Theory of the Firm
Rationales for Establishing Firms
Input/Output
Transactions costs
Efficient scale/technology
Contracts
Firm Objectives
• Maximize profits
• Maximize growth
• Maximize sales
• Maximize stock price
• Maximize managers’ income/career path
Firm Organization
• Vertical integration
• Organization of management
• Functional/divisional separation
• Compensation system
Forms of Firm Ownership
Sole proprietorship
Partnership
Forms of Firm Ownership
Corporation
Companies whose capital is divided into shares that are owned by individuals
who have limited responsibility for the debts of the company.
Corporations
• Benefits
• Costs
• Objectives
• Conflicts
Separation of ownership from control
• Expected returns to stockholders > bondholders
These firms have remained privately owned
Ermenegildo
Zegna
Emporio
Armani
$1 billion
$2.3 billion
Illy Caffe’
$450 million
Ferrero
$10 billion
These firms have remained privately owned
$1 billion
$450 million
$2.3 billion
$10 billion
The Firm’s Cost Curves
Price
MC
ATC
AVC
MC and AC intersect at ATC minimum
0
Quantity
Strategy: What Size Plant to Build
Avg. total cost
ATC with
small plant
0
ATC with
medium plant
Small plant Medium plant
ATC with
large plant
Large plant
Output/day
Strategy: Identifying Economies of Scale
Average
total cost
Economies
of scale
0
Constant Returns
to scale
Diseconomies
of scale
Output per day
Strategy: Identifying Economies of Scope
Cost of producing x alone = C(x)
Cost of producing y alone = C(y)
Cost of producing 2 goods together = C(x,y)
Economies of scope are present if:
C(x,y) < C(x) + C(y)
Measure or degree of economies of scope:
[C(x) + C(y)] – C(x,y)
C(x,y)