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QUESTION 1

If the goal of the firm is both short- and long-run profit maximization,
(i) explain why a firm may sacrifice short-run profits for long-run growth and profitability;

A firm may have monopolize a product or service, thus taking advantage of the optimum condition the firm will maximize profit by keeping the price high. However, with such high profit margins, competitors will start to evaluate the potential of joining “the bandwagon” in order to take advantage of such high return of investments. Hence the firm will enjoy short term profits until a new competitor enters the market with a lower price structure (this is to ensure market penetration).
Due to these circumstances the firm is forced to reduce the price, thus reducing the high profits. This translates to a reduced total profits in the long run. Long term growth of the firm will be highly influence by the firm’s and competitor’s performance.
To avoid competition to enter the firm’s monopolized market segment, it is foreseen that the pricing should be position in a level that would make the competitor’s initial return of investments to be low.

(ii) Explain how and why the management team of the firm may have different objectives (goals) than the owners of the firm; and

Modern corporations do not allow ownership participation of managers in the profitability of the firm. The shareholders (owners) want profits, but managers want leisure and security. The shareholders want to maximize the Return Of Investments (ROI) while the managers will only seek acceptable levels of performance without jeopardizing their job security. The owners are principals and the managers are termed as agents. These conflicting motivations between the groups are called agency problems.

(iii) Explain how the owners of the firm can bring the management team’s objectives (goals) to be consistent with the owners’ goals.