Topic 3.2

What motivates a firm?

• Exists to organise production
• Directors and managers - Shareholders elect these
• Workers - Collectively may be able to influence decisions
• Consumers - Influence work of businesses through demand.

Objectives of firms:

• Survival. Most firms begin small and grow. Firms encounter several problems when they begin trading, which puts them at a disadvantage to larger firms e.g. lack of expertise and limited recognition by customers.
• Profit maximisation. The classical model of economics assumes firms want to maximise profits, i.e. produce where MC = MR. The cost of producing one more unit of a good is exactly equal to the revenue derived from selling 1 extra unit. Short run - shareholders motivated to maximise profits. However, some firms will be faced with making a loss. As long as average variable costs are covered this is acceptable. Long run - Keynesian economists believe firms seek to maximise in the long run rather than the short run. In the long run it is believed firms use cost plus pricing.

It is assumed in the short run that firms adjust prices and output accordingly. However, economists agree this price change may affect a firms position in the market.

• Sales maximisation. Tends to focuse on volume of sales and leads to increased output. It is often the case that increased sales go hand in hand with increased salaries for top executives.
• Managerial objectives. Sometimes managers in the firm are able to pursue their own objectives. There must be some divorce of ownership for control e.g. company cars, power of workers and maximising leisure time.
• Satisficing. It may seem reasonable to assume that firms aim for as much profit as possible but in practice a firm may have an acceptable level of profit. This occurs due to: owners of small firms - happy at present levels and would involve more workers, time etc. Lack of information - difficult to identify exactly where the profit maximising point is. Other aims - may sacrifice short term profit for long term e.g. a lower price initially to build up a market.