e-book Understanding Firms - A Managers Model of the Firm

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At sales maximisation there are normal profits or no supernormal profits. The objective of maximising sales revenue rather than profits was developed by economist William Baumol whose work focused on the behaviour of manager-controlled businesses. Read more about sales maximisation as a business objective.

If a firm's managers are looking to maximise revenue rather than profit, this will lead to a different price and output combination. Assuming that the firm's costs remain the same, a firm will choose a lower price and supply a higher output when sales revenue maximisation is the main objective. Consumer surplus is higher with sales revenue maximisation because output is higher and price is lower. Producer surplus is greater when profits are maximised.

Join s of fellow Economics teachers and students all getting the tutor2u Economics team's latest resources and support delivered fresh in their inbox every morning. You can also follow tutor2uEconomics on Twitter, subscribe to our YouTube channel , or join our popular Facebook Groups. He has over twenty years experience as Head of Economics at leading schools.

Don't miss one if you are taking A Level Taking into account the detailed feedback from Examiner Reports from this intensive CPD course has one focus. Reach the audience you really want to apply for your teaching vacancy by posting directly to our website and related social media audiences. Cart Account Log in Sign up. Economics Explore Economics Search Go. Economics Reference library. Examples include: Managers employed by a business and other employees Shareholders are people who have a stake in a business Customers The government and its agencies Each group of stakeholders will have different objectives or goals.

Examples of alternatives to profit maximisation Satisficing behaviour This happens when businesses aim for minimum acceptable levels of achievement in terms of revenue and profit. Read more on satisficing behaviour Sales output maximisation Selling as much as you can without making a loss. Sales revenue maximisation The objective of maximising sales revenue rather than profits was developed by economist William Baumol whose work focused on the behaviour of manager-controlled businesses.

Annual salaries and perks are linked to sales revenue rather than profits Companies geared towards maximising revenue are likely to make frequent use of price discrimination to extract extra revenue and marginal profit from consumers A business might also aim to maximise sales revenue rather than profits because it wishes to deter the entry of new firms If a firm decides to aim to maximise sales revenue rather than profits, one of the consequences might be a reduction in the price of the firm's shares since the rate of profit is likely to be lower Read more about sales maximisation as a business objective Managerial Satisfaction Model If a firm's managers are looking to maximise revenue rather than profit, this will lead to a different price and output combination.

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Theory of the firm

Such a wage would make the worker indifferent between remaining in the job and losing it. But in practice most workers care very much. There is a difference between the value of the job taking into account all the benefits and costs it entails and the value of the next best option—which is being unemployed and having to search for a new job.

In other words, there is an employment rent.

We can use the same reasoning in the employment of managers by the owners of the firm. The main reason owners wield power over managers is that they can fire them, and so eliminate their managerial employment rents.

Understanding a Company's Culture

For example, the two leading economists of the early nineteenth century—Ricardo and Malthus—were political opponents. Ricardo often sided with businesspeople, for example in supporting freer imports of grain to Britain to reduce food prices and allow lower wages. Malthus opposed him and supported the Corn Laws that restricted grain imports, a position favoured by the landed gentry. But the two economists both proposed the same theory of land rents, which we still use today.

Even more striking is that two economists from different centuries and political orientations came up with similar ways of understanding the firm and its employees. In the nineteenth century, Marx contrasted the way that buyers and sellers interact on a market, voluntarily engaging in trade, with how the firm is organized as a top—down structure, one in which employers issue orders and workers follow them.

6.1 Firms, markets, and the division of labour

The nature of the firm , Both based their thinking on careful empirical observation, and they arrived at a similar understanding of the hierarchy of the firm. They disagreed, however, on the consequences of what they observed: Coase thought that the hierarchy of the firm was a cost-reducing way to do business.

Managerial Satisfaction Model

Like Malthus and Ricardo, Coase and Marx disagreed. But like Malthus and Ricardo, they also advanced economics with a common idea. Recall that an economic rent measures the value of a situation—for example, having your current job—compared to what you would get if the current situation were no longer possible.

To calculate employment rent—or in other words, the net cost of job loss—we need to weigh up all the benefits and costs of working compared with being unemployed and searching for another job.

Even confining attention to the loss in wages, the cost is high. But how do we measure how high it is? Can we compare the economic situation of workers currently employed with the economic situation of unemployed people? No, because the unemployed are a different group of people, with different abilities and skills.

Even if they were employed, they would be likely on average to earn less than people who currently have jobs. An entire firm closing, or a mass layoff of workers, provides a natural experiment that can help. We could look at the earnings of workers before and after they lost their job during a major employment cutback. When a factory closes because the parent company has decided to relocate production to some other part of the world, for example, virtually all workers lose their jobs, and not just the ones who were most likely to lose their jobs through poor performance.

Louis Jacobson, Robert Lalonde, and Daniel Sullivan used such a natural experiment to estimate the cost of job loss. They studied experienced not recently hired full-time workers hit by mass layoffs in the US state of Pennsylvania in The year was not a good time to be looking for work in Pennsylvania, but similar estimates from the US state of Connecticut between and for example suggest that even in better times, employment rents are large enough that workers would worry about losing them.

In which of the following employment situations would the employment rent be high, ceteris paribus? To determine her economic rent, we need to think how she would evaluate two aspects of her job:. Her disutility of work depends on how much effort she puts into her job. Suppose she spends half of her working time actually working, and half doing other things like checking Facebook.

We represent this as an effort level of 0. This is her employment rent per hour.

The total employment rent or cost of job loss , depends on how long she expects to remain unemployed. We will suppose that if she loses her job she can expect to remain unemployed for 44 weeks before finding another. The analysis in Figure 6. Looking ahead from now taken as time 0 , she will continue to receive this wage for the foreseeable future if she keeps her job, indicated by the horizontal line at the top of the figure. The difference between her wage and disutility of effort is the economic rent per hour that she receives while employed. If instead Maria were to lose her job at time 0, she would no longer receive her wages.

This unfortunate state would persist as long as she remains unemployed, indicated by the horizontal line at the bottom of the figure. The expected duration of unemployment is 44 weeks, where she would have worked 35 hours per week. That is how long she will remain without pay and without the disutility of working. The shaded area is her total cost of job loss from the spell of unemployment, that is, her employment rent. Her total employment rent is the employment rent per hour times the number of hours of work she will lose if her job is terminated.

It is the shaded area in the figure. People who lose their jobs can typically expect help from family and friends while they are out of work. Also, in many economies, people who lose their jobs receive unemployment benefit or financial assistance from the government.

In poorer economies, they may be able to earn a small amount in informal self-employment. If Maria receives an unemployment benefit or income from any of these sources, it will partially offset the lost wage income. Unemployment benefits usually run out eventually: families and friends will not be able to help forever, and government unemployment benefits are often time-limited. For example, we have assumed that:. Redraw Figure 6. Specifically, assume:.

When the cost of job loss the employment rent is large, workers will be willing to work harder in order to reduce the likelihood of losing the job.