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					    SM139

      The Objectives of Organisations

                         Kevin Hinde




1
                     What are organisations?

   “Even in the most libertarian of free-market
    economies, individuals voluntarily
    surrender their freedom of action in order
    to form and join organisations.”
          –   Bruce Lyons in Hargreaves Heap et al (1993) The Theory
              of Choice. A critical guide, Blackwell, London. p155.

   They transform inputs into outputs with
    some aim in mind.
                          Types of organisations

   Private sector
          Small business, partnerships, cooperatives, Limited
           Companies (including large multinationals.
   Public sector
          Local government, Central Government, schools, hospitals
   Quasi-Governmental
          Regulators such as OFTEL, OFT
   Charitable Sector
   What about churches, trade unions?
                                      Public sector

   Public Interest Theory
    –   Civil Servants and politicians seen as
        maximisers of social welfare.
    –   acting in pursuit of the public rather than private
        interests, e.g. where markets fail.
    –   Civil servant seen to be trustworthy and a
        disinterested expert.
     Criticism of Public interest theory
   difficulties in defining the public interest.
   Institutions seen as political instruments
   Regulators are usually politicians or civil servants and critics
    argue that they have their own agendas.
   regulatory capture.
   competition for power between interest groups which
    provides the various forms of regulation.
   Alternative views
            – Niskanen (1971) emphasises the propensity of bureaucrats to
              maximise agency budgets.
            – Dunleavy (1991) notes how agents of regulation engage in
              „bureau-shaping‟ to create job satisfaction.
            – Majone (1996) points out how regulators seek to maximise the
              scope of their political influence across activities and space
                                               However……
   Civil servants and politicians are accountable to
    parliaments parliamentary bodies and independent
    scrutinisers
           –   (e.g. the National Audit Office and the Media).
   Civil servants can act in the public interest if
    appropriate incentive schemes are in place.
           –   the existence of a competitive managerial labour market
               as well as remuneration packages.
   There has also been a greater emphasis on
    competition in recent times, e.g privatisation,
    liberalisation, compulsory competitive tendering,
    Best Value.
                      Private sector firms

   Objectives are varied but the dominant one
    is profit maximisation.
   But what is profit maximisation?
   This occurs at the output level where the
    organisation's Total revenue (TR) most
    greatly exceeds its Total Cost (TC )
    Normal profit and economic profit
   Economists definition of cost
           The opportunity cost of an input. I.e. the cost of putting that
            input to its next best alternative use.
   However, economists include normal profit in their
    analysis of costs.
   „normal profit‟, i.e. a return to the investors
    /entrepreneurs that reflects the risk associated with
    their investment and which just keeps them from
    exiting that activity.
   Economic profit (Sometimes called abnormal or
    supernormal profit) is profit from market power. In
    perfect competition firms can only earn a normal
    return in the long run.
                       A simple example

   Assume a linear demand and constant
    marginal (and so average) costs.
   We will use a numerical example.
                        Total Revenue
Price   Quantity   Total Revenue
6       0          0
5       1          5
4       2          8
3       3          9
2       4          8
1       5          5
0       6          0
    TR                Demand and Total Revenue
                                     Graph A
     9



                            TR
      0       3            6     Q
Price 6   D


                                     Graph B
      3


                            AR = D
     0            3         6    Q
                                        Marginal Revenue
   TR                         C
                A                               Graph A
                                  B



                                       TR
       0                                    Q
P,MR

                                                Graph B
       A


       C
                         X            AR = D
       0   Q1       Q2                     Q
                         MR
          Costs and profit
     TC
               Graph A
          TC




     0     Q
MC

               Graph B


           MC=AC

      0
           Q
         Profit maximisation under perfect competition:
TR, TC                                   ‘Break even’?

                                      TC     Graph A
                          X


                                    TR
   0                                     Q
P,MR,
MC
                                             Graph B


                              Y        MC=AC
                                  AR = D
    0
                         Qpc           Q
                MR
             Profit maximisation with market power
TR,TC              C
                                         Graph A
                                 TC



                                TR
   0                                 Q
P,MR,
MC
                                         Graph B


         X                         MC=AC
                              AR = D
   0
        Qm          Qpc            Q
             MR
             Profit maximisation with market power
TR,TC              C
                                         Graph A
                                 TC



                                TR
   0                                 Q
P,MR,
MC
                                         Graph B
  Pm

  Ppc                              MC=AC
                              AR = D
   0
        Qm          Qpc            Q
             MR
         Alternatives to profit maximisation: the
              divorce of ownership from control

   Sales maximisation (Baumol 1959)
   Growth maximisation (Marris 1964)
   Utility maximisation (Williamson 1959)
   Satisficing (Cyert and March 1963).
    Emphasis on managers with bounded
    rationality.
          However, profit maximisation
                        bounces back.

   “The Firm is a legal fiction that serves as a
    nexus of contracts” Jensen M. C and
    Meckling W. H (1976).
   Principal Agent analysis stresses the role
    of incentives to encourage errant managers
    to maximise profits rather than their own
    objectives.

				
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