The Firm

1
The Firm

• Outline
• 1. The objectives of the firm
• 2. Measuring costs of production
• 3. Rules for profit maximisation
• 2. Economies of scale scope

2
1. The objectives of the firm

• A) Profit maximisation
• B) Sales revenue maximisation
• C) Growth maximisation
• investment
• acquisitions
• mergers
• Modern business
• shareholders - profit maximisation
• managers - salary, status, etc.

3
The Principal-Agent Problem

• Principal shareholder
• Agents Board, Senior Managers
• Incentives
• Board threat of take-over if share prices fall
• Managers
• profit-related pay
• share options
• fixed-term contracts

4
2. Measuring the costs of production

• The production function
• transformation of inputs into outputs
• short-run versus long run
• The cost structure of the firm
• short-run versus long run
• fixed and variable costs
• total, average and marginal costs
• break-even point

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Total costs for firm X
Output (Q) 0 1 2 3 4 5 6 7
TVC () 0 10 16 21 28 40 60 91
TC () 12 22 28 33 40 52 72 103
TFC () 12 12 12 12 12 12 12 12
TC
TVC
TFC
6
Average and marginal costs
Costs ()
Output (Q)
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3. Rules for profit maximisation

• Economic profit
• Total revenue - Total costs
• Marginal revenue - Marginal costs

8
Finding maximum profit using total curves
TC
TR
TR, TC, TP ()
Quantity
TP
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Finding the profit-maximising output using
marginal curves
MC
Costs and revenue ()
Quantity
MR
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4. Economies of scale scope

• The long run
• returns to scale
• scale economies
• Internal scale economies
• indivisibilities
• increased specialisation
• economies of increased dimension
• economies of scope

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4. Economies of scale scope

• External economies of scale
• availability of finance
• agglomeration economies
• Diseconomies of scale
• Information flows
• industrial relations problems
• Loss of flexibility
• The shape of cost curves

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5. The external environment

• The nature of competition
• structure - conduct - performance
• the competitive environment
• perfectly competitive (e.g. stock markets)
• monopolistic (e.g. restaurants)
• oligopolistic (e.g. breakfast cereal,
  newspapers)
• monopoly