Running a Limited Company - Assignment Example

Question 1: What are the objectives of the firm in a capitalist economy? A capitalist economy is an economic system that is based on the principles of supply and demand. In a capitalist economy, there is no government intervention. The market forces of supply and demand are left to control the market, that is, determine the prices of good and services. The objectives of a firm operating in a capitalist economy include profit maximization, sales maximization, growth maximization (İbrahim, 2009). Profit maximization Profit maximization is the main objective of all firms. It is the process by which firms aim at acquiring the highest achievable levels of profit in the process of producing and selling goods and services. In economic analysis, firms undertake activities and actions that are aimed at increasing profits (İbrahim, 2009). The difference between total revenue obtained by selling output and total cost that is used in producing output in a firm is the profit. Therefore, firms with an objective of maximizing profits cuts on their costs of production maximize revenues in order to generate the highest difference between total costs and total revenues. Sales maximization This is another objective of a firm in a capitalist economy. Maximizing sales involves selling as much output as probable. Firms that maximize sales are bound to maximize their revenues. However, it is not a guarantee that firms maximizing sales will essentially maximize their profits, this is because; increasing sales can lead to increase in the cost of production such that marginal cost surpasses marginal revenues (İbrahim, 2009). A firm benefits from sales maximization in that, it obtains a competitive advantage over its rivals and at the same time increasing its monopoly power in such a way that, it can increase its prices thus, maximizes profits. Growth maximization is the same as sales maximization and it involves takeovers and mergers. Question 2: Discuss the view that the Keynesian theory of circular flow of money does not provide a full explanation of 21st century economy, and the private sector will fulfill the role of Government in maintaining the levels of aggregate demand. Use any graphs, diagrams or calculations to illustrate this view? Keynes tried to analyze aggregate demand using the circular flow diagram. The diagram indicates how income earned is spent thus supporting a circular flow of money which sustains a normal functioning economy (Peter, 2000). Keynes argued that, people should not hoard money as this will break the continuous money flow. Some critiques argue that, Keynesian theory of circular flow of money does not provide a full explanation of the 21st century economy. This is based on the fact that savings and investments, GDP and money growth are not well addressed. Keynesian theory of circular flow of money does not indicate individuals or corporations responsible for financial saving and how these savings gets back into the flow through consumer credit financed consumption and business investments. On the issue of GDP and money growth, Keynes, in the circular flow does not explain how money created by financial systems finds its way into the flow, or how it exits and become locked into the money inventory stocks. In order to maintain levels of aggregate demand, there should be increased government spending, GDP growth, increased household employment which as a result increases levels of income flow thus increasing aggregate demand (Peter, 2000). The circular flow of money does not explain how this can be achieved especially in the changing economic times of the 21st century. It is true that, to some extent, the private sector has taken the governments responsibilities of marinating aggregate demand. In this century, most employments with good wages are offered by the private sectors. This as a result has increased income levels and it is evident that, incomes are directly related to demand levels. Question 3: From the end of the Second World War all governments, to some degree, have used the principles of Keynesianism to ‘correct’ problems in the economy. Discuss these principles and how they might affect the economy. Keynes developed the Keynesian economics, a macroeconomic theory that is founded on the preposition that, aggregate demand is the main cause of recessions and a source of instability in the business cycle. Keynes did not concur with classical economists and he gave arguments for the wrongness of the classical theory (Markwell, 2006). After the Second World War, many governments, to some extent, adopted the Keynesianism principles to correct problems in the economy. Some of these principles focused on investors and savers, money markets and interest rates, and Prime and pump. Investment and savings Keynes, in his theory of Keynesian economics warns people against practicing too much under consumption, saving, and low spending in the economy. His theory also supports substantial redistribution of wealth. Keynes argues that, a country’s economic growth will be promoted if wealth is redistributed to the poorer individuals as, instead of saving it, they will spend it (Markwell, 2006). His theory supports consumption rather than saving. Though to some extent, this principle promotes economic growth, it also affects the economy in one way or another. For instance, for a country to develop economically there must be savings and investments. Therefore, a country that consumes without saving may experience decreased economic development. This is because; a country requires saving for speculative purposes. In addition, there will be a slow growth in GDP and the levels of sustainability will also be low. This will be contributed by the fact that, individuals will not work towards the country’s growth as everything will be left in the hands of the government to redistribute wealth to the less fortunate individuals. Prime and pump Keynes principles can also be explained using his theory of circular flow of money. This theory supports a continuous circular flow of money. He argues that, in cases of depression when people tend to hoard their money, the economy is put at a stand stills as the circular flow of money is stopped. As a result, the government should pump money into the economy by increasing spending. This can be done through buying assets in the market or increasing money supply (Markwell, 2006). Economists have argued against this saying that, increasing spending into a depressed economy will add more harm. Question 4: Explain what is meant by perfect competition and the concept of profit maximization. Also explain the assumptions underlying perfect competition, with reference to MR=MC. Perfect competition Perfect competition refers to an ideal market structure that comprises of characteristics such as freedom of entry and exit, perfect knowledge of technology and prices, similar products sold by all firms within the industry, and a large number of small firms. The firms within this market structure are so small relative to the general size of the market in that no single firm may have the power to affect the quantity exchanged or the market price. Therefore, perfectly competitive firms are considered as price takers. They often set production levels that are determined by the market price and therefore if the market price changes, the firms have to re-evaluate the production decision. Profit maximization This is a process that firms undergo to establish the best price levels and output in order to maximize return. Firms will often have to adjust influential factors like sales prices, production costs and output levels to attain the profit goal. The first profit maximization method is the marginal cost-marginal revenue method, and the second method is the total cost-total revenue method. These are the models that firms employ to determine the most effective ways of attaining the highest return from their production methods. Assumptions underlying perfect competition, with reference to MR=MC The main assumptions under perfect competition include perfect mobility of resources, perfect information, many buyers and sellers and homogenous products. This implies therefore that the firm is a piece taker, in that all firms maintain a constant price (Landsburg, 2002). However, the main profit maximization rule is that the marginal revenue equals the marginal cost (MR=MC) Profit Maximizing Rule (all firms): MR=MC ∆TR ∆TC i. MR= ; MC= ∆Q ∆ Q ii. Suppose not: MR>MC -π ↑ MR Read More