What motivates a firm?

The motives of a firm depend on the type of firm you are talking about, for instance the BBC's mission statement is "to inform. educate and entertain"; in constrast to this the objective of many firms in the private sector is often seen to be to maximise profits.

However this is not always the case, on alternative objective is sales revenue maximisation, this is due to the fact managers salaries are more often linked to a growth in sales than to profit performance. Expanding sales can also help to increase economies of scale. To maximise sales revenue, a firm would continue producing more as long as extra output would increase revenue. In theory producing where marginal revenue is 0. However, this is often subject to a minimum profit constraint, based on the level needed to keep shareholders happy.

Another motive is that of growth maximisation. Managers want to increase the size of their firms because a manager of a bigger firm is likely to earn more than the manager of a smaller firm. Being the manager of a larger firm is also likely to come with an increased level of job security; as with sales revenue objectives, it thought that growth is subject to a minimum profit constraint.

Profit satisficing can allow firms to pursue a number of objectives. It is important  to remember firms consist of different groups of stakeholders, such as owners, managers, workers and creditors. While the owner may want high profits, accountants may want to cut firms costs. Being prepared to sacrifice some profit may enable a firm to achieve a satisfactory performance in more areas.

Impact of Subsidies,regulation and indirect taxes as possible solutions to market failure

Indirect taxation can be an effective solution to market failure. Indirect taxation includes VAT and excise duties on goods such as tobacco and alcohol. One issue with indirect taxation is that much of the burden of the tax can be passed onto the consumer if the good has an inelastic PED. They can be an effective instrument in controlling and correcting market failure arising from externalities, governments try to act upon a “polluter pays” principle by internalizing the external costs of production and consumption. One issue with this form of taxation is that in the case of many goods (cigarettes, alcohol) much of the tax is passed onto the consumer as the inelasticity of the product means that the consumer is able to do this without adversely affecting demand.

A subsidy is a payment paid by the government to a producer which aims to reduce their costs and increase output. The effect of a subsidy is to increase supply and drive prices down, if all things remain equal (ceteris paribus). In terms of correcting market failure this should raise demand to the level it should be at if the benefits of consumption were taken into account, this can be seen as a correction of market failure as under consumption of merit goods can lead to a loss of social welfare. One issue with subsidising an industry is that they can become over reliant on the subsidy and therefore become inefficient as a result, leading to a delay of economic reform.

Regulation is often used as an alternative to taxation and subsidy, the government can regulate the level of output and pollution in a market. In theory it can act by a government setting a limit (quota) so that output is set at the social optimum. An issue with this kind of regulation is it requires accurate and up to date information in order for the government to set the quota at the right level.

Quantitative easing

Quantitative easing is a monetary policy which is used to increase the money supply in an economy. It is often used once other monetary policies have proved ineffective and interest rates are either at, or close to, zero. It works by the central bank purchasing government bonds and other financial assets. Quantitative easing increases the money supply by flooding the financial system with capital, easing pressure on banks by giving them extra capital.

A central bank can do this by crediting its own account with money it has created out of nothing. It then buys government bonds, corporate bonds and other financial assests in “open market operations”. These purchases give banks the excess reserves required for them to create new money by “deposit multiplication” from increased lending in the fractional reserve banking system. This increase in money supply should therefore stimulate the economy.

There are however risks associated with this measure, one such risk being over effectiveness which could lead to hyperinflation. Another risk could be the measure not being effective enough, which could occur if banks decide to keep the additional capital in order to increase capital reserves.

Causes of cyclical instability

Cyclical instability is caused by shocks either to demand or supply. Shocks are unexpected events that impact demand or supply in the economy, due to the fact that the UK operates in a global market the economy is susceptible to shocks from around the world.

 

         Demand side shocks can be caused by:

·      Changes in the rate of economic growth for countries that you have a lot of trade with

·      Changes in aggregate demand

·      A boom in capital expenditure

·      A significant rise or fall in exchange rates in the short term

Supply side shocks can be caused by:

·      Natural disasters which can impact the supply of certain goods (specifically the growth of crops in areas such as the Caribbean with unpredictable climates)

·      Technology

·      Political situations