Theory of the Firm 1. The document discusses several theories of the firm including the economic theory of profit maximization, behavioral theories such as Simon's satisficing model and Cyert and March's model, and alternative objectives like sales maximization. 2. It also explains key concepts like the firm, industry, and market, and compares accounting profit versus economic profit. 3. The theories aim to explain how firms make decisions and set objectives in different market structures under conditions of uncertainty.

1. Theory of the Firm

2. Highlighting the concept of Firm ,Industry and Market
Bamoul’s Model of Sales Revenue Maximization
This is an example text. Go ahead and replace it
Simon’s Satisficing Model
The Behavior Theory of Firm
Cyert and March Model
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The Economic Theory of firm
State the rationale of ‘Theory of Firm’
Objectives of Business under Economic Theory of Firm8
Traditional and Modern Views of Profit9
Learning Objectives :

3. •Conceptof theFirm :
Firm, Industry and Market
A firm is a Business unit which owns,controls and manages a plant.Such
a Business unit may be a sole Proprietor,a partnership,a company or a
cooperative enterprise.The Firm is the owner of the plant and it
controls the operation of plants.
A plant is an aggregate of the physical facilities like land and
building,machines and equipment meant for production.The Plant owned
by the firm may be engaged in the production of the same product or in
the production of different goods and services.

4. •Concept of the Industry :
Firm, Industry and Market
An Industry may be defined as a group of firms producing and
distributing similar products and services.We can classify various firms
into different industries on the basis of type of products,use of raw
material,use of process of manufacture.
The Concept of industry serves a lot of purposes.
• Helps to group the firm in terms of specified criteria.
• Makes it possible to derive a set of rules that constitute industry
behaviour of competing members.
• Provides framework for the analysis of effect of entry on
behaviour,equilibrium price & output of the firm.
• The Bussinessman design their strategy in view of industry they
belong to.
• Government policy is designed with refernce to industry..

5. •Concept of the Market:
Firm, Industry and Market
For understanding the concept of firm,understand the following kinds
0f market.
i. Perfect Competition:It refers to the market situation where there
are many firms in the industry,producing homogeneous
products,enjoying freedom of movement,having neither
transportation cost nor information cost and selling product at a
single price.
ii. Monopoly:Situation where single firm constitutes the entire
industry.Entry of other firms is blocked.
iii. Oligopoly:It exist in the market with the small number of
firms,grouped together ,producing either homogeneous or
different products.Individual sellers are consious of their
interdependance and therefore take care of rival’s actions and
reaction in a variety of ways.

6. Objectivesof Business Firms
Profit Maximization
Sales Maximization
Growth Maximization
Maximization Of Satisfaction
Security Profits
Maximization Of Managerial Utility
Output Maximization
Cyert & March's Behavioral Theory
Satisfying Theory

7. According to classical theory of firms, principle objective
of a firm is to maximize profit. Total Profit is defined as the
excess of Total Revenue(TR) over Total Cost(TC).
Symbolically it can be represented as:
PROFIT=TR-TC
A profit maximizing firm seeks to maximize the difference
between the total revenue and total cost. If price for its
products and its cost functions are given, the firm produces
quantity that yields maximum profit.
Objectives of Profit
Maximization

8. Condition for Profit Maximization

9. Rationale Behind Profit Maximization
1.Essential for survival of the firm.
2.Greater relevance to competitive firm
3. Based on Empirical Analysis.
4.Strongest motive.

10. CRITICISM OF PROFIT MAXIMISATION
• Traditional theory of profit maximization assumed stable demand and
stable supply conditions but in practise,the firm can't determine its
demand and supply with certainty.
• Modern firms can't afford to follow profit maximization only. They have to
follow multiple objectives and profit is one of them.
• In the modern era of globalization, survival of the business firm is the
foremost goal. It may require cost reduction, generation of demand,
fighting competition, enhancing public image through spending business
funds on socially useful projects.
• The objective of profit maximization has been criticized by many
economists saying that a firm may indulge in illegal and unfair trade
practices when it is run with the sole objectives of profit maximization.
• In the present context the multinational companies are not run by their
owners(share holders) but by the professional managers. Theses
managers have their own different interests. So profit maximization may
not be taken as the sole objective of the firm.

11. .Explain what exist
.Explain what does not exist
.Theory must have both
Explanatory And Predictive values
.Explanation – Logical Analysis for Analysis
.Prediction – Forecasting Based on Observation
Purpose of any Theory
.P redic tiv e P o w er
. C o nsistenc y
. Assumption
. A pplic atio n
. Simplic ity
Validity of Any Theory

12. Rationale Theory Of
Firm
› Theory which provide models for the Analysis of Decision-
making in the Firm in various Market structure
› Tell about the whole range of Price Output Decision
› Tell about How Firm set the following decisions:
.How Firm Set The Price
.Decide Their Product-Line
.Advertisement Expenses
.Sales Promotion
.Research And Development
.Expenditure

13. EconomicTheory of Firm
› Popular Due To Explanatory And
Predictive value
› Build Around The Concept of “PROFIT
MAXIMIZATION”
› Explain How Firm Adjust its
Operation to Maximise its Profit

14. Economic Theory of Firm
Firm Undertakes Transformation
of input into products to create
surplus values(profit)
Contd..
Firm is a Transformation Unit
Major propositions of Economic Theory of
Firm:
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34 Guided by Profit MaximizationFollows Equi-marginal principle
5 Marginal Revenue = marginal Cost 6
Market Environment is Known
Completely
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Use Knowledge of market to
Maximise Profit

15. 1
Came Because of
limitation of Economic
Theory
REVIEW…
Re-examine the concept of
firm and Decision Making
Process
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Provide Tradition Thinking
About the firm and its
Activity
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Consider a Large Firm-production
Multiple Goals under Uncertainty in
an Imperfect Market
Contrast the Theory which
Maximise
Profit
Does not Replace Traditional theory
but Supplement it
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2
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3
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It Suggest firm Is not a
Single-goal Decision Making
unit
It has multiple goals
Operating unit (In addition
to profit goal the firm has
other goals like production
goal inventory goal etc. )
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Behavioral Theory of Firm
Does Behavioral Theory Replace Traditional
Economic Theory of Firm

16. Given byHerbert Simon
Simon’s Satisficing Model
Review...
Herbert Simon in his satisficing model explains the behavior of practicing business
managers. According to Simon, organizational behavior and individual behavior are
comparable. Like an individual every organization or firm has its own aspiration,
achievement, success or failure record and its aspiration level mechanism is set to
work in view of its need, drive and attainment of goals. Firms make periodic review
of their goals. They may face three alternative situations:
i. The actual performance is less than the aspirations.
ii. The actual performance is equal to the aspirations.
iii. The actual performance is greater than the aspirations.
The first situation may be due to incomplete information about the future and the
firms initiate the process of improving the quality of information. It is possible that
the aspiration level has been pitched too high. The achievement level may lag behind
the aspiration level because-
a) There are wide fluctuations in economic activity, or
b) There is a qualitative deterioration in the performance level.

17. Given byHerbert Simon
Simon’s Satisficing Model
Contd...
Either way, there is a problem in information flow. The firm will have to
organize ‘search activity’ and ‘choice’ to improve flow of information. It
may even lower the aspiration level for the achievement of ‘satisfactory’
situation.
The second situation, when achievement matches the aspiration(targets),
the firm is more or less satisfied. No action will be taken except to review
that the aspired targets have not been pegged too low and that the firm’s
potential performance has been rightly estimated.
The third situation speaks of commendable performance by the firm. The
firm is satisfied but there is a need to ensure that the quantitative
achievement is not the outcome of decreasing quality of performance. It is
suggested that we should question success rather than failure; questioning
failure is normal, but questioning success is rare. When the firm critically
analyses its success, it is in a position to detect the quality of its
performance; this may enable the firm to formulate its future policy more
efficiently.

18. DrawbacksAppraisal
Simon’s Satisficing Mode
Simon has based his analysis on
the study of individual
psychology and organizational
psychology. Simon’s theory seems
plausible because it is consistent
with psychological theory of
motivation which suggests that
human action stem from drives,
and that these actions terminate
once the drives are satisfied.
Thus, Simon’s model envisages a
marriage between economics and
psychology. Secondly, Simon’s
model is quite consistent with
empirical observations of
Simon Model has certain drawbacks
also. Its main drawback is the
difficulty of making an operational
statement of what is to be regarded as
a “satisfactory” level of performance.
A firm has several stakeholders or
groups such as shareholders,
customers, workers, managers,
suppliers, government, etc. It has to
satisfy them all. For example,
shareholders expect higher dividends,
workers and managers want higher
wages and perquisites and customers
want lower prices. As a result, the
firm has to choose a particular profit
level which will satisfy all the
stakeholders. However, this may not
be practically feasible.

19. Cyert and March Model
∞ Cyert and March opined that a large-scale corporate type of
firm exists these days.
∞ Hence, entrepreneur cannot alone be a decision maker.
∞ The decision-making involves a complex group or
organization.
∞ It consists of various individuals whose interest may conflict
with each other.
∞ The group is called ‘organizational coalition’ and includes
managers, stockholders, workers, consumers and so on.
∞ All of these individuals participate in setting the goals of an
organization.

20. Goa
 Production Goal: According to this goal, production should not
fluctuate too much nor fall below an acceptable level.
 Inventory Goal: This goal originates mainly from the inventory
department, or from the sales and production departments.
 Sales Goal: The sales goal is simply an aspirations with
respect to the level of sales. Particularly, this goal arises from
salesmen,
since their success depends on their ability to maintain or
expand the sales.
 Market-share Goal: This goal is an alternative to the sales
goal and arises from the sales department.
This department decides on the advertising campaigns, the
market research programmes, and so on.
 Profit Goal: This goal is set by the top management in order
to satisfy the demands of shareholders and the expectations
of bankers and
satisfy the other goals of the firm.

21. Cyert and March Model (contd..)
The firm is a satisficing organization rather than a maximizing
entrepreneur.
The top management, accountable for the coordination of the
activities of the various members of the firm, want:
-to attain a ‘satisfactory’ level of production,
-to attain a ‘satisfactory’ share of the market,
-to earn a ‘satisfactory’ level of profit
-to divert a ‘satisfactory’ percentage of their total receipts to
research and development or to advertising,
-to acquire a ‘satisfactory’ public image, and so on.

22. Delegation of authority
decentralization of decision-making.
Monetary payments like wages, salary and dividend
slack payments – it is defined as payments to the various groups of the coalition
above than the payments required for efficient working of the firm.
Budget determination
Side payment given to the scientist of research department in addition to regular
salary
fulfilling demand according priority
Resolution of Conflicts:
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23. Of Sales Revenue Maximization
Bamoul’s
Model
. The salaries and Perks of top executives closely related to sales profit then Profit.
.Financial Institution mainly look at the sales Revenue while financing the Firms.
.Trend in Sales revenue is most available indicator of Performance of firm.
.Manager prefers steady Performance with Satisfactory profit to high profit.
.Growing sales Strength Competitive position of the firm in the market.
.Personal problem handled when sales growing by giving Higher wages, bonus and
better work environment to employees.
Major Reasons for Manager Objective of Sales Revenue Maximisation :
W.J. Bamouls Suggested sales maximization as an alternative to the profit maximization objective.
It is because of separation of ownership from management. It provide manager with an opportunity to
set goals other than profit
maximization which most owner of firm pursues.
According to Bamoul's most factor in manager utility function is Maximization of Sales revenue.
Review..

24. EconomicTheory of Firm
Profit objective
provide discipline to
the manager of
firms.
Profit is a return for
capital invested and
also Reward for
Enterpreneur.
Economic Theory of
firm is mostly based
on the concept of
Profit Maximisation..
It guide all business
planning and
decision-making.
Objectives of Business
• It play a significant role in a free enterprise economy.
• It provide resources for expansion and
encourage entrepreneurs to increase production
• Ensure that production is carried on efficiency
• Most important function to help entrepreneurs to take
risk of uncertainty.

25. Alternative Objectives of
Firms
 reasonable level profits
 ensures stable profits over long period
 more relevant under oligopoly
Secured profits
 Intended to popularize the product and boost the morale of employee.
Sales maximisation
 expansion of firm
 should be of balanced rate
Growth maximisation
maximisation of managerial utilities such as
• better salaries
• job security
• reputation of firm etc.
Utility maximisation
 Aimed to satisfactory profits rather than profit maximisation
Satisficing profits
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26. J.B.Clark defined profit as an
excess of market price of good
produced over their cost.
He develop a Dynamic Theory of
profit which have five generic
changes:-
• Change in size of population;
• Change in Stock of capital;
• Change in technique of
production;
• Change in form of business
organisation and
• Change in consumer's wants
and preference
The above changes affect cost,
demand and supply.
Thus profit according to clrk
belongs to economic dynamics not
economic statics.
Classical economist Adam smith
and Ricardo Treat profit as a kind
of Business income
left after paying for labour and
Indestructible power of soil.
according to this view there is no
distinction b/w ownership capital
and management of firms
he regard profit as "surplus value"
according to him profit is socially
not justifiable.
Neo-classic economist F.A.
WALKER developed the marginal
productivity theory of profit
according to which factors of
production paid by their respective
marginal productivities.
Views Of Profit

27. Economic Profit:Accounting Profit:
Accounting vs. Economic Profit
Accounting profit figures
consider realized or actual
financial gains and losses.
Accounting profit is the total
of all the company's revenue
minus cash payments for all
explicit company costs and
purchased resources. These
resources include raw
materials, materials transport,
staff wages and benefits, rent
paid on company property and
interest on capital.
Unlike accounting profit,
economic profit considers the cost
of an organization's in-house
resources that are utilized in their
production of their goods or
services. These items are also
referred to in finance as implicit
resources. Implicit or self-owned
resources can include company-
owned property, equipment, self-
employment resources, company-
owned vehicles and independently
conducted staff training
initiatives

28. Created By:
Apoorv Pandey
B.Tech (CSE)
3rd yr
Roll No.1150810015