OBJECTIVES AND GROWTH OF FIRMS

What is a firm?
In simple terms, firms are companies. They are legally recognised bodies that provide goods
and/or services to their consumers, government bodies, and other businesses.

A firm is an organization that combines and organizes resources for the purpose of
producing goods and services for sale at profits.¹

Firms can be divided on the basis of their legality, nature of work, number of owners, size, and
need for its resources. Firms can be broadly classified into three main categories. These
categories are then divided into subcategories:
Private sectors
Proprietary
Partnerships
Companies
Cooperatives

2. Public sector
Companies
Cooperations
Departments

Profit maximisation:

If we move to the right of the profit-maximising point, M, the marginal cost curve is above the
marginal revenue curve. This means that there is only loss for any units above the profit-
maximising quantity, Qm. This results in the reduction of profits.

On the other hand, if we move to the left of the profit-maximising point, M, the marginal
revenue curve is above the marginal cost curve. This means that any additional unit produced
will increase profits until the profit-maximising quantity, Qm is reached. This happens at the
point where the marginal revenue curve meets the marginal cost curve. Hence, the firm will
choose to produce at this profit-maximising point where MC = MR. The price that the firm will
set is read off the AR curve at the profit-maximising quantity, Qm (point P in Figure 2.)

Other possible objectives of firms

Most firms have a basic objective of profit maximisation. However, for many reasons, some
firms may also try to fulfill other objectives:

If a firm has a too large level of profit, this may result in the regulators' investigating it. They
may scrutinise the firm's processes and ask to reduce prices to meet customers’ demands.

Sometimes, firms may not have a profit-maximisation objective as they are not able to
ascertain their actual marginal cost and marginal revenue.
Other objectives may be more crucial for the firm over profit maximisation.
Growth maximisation/sales maximisation
The firms may pursue the objective of sales maximisation which can also be referred to as
growth maximisation. A firm achieves sales maximisation when the average cost (AC) is
equal to the average revenue (AR) which is also a point at which a firm breaks even (makes
zero profit.)

Growth Maximisation:

Here are some reasons why firms would have sales maximisation as their objective:
1. Economies of scale
When the firm increases the production levels to reduce its cost of production, it helps to
create economies of scale. As the output increases, firms aim for higher sales.
2. Market flooding
This is the marketing tactic a firm uses to hammer the consumer’s memory with the firm’s
product by showing it everywhere possible. This kind of strategy helps the firms to gain more
market share and at the same time loyal customers.
3. Limit pricing
Here the firm prices its product at the break-even point. The price allows it to make only
normal profit, which takes away the incentive for new firms to enter the market.

Revenue maximisation:
Revenue maximisation occurs when marginal revenue is equal to zero (MR = 0.) This is also a
point where the MR curve crosses the quantity axis. The price, as always, is read off the AR
curve.
Objectives of Firms Revenue maximisation
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Revenue maximisation (at point R) can help the firms increase their produced quantities
whilst lowering their prices compared to the prices in profit (at point P) or sales maximisation
(at point S.)
Again, profit maximisation occurs at the point M where MC = MR. We read the price from the
average revenue (AR) curve at point P, which gives us the price, Pm, and quantity, Qm, for
profit maximisation.
Similarly, revenue maximisation occurs when marginal revenue equals 0. We read the price
from the average revenue (AR) curve at point R, which gives us with the price, P2, and quantity,
Q2, for revenue maximisation.
Clearly, at the point of revenue maximisation, the prices are lower and the quantities are
higher than those determined for profit maximisation. Hence, firms may be willing to go for
revenue maximisation over profit maximisation.
With the objective of revenue maximisation, the firm may cut down the competition by
charging lower prices and taking the market share away from its competitors.

The satisficing principle:

The satisficing principle refers to sacrificing profits to satisfy as many key stakeholders as
possible. The word satisficing comes from ‘satisfy’ and ‘sacrificing.’ A satisficing principle
often happens when stakeholders have conflicting interests. Stakeholders can be anyone
associated with the firm including consumers, employees, shareholders, trade unions, or the
government.

Each stakeholder may have a different motive for running the business, resulting in not having
profit maximisation as their main objective.

Workers may be unhappy if they are underpaid due to cost-cutting and would want firms to
pay them better sacrificing the profit margin. Similarly, the government may also want a firm
to reduce its profit margin and pass the benefits to the consumer who might be overcharged.
Survival is another objective some firms might pursue in the short run. Some firms decide to
survive to capture market share and gain consumers’ loyalty over profits or sales. In fact, in
some cases, the firm may also experience losses. However, if they can survive in the short
run, they would be able to sustain and reverse the losses in the long run.
Corporate social responsibility
Corporate social responsibility has been gaining importance recently. More firms are aiming
to be socially responsible to gain more customers’ trust and to be environmentally friendly.
This allows them to be within the rules and regulations of the government.
Increasing market share
The firm may want to increase its market share, which will help it expand and result in a better
position in the market over its competitors. Also, some firm managers like to manage big
companies and create more opportunities for employees.
Effects of divorce of ownership from control on firms’ objectives
In many companies, the owners are different from those who manage the business. The
owners don’t control the company. This isn’t usually the case in small companies. In larger
companies, the owners are the shareholders while those who manage the company are the
directors. The owners’ objectives may be different from the directors’ objectives.

This is known as a divorce of ownership from control or the principal-agent problem. The
principals are the owners and the agents acting on behalf of the owners are the managers.

The managers who control the company know the day in and day out of the business and
may have objectives of revenue maximisation, such as giving their employees better perks,
good health benefits, bonuses, etc.

On the other hand, the owners or shareholders may have an objective of profit maximisation
so they can get better returns and the value of their shares increases.

Firms are legally recognised bodies that work to provide goods and/or services to their
consumers, government bodies, and other businesses.
In economics, profit refers to the returns over and above the opportunity cost. It is also
referred to as the pure profits.
The main objective of most firms is profit maximisation. They can use it for re-investments,
giving better dividends, rewards for entrepreneurship, etc.
Profit maximisation occurs when marginal cost is equal to the marginal revenue.
The objective of sales maximisation is achieved when the average cost is equal to the
average revenue which is also breakeven.
Revenue maximisation occurs when marginal revenue is equal to zero.
The satisficing principle refers to sacrificing profits to satisfy as many key stakeholders as
possible.
The divorce of ownership from control is also called the Principal-Agent problem.

Bank mergers
Like all firms, banks can derive considerable benefits from merging, including economies of
scale. In addition, there are considerable benefits to financial institutions from merging rather
than expanding organically. Over time, banks will have built up a range of low, medium, and
high-risk borrowers. To expand organically, a bank may have to take on higher risk customers.
However, if a bank acquires another bank it will not need to increase its average risk because
it will acquire a range of customers of all risks. Banks can also merge to help secure extra
liquidity.

The advantages of mergers

Mergers can generate a number of advantages:

Firms that merge can take advantage of a range of economies of scale, such as cost savings
associated with marketing and technology.
In the case of vertical integration there are savings in terms of not having to pay ‘3rd party’
profits. For example, if a tour operator owns its own hotels it will not need to pay profits to the
hotel, and will be able to keeps costs and prices down.
Economies of scope are also available to firms that merger and are benefits associated with
using the fixed assets of one firm to produce output for the other firm.
Unexpected synergies are unpredicted benefits that arise when firms merge or undertake a
joint venture, such as when two pharmaceutical companies merge, and create a new drug.
Rationalisation is the process of eliminating parts of a business that are inefficient or
unprofitable, and is a possible consequence of two or more firms merging.
When firms merge, they can share knowledge with each firm benefitting from the knowledge
and experience acquired by the other. With vertical integration, information asymmetries can
be reduced or removed.

Disadvantages of mergers
Increased concentration and reduced competition are obvious disadvantages of a merger
between two dominant firms.
Firms that merge may experience diseconomies of scale, such as difficulties with co-
ordination and control. This will increase average cost in the long run, and reduce profitability.
Higher prices are a likely consequence of a merger because, with less competition, demand is
more inelastic and raising price will raise revenue.
There may be less output from the merged firm, compared with combined output of the two
firms.
Rationalisation is likely to lead to lost jobs as the merged firms attempt to increase
profitability. For example, two advertising agencies that merge could dispense with two
design departments, and share one.
Consumers are likely to suffer from reduced choice following a merger of two close
competitors. This is a common criticism of banking and supermarket mergers, and one
reason why they are the subject of scrutiny

Economies of scale
are the cost advantages that enterprises obtain due to their scale of operation, and are
typically measured by the amount of output produced per unit of time. A decrease in cost per
unit of output enables an increase in scale. At the basis of economies of scale, there may be
technical, statistical, organizational or related factors to the degree of market control. This is
just a partial description of the concept
Economies of scale apply to a variety of the organizational and business situations and at
various levels, such as a production, plant or an entire enterprise. When average costs start
falling as output increases, then economies of scale occur. Some economies of scale, such
as capital cost of manufacturing facilities and friction loss of transportation and industrial
equipment, have a physical or engineering basis.

The economic concept dates back to Adam Smith and the idea of obtaining larger production
returns through the use of division of labor.[1] Diseconomies of scale are the opposite.

.
Market control is the ability of buyers or sellers to influence the price, quantity, or other
aspects of a market. The number of competitors is the key determinant of market control.
More competitors mean less market control and fewer competitors mean greater market
control.
Buyers with market control face a negatively-sloped demand curve. Buyers with no market
control face a horizontal or perfectly elastic demand curve at the market price. Sellers with
market control face a positively-sloped supply curve. Sellers with no market control face a
horizontal or perfectly elastic supply curve at the market price.

Market control is a key source of inefficiency. With market control profit-maximizing firms do
not equate demand price and supply price. As such, the value of goods produced is not equal
to the value of goods not produced. Society's overall satisfaction can be increased by
producing more of one good and less of another good.

Price Takers and Makers

Market control, or lack thereof, underlies two types of market participants--price takers and
price makers.
Price Takers: These are participants with no market control. They can do nothing but "take"
the going market price. Price-taking sellers sell all of their output that they want at the
existing market price. Price-taking buyers can buy all of the good that they want at the
existing market price. Price takers are also called price seekers.

Price Makers: These are participants with some market control. They are able to "make" the
market price, that is, to set the price. Price-making sellers can select from a range of prices,
and in so doing, affect the quantities that buyers are willing to purchase. Price-making buyers
can also select from a range of prices, and in so doing, affect the quantities that sellers are
willing to sell. Price makers are also called price setters.

Risk reduction refers to methods used to mitigate the risk associated with an asset when
investing money.

For example, imagine that it is 2005, and Anna has won the lottery. She has just made 1
million dollars and has to decide how to spend these 1 million dollars.

Anna consults with a financial advisor, who convinces her that real estate is the best asset to
put her money on. And in fact, at that time, the real estate market in the united states was
significantly attractive, making people richer and richer and richer.

So, Anna invests all her 1 million dollars in the real estate market. She buys some property
and buys some real estate stocks.

Fast forward to the year 2008.

A financial crisis has hit the United States, and the market that's exposed most is the real
estate market. Banks have given many loans out to individuals who can't pay them back. The
number of people defaulting on their loans increases which causes housing prices to
plummet.

If you want to find out more about what happened during the 2008 financial crisis and how
the housing crisis plummeted, click here:

- 2008 Financial Crisis.

As a result, Anna lost the majority of her money.

At the same time, U.S treasury bonds and gold were outperforming all the other assets.

Had Anna reduced the risk by investing a portion of her money into real estate and another
portion in U.S. treasury bonds and gold, Anna would not have lost all her money.

Risk reduction refers to investing strategies whereby an investor invests their money across
multiple assets with different degrees of risk in order to mitigate the risk which comes with
investing in one asset only.

A person or an organization must be fully aware of all the available financial information. That
way they can calculate the risk that the asset bears and whether or not it is valuable for the
company to invest in such an asset.

Risk Reduction Strategy

One of the main risk reduction strategies is to reduce risk by investing in different assets with
different degrees of risk. Multiple investments in different assets are called a portfolio.

Risk Reduction Examples

Risk reduction examples include investors who invest in various asset classes to mitigate the
risk they face in their portfolios.
Contrary to risk avoidance, when faced with risk, risk reduction involves using different
strategies to mitigate the overall risk faced on their portfolio.

For example, let's assume that an investor owns a certain amount of shares in oil companies
when the price of oil is volatile.

The volatility of the price of oil is due to the political setting as oil exporting countries are
having political tension, which is also making oil companies viable in terms of their credit
default risk.

To reduce the risk that an investor faces in their portfolio, the investor will consider buying
shares in companies that move in the opposite direction of the oil price.

Think about it, when oil prices drop, the demand for cars increases, as people can spend less
money driving. This will expand the profitability of car-making companies such as Ford or
Mercedes, causing their stock price to increase. Hence, the investor decides to buy shares in
these companies.