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Firm Theory for Managerial Economics Mcom Delhi University

Firm Theory for Managerial Economics Mcom Delhi University

Firm Theory for Managerial Economics Mcom Delhi University

The theory of the firm consists of a number of economic theories that explain and predict the nature of the firm, company, or corporation, including its existence, behavior, structure, and relationship to the market.

Firm Theory for Managerial Economics Mcom Delhi University

In simplified terms, the theory of the firm aims to answer these questions:

  1. Existence. Why do firms emerge? Why are not all transactions in the economy mediated over the market?
  2. Boundaries. Why is the boundary between firms and the market located exactly there with relation to size and output variety? Which transactions are performed internally and which are negotiated on the market?
  3. Organization. Why are firms structured in such a specific way, for example as to hierarchy or decentralization? What is the interplay of formal and informal relationships?
  4. Heterogeneity of firm actions/performances. What drives different actions and performances of firms?
  5. Evidence. What tests are there for respective theories of the firm?

Firms exist as an alternative system to the market-price mechanism when it is more efficient to produce in a non-market environment. For example, in a labor market, it might be very difficult or costly for firms or organizations to engage in production when they have to hire and fire their workers depending on demand/supply conditions. It might also be costly for employees to shift companies every day looking for better alternatives. Similarly, it may be costly for companies to find new suppliers daily. Thus, firms engage in a long-term contract with their employees or a long-term contract with suppliers to minimize the cost or maximize the value of property rights.

Firm Theory for Managerial Economics Mcom Delhi University

Nature Of The Firm A firm is an association of individuals who have organized themselves for the purpose of turning inputs into output. The firm organizes the factors of production to produce goods and services to fulfill the needs of the households. Each firm lays down its own objectives which is fundamental to the existence of a firm. The major objectives of the firm are: Ֆ To achieve the Organizational Goal Ֆ To maximize the Output Ֆ To maximize the Sales Ֆ To maximize the Profit of the Organization Ֆ To maximize the Customer and Stakeholders Satisfaction Ֆ To maximize Shareholder’s Return on Investment Ֆ To maximize the Growth of the Organization Firms are established to earn profit, to keep the shareholders happy. To increase their market share, they try to maximize their sales. In the present business world firms try to produce goods and services without harming the environment. Firms are not always able to operate at a profit. They may be facing the operating loss also. Economists believe that firms maximize their long run rather than their short run profit. So managers have to make enough profit to satisfy the demands of their shareholders and to maximize their wealth through the company

Firm Theory for Managerial Economics Mcom Delhi University


Strategy in the absence of market power ◮ Firms cannot influence price and, because products are not unique, they cannot influence demand by advertising or product differentiation. ◮ Managers in this environment maximize profit by minimizing cost, through the efficient use of resources, and by determining the quantity to produce.


Perfect competition: When there are many firms that are small relative to the entire market and produce similar products

◮ Firms are price takers.

◮ Products are standardized (identical).

◮ There are no barriers to entry.

◮ There is no nonprice competition.


Imperfect competition

◮ Firms have some degree of market power and can determine prices strategically.

◮ Products may not be standardized.

◮ Firms employ nonprice competition.

  • Product differentiation
  • Advertising
  • Branding
  • Public relations

Part A Firm and Market for Managerial Economics Mcom Delhi University

Micro, Macro, and Managerial Economics Relationship

Microeconomics studies the actions of individual consumers and firms; managerial economics is an applied specialty of this branch. Macroeconomics deals with the performance, structure, and behavior of an economy as a whole. Managerial economics applies microeconomic theories and techniques to management decisions. It is more limited in scope as compared to microeconomics. Macroeconomists study aggregate indicators such as GDP, unemployment rates to understand the functions of the whole economy.

Microeconomics and managerial economics both encourage the use of quantitative methods to analyze economic data. Businesses have finite human and financial resources; managerial economic principles can aid management decisions in allocating these resources efficiently. Macroeconomics models and their estimates are used by the government to assist in the development of economic policy.

Nature and Scope of Managerial Economics

The most important function in managerial economics is decision-making. It involves the complete course of selecting the most suitable action from two or more alternatives. The primary function is to make the most profitable use of resources which are limited such as labor, capital, land etc. A manager is very careful while taking decisions as the future is uncertain; he ensures that the best possible plans are made in the most effective manner to achieve the desired objective which is profit maximization.

  • Economic theory and economic analysis are used to solve the problems of managerial economics.
  • Economics basically comprises of two main divisions namely Micro economics and Macro economics.

Micro and Macro Economics

  • Managerial economics covers both macroeconomics as well as microeconomics, as both are equally important for decision making and business analysis.
  • Macroeconomics deals with the study of entire economy. It considers all the factors such as government policies, business cycles, national income, etc.
  • Microeconomics includes the analysis of small individual units of economy such as individual firms, individual industry, or a single individual consumer.

All the economic theories, tools, and concepts are covered under the scope of managerial economics to analyze the business environment. The scope of managerial economics is a continual process, as it is a developing science. Demand analysis and forecasting, profit management, and capital management are also considered under the scope of managerial economics.

Firm Theory for Managerial Economics Mcom Delhi University

Recommended Mcom Notes

M. Com. (Part-I)

M. Com. (Part-II)

Firm Theory for Managerial Economics Mcom Delhi University

Firm Theory for Managerial Economics Mcom Delhi University

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