm Regarding the objectives of a business firm, the economists hold to the classical economists, the main aim of the firm was to. ihe reason for this was that during the era of classicals, firms enutaniters, i.c., managers or organisers were the owners of joint-stock com, entrepreneurs or partnership, : of ‘shareholders, who reside atTI RT Tid eal i, , ; For BBA promt 281 nager ds on mi tos: ¢ ofthe manager depen lany factors like the sales and d aoce ig their salaries and other facilities, The manager tier nee ny a ing, adequate profits so that share holders may remain satisfied. But ie importance must also grow. Thus, there are m, besides the maximisation of profit, any alternative objectives of pany profit Maximisation (2) Revenue or Sales Maximisation jaximisation of Satisfaction (4) Security Profits +h Maximisation: tion of Managerial Utility or Discretion Maxim 4, profit Maximisation The in assumption of classical economists is that the sole objective of the business oft maximisation. It is also the basis of conventional price theory. Profit Mon has been considered most appropriate and very “productive’ business . analytical point of view. Truth of this assumption lies in the fact that it has unambiguously disproved. Assumption of profit maximisation, as a matter of «the behaviour of the business firms and the behaviour of price and output in crket conditions. No other or alternative hypothesis explains and predicts in a behaviour of the firm that the assumption of profit maximisation. is calculated by deducting total cost from total revenue (x= TR-TC).Itisa earned by the entrepreneur after making payment to all factors of production for senvices. Itincludes payment to the entrepreneur for his own services. In other words, cludes normal profit. Thus, the revenue earned by the firm over and above its normal fi, ‘scalled Super normal profit, The goal of the firm is to maximize this super normal fit. In the context of profit maximisation, the basic propositions of firms principle can be ribed in brief as under: isa i i i i ‘bination |i) Firm isa transformation unit, If production function and least cost com! are known it transforms valuable resources into goods of higher value. (i) Firm endeavours to achieve the objective of profit man Gees hich a firm (ii) Market conditions (like oon Peay etc.) under wl operates are given and are visible at pees ay i h e (vy) Condition of profit maximisation does not change in the contest of ne period (short-run and long-run). x i (0) Primary approach of firm's prices of related inputs and ,, -Pssically firm's prineiple is eoncen! also focussed on the assum]282 conditions, factor payments, production technique, ete. the firmretmaing achieving this objective. @ DEFINITION Inthe words of Nicholson, “A profit maximising firm chooses bathi outputs with the sole goal of achieving maximum economic profits, firm seeks to make the difference between its ‘economic costs as large as possible.” i 3.1 Conditions of Profit Maximisation Profit ofa firmis calculated by and total revenue (TR) obtained from t TR-TC u the difference between its total cost ofp hhe sale of a given level of production. Microecono total revenues (Here x = Profit; TR =Total Revenue; TC Total Cost) With a view to maximising its profit, a firm should produce upto that quantity at which the following two conditions are fulfilled: (1) Marginal Revenue (MR) = Marginal Cost (Mc). (2) Slope of marginal revenue curve should be less than the slope of marginal cost curve or, marginal cost curve must cut marginal revenue curve from below. In the words of Nicholson, “In order to maximise profit firm should choose the output for ‘which marginal revenue is equal to marginal cost and marginal profit must be decreasing at the optimai level of output.” Maximum profit of a firm has been expressed diagrammatically in Figs. 1 (A), 1 (B) and 1(C). In Fig. 1 (A) and 1(C) revenue and cost have been shown on OY axis. In 1 (B) total profit has been shown on OY axis. In all the figures, output is shown on OX axis. (1) In Fig. 1 (A) TC is total cost curve and TR is total yentie curve. Difference between total revenue curve and ost curve will be maximum at that level of output where s of both these curves will be equal. To know their two parallel tangents have been drawn. The points these tangents are parallel, slope of the curves will be & their distance will be maximum. It is evident that za pairs is equalat point ‘\’and point 'B’ Be cn ce which is maximum also represents >< ‘COST / REVENUE (Rs) PROFIT (Rs) REVENUE COST (Rs)Sai a SREP pusiness Firm and Optimur Size of the Rim of 4 it jqure shows that AB difference between total er0Q output. In other words, firm ig eehing J Jo; and 0Q2 amount of output, total cost jg ting any profit. equal 283 ui ‘im at C ar ue curve and total cost curve AB maximum profit. On the to total revenue. It means the _, Fig. 1(B) total profit curve has been shown, Ato point ‘P’ It means firm is earning maxirau, 10 output, total profit (TP) curve im profit at OQ output. rig. (C) shows that at OQ amount of output, ‘marginal reve1 nue curve cuts vt curve at point ‘B’. In other words, , 1. MR) when firm produces 09 outed tenant ante ee © 00 output. If firm produces less than OO output, say OO, tonne ‘9: will be more than marginal cost B Qi (MR > MC). ie Pe eee ¢ Mire than OQ: output, its profit will go om increasing, On the Pee ces more than OQ output, say OQz, then its marginal cost NQ2 will be mor aoe “pat revenue DQ2 (MC > MR). Itmeans thatas the firm produces more than OQou it So, it will suffer ND loss. Thus, firm will earn maximum profit by producing OQ meet . wnere both the conditions of maximum profit are fulfilled. a ording to William F, Samuelson and Stephen G. Marks, “The firm's profit jevel of output occurs when the additional revenue from setting an extra unit just cost of producing it, that is when MR = MC." n short, according to classical economists firm will produce OQ output to get profit. Its total cost will be BQ and total revenue AQ. The firm will, therefore, earn profit AB (PQ) as shown in Fig. 1(A) and (B). In the situation of maximum profit ost will be equal to marginal revenue (MC = MR) and marginal cost curve will cut from below as shown by point E in Fig. 1 (C)- 4, Alternative Objectives of a Firm classical theory of firm makes no distinction However, the modern theory of firm, called n imit that owners and managers es i . tives are different. Berle arate roles in those big companies Whi BT cad eceat end ns had, first of all, referred to the dichotomy between ga 4 oS anes eiice: tioned about their role in mangerial behaviour and sS1808 © sively on this s, That they supervise and manage- Subsequent Galore oe ‘hypothesis reveals that ue, It is known as Berle-Means- Galbraith-Hype ntrolled firms: and (i) Manager profit than man corporations of284 Microecono, ™@ (1) Revenue or Sales Maximisation Goal — Baumol's Theory Prof. Baumol, in his book ‘Business behaviour, Valte and Growth’has py theory of Sales Maximisation. Main aim of a firm is to maximise sales, By total revenue earned by the sale of goods. That is why this goalis also referre Maximisation Goal. According to this theory, once profits reach acceptable goal of the firms become maximisation of sales revenue rather than profits. @ DEFINITION — Inthe words of Baumoul, “The sales maximisation goal says that {firms seek to maximise their sales revenue subject to the constrai ‘Satisfactory profits.” ‘The above definition maintains that when the profits of firms reach a satisfactory by the shareholders then the efforts of the managers are di revenue by promoting sales instead of maximising profit. While studying ist be kept in view that firms do not ignore profit altogether. They do level of profit. But once an acceptable level of profit is obtained thei maximisation in place of profit maximisation. Conditions of Revenue or Sales Maximisation In order to maximise total revenue by the sale of goods, a firm prod. tity of the good where marginal revenue becomes It means that if the firm produces more than that it where marginal revenue is zero then its total jue will be less than the maximum. Goal of sales revenue) maximisation is illustrated in Fig. 2. In Fig. 2 output is shown on OX-axis and cost, ue and profit on OY-axis, (1) In Fig, 2(A), TRis total revenue curve, TC is total ‘cost curve and TP is total profit curve, PP line represents minimum profit. In Fig. 2 (B), PN curve represents marginal revenue (MR) and PD curve represents average revenue (AR). PROFIT, COST, REVENUE (Re) In order to maximize its revenue, the firm will produce 0 output because at OQ output marginal revenue is zero, as shown by point ‘N’ in Fig. 2 (B). OQ output signifies maximum total revenue AQ as shown in Fig. 2 (A). But at 0Q output firm will get only KQ profit which is less than minimum profit (OP). In case firm produces more than OQ output, its marginal revenue willisiness Firm and Optimum Size ofthe i im fa BU oF" na total revenue Will be less than the max 285 pia), shows that ifthe firm desires min ee “t,mount of output. In this case, firm imum profit K; Will get BQ, 8 level of output 4:01 (OP) then it wilt have ae Tevenue which is less 1) firm will get minimum ne oP) P! oF rofit jal of the firm is profit maximisatio; n, then i rue is equal to marginal cost (MR = MG) ae will produce 0; output where "irmn’s total revenue will be CQa which is mech ent ® in Fig. 2 (B). In "thus evident from Fig. 2 that sales Hisgebaues te pe rmisation firms, but their profits wil be less, becarres tay, Prxiuce more ee nal cost (MR < MC) as shown in Fig. 2 (B) their marginal revenue jay be noted that total revenue of the firm will , amount of profit is KQ, the firm will be ae ue upon minimum amount of ‘tis KiQh, the firm will get alittleless (BQl}than the mariner nace ene aximum revenue AQ. the i ever pie AQ aft maxi ro n marg view of Prof. Scitovosky. sation of satisfaction is the main ~ of the firm. An entrepreneur] satisfaction even at) profits. It is due to the fact certain level of profits, the of the entrepreneur will be to preference to leisure in on to profits. As the income off eneur increases, he prefers efforts to be incurred in cing output. The objective of tion of satisfaction can be 4 with the help of the following’ leisure and efforts (output) tal revenue and Inthe above figure profits are “axis, APis the net profits curve, cost, In the above figure efforts or output : ean morelei wo indifferen is mean less leisure and less efforts ms point © towards P. Il and lily are tWo 7 eoreneur’s level of satisfaction yieldingv gos Microeconomics produce PQ amount of output. The above figure shows that entrepreneur will be ge maximum profit at point N which is the highest point of AP net profit curve. At matin profit the level of output will be PQi, The satisfaction - maximum level of output PO jg} than profit-maximum level of output PQr. In other words, at (OM level of profit the gam preneut maximises his satisfaction because he enjoys OQ leisure which is QQu more the, he would have enjoyed under profit maximisation (0Q)) @ (3) Secure Profits Prof, Rothschild ia of the view that the objective of the ttm 1s te det seas ‘The firm is motivated not by profit maximisation but by the objective of security profit, j implies that a firm in deciding its price ‘and output policy does not aim at maxi is profits at a particular time or for a particular period of time, but to have a constant flow of profits for a long-period of time. In other words, the firm seeks not maximum Profits bi secure profits. In the words of Rothschild, “There is another motive which cannot be so lighity dismissed and which is probably of a similar order of magnitude as the desire for maximum profits, the desire for secure profits.” ] prof, Rothschild is of the opinion that the objective of profit maximisation may bea valid assumption under conditions of perfect competition and monopolistic competition as well as monopoly. Under perfect competition or monopolistic competition the numberof ems i very large, so that the individual firm isnot faced with the secure profits. In case of monopoly, security against competition 1s ensured by virtue of its monopoly position. ‘thechild says that under oligopoly, the objective of the firm is not profit maximisation, it er to achieve secure position among other existing firms. The primary objective list is long-run survival. The desire to increase its security leads to the struggle for wn and to the setting of a reasonable price which may provide secure profit. In fact sthschild’s hypothesis is an other version of profit maximisation. (4) Growth Maximistion ‘The growth maximisation of a firm is regarded as an important objective of corporations. The credit of introducing this objectives goes to Mrs. Penrose. In he! othe Theory of the Growth of Firms’, she suggested that modern managers interested in the objective of growth maximisation rather than in profit m: However, a systematic growth maximising theory is developed by R.T. Marti Baumoul. According to this theory, rate of growth and potential of growth are yardsticks used to measure the success of a firm. The manager ofa firmaims at me the growth ofhis firm. The growth ofa firm implies increase in its size, prod sales. The firm may grow in size by expanding new markets domestically and global he done through the creation of new products and an enlarged demand. In the words of 8.K. Seo, “Under the conventional profit maximisa' however, once the firm finds an equilibrium level of output that will maximise its profs will remain constant as long as cost and demand remain constant. There is no = Bet5 Firm and Optimum Size of the Firm 287 juction for sales any further. In In reality, vipreyant andi firms do want to grow be ae and cost do jvate them to maximise _,, oa firm is financed either from internal sou 01 awit Of * Fnancing of growth is more desi or from market bo: internal 0 ; ; esirable that rowing neemat ehat interest and instalment of the debt Grn funds, The main vice payments) might ns ‘ation in the future growth capacity, Int obstr” : Internal fund: sir aximisation. The decision to maximise growth aes however, grow only ‘uma profit In order to avoid the threat of take he cae nwa choose that growth rate which maximises es of the corporation, the ould take place. et value and the rate at maximisation of Managerial Utility Or Discretion tneory of Managerial Utility Maximisati «Galbraith and Williamson. It is assed ee eae es jeory is based on the concept that shareholders or owners of ae two separate groups, The owners or the shareholders peieg amacsteess fore, interested in maximising profits, the managers, on the other hand, have ‘ves other than profit maximisation, Once the managers have achieved a level will pay satisfactory dividends to shareholders and still ensure growth, theyare ve their own emoluments and also the size of their staff and expenditure on words of Williamson, “To the extent that the pressure from the capital market ‘on in the product market is imperfect, the manager, therefore, has discretion to other than profits.” Further Berle and Means suggested that “The lack of owners or shareholders with little or no power to change 6) democracy leaves policy.” According to Williamson, “Manager u=1(S, M, ID) it will be read: Managerial utility is a function (of agerial emoluments and discretionary investment. (Here, U = managerial utility; S = additional expenditure uments and ID = discretionary investment.) z ati ther than ‘ofits Menagerial utility function maximises te utility of the ik the following the firm. The manager is expected t® follow policies whic ponents of his utility function: ¥ increase the quality like 0 a lore staff are (i) Expansion of Staff: The manage will f the staff. M reporting to him, This willless/ amet in ea, ‘more prestige lied because they lead to the manaees getting mo rity ve al Utility function may be expressed as follows: additional expenditure on staff, on staff; M = managerial and number ofMicroeconomics 288 (ii) Increase in Managerial Emoluments: Managerial Utility also dep managerial emoluments. It includes facilities like entertainment allowance, office, staff car, company phone, etc. Expenditure of this nature reflects toa la the prestige, power and status of the manager. : i (iii) Discretionary Power of Investment: Managerial utility also depends, discretion of the manager to undertake investment beyond those required for operations. The manager is in a position to invest in advanced technology and plants. Such investments may or may not be economically efficient. These investm be undertaken for the self-satisfaction of the manager. © Conclusion It is clear from the above account that there can be several objectives ofa fiz isno unanimity between the economists and the researchers regarding the objecti firm. But one thing is certain that survival of a firm depends on that amount of pro a firm earns. A firm may have any goal or objective like—Revenue or Sales ma Grow maximisation, maximisation of managerial utility, long-term survival, ma or satisfactory over-all performance—it must be a profitable organisation. Techn term profit maximisation may not be practicable, yet in the objective function of profit isa must. Firms may have difference of opinion with regard to the "quantumo but they can determine the target of profit for themselves. :