Short-run profit maximization - Assignment Example

Short-run Profit Maximization In business, you obviously want to avoid spending more money than you make. Speaking in terms of production, there is a point where when you start producing too much, it becomes unprofitable. Therefore, it is optimal for a company to produce as long as they are making a profit. After the optimal production point is reached, the company begins to lose money if they continue to produce. If you picture marginal revenue (the additional revenue generated from increasing sales by one unit) as a line on a graph, and picture marginal cost (the cost of producing one more unit) as another line on a graph, you can observe that the lines will intersect at some point.

Up until this intersection, marginal revenue will exceed Marginal Cost, whereas after this point, marginal cost will begin to exceed marginal revenue. Thus, in order to maximize short-run profit you should produce up until the cost of producing another unit exceeds revenue gained from producing that unit. The mechanism responsible for pushing optimal output is the demand for the product and the price of the product. Ideally, a business would like to set the price for each unit as high as possible.

However, how much you should charge for a product is limited by the demand for that product. So in order to produce at the point where marginal revenue equals marginal cost, the price of the product may need to be either raised or lowered. A popular theory that explains this is known as price elasticity of demand and is expressed as the equation P(1-1/n) = MC. 2. The Agency Problem The text gives a great example of the agency problem by comparing it to the relationship between our country’s president and its citizens.

In this case, the citizens are the principle and the president is the agent because the objectives and policies that the president pursues will ultimately effect the citizens of the country. In business terms, we can think of citizens as shareholders and the president as the agent. Shareholders desire agents whose objectives are in alignment with their objectives. However, the objectives of the principal and agent can differ for a variety of reasons. For example, the president may have a personal motive for doing something that is detrimental to the goals of the citizen.

What creates the agency problem, though, is when the agent hides the action and/or the information, making the problem more difficult to overcome. These agency problems occur in the business world between shareholders and managers as well as in business to business interactions. In a way, managers do get in the way of achieving shareholder goals. This is simply because, in addition to trying to satisfy shareholder objectives, managers have their own individual motives which they act upon and conceal from their shareholders.

Managers and employees act on and hide these actions for a variety of reasons. Perhaps they feel they are not being compensated fairly so they don’t put their best effort into the job. Or maybe they are trying to take advantage of the situation by doing as little work as possible. A manager could also sacrifice long-term growth for short-term growth in order to land a promotion or another job. So yes, managers do get in the way sometimes, but ultimately someone has to do the job the shareholders require, and it’s their job to pick the best candidates possible and make sure the managers are invested and motivated to help the shareholders reach their objectives. 3. The Agency Problem, Part 2 My employer deals with the agency problem in a variety of ways.

They monitor what the CEO is doing and meet with him often. They discuss the direction they want the company to go in and make sure that is communicated to the CEO, who then makes sure it is communicated to managers and employees. They also review financial statements to see what is being done. Additionally, they look at what is being produced to determine if it accurately reflects the values of the company. Monitoring what is being produced and what is being done gives them a better idea of revealing what people are actually doing.

My employer also uses performance-based incentives in the form of bonuses. These performance-based bonuses have basically been the same for all employees all across the board which makes me question whether they are really performance-based or simply generic bonuses. In my opinion, this is an area that my company could be better in. They have also not given raises in 5 years also. Because of this I have seen agency problems arise which could easily be dealt with by having a better performance-based program in place.

I guess you could say they are much better at inspiring their employees through fear of losing their job as opposed to giving them extra incentives in order to motivate them.