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Theory of the Firm Analysis Essay

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This is a process of looking at the behaviors of various organizations in terms of the prices of their product’s output, the methods that they use for production, and the input materials that they use. The theory of the firm can be looked at, in terms of the kind of decisions that firms make so as to generate more profit. From these decisions, the businesses are able to interact well with the market and thus be able to determine the demand for and pricing of their products in the market. With the knowledge of demand and pricing, the firms are able to allocate the resources of the firm well hence ensuring that maximum profits are achieved (Putterman 36).

This theory of the firm goes in line with the theory of the consumer which says that a consumer wants to get maximum satisfaction from a commodity and spend less. Just like the consumer, firms also aim at making maximum utilization of their resources so as to get maximum profits. In economics, the theory of the firm looks at how the firms or businesses behave based on what the theory states, with regard to making maximum profits. Economics, therefore, explains that all kinds of decisions that are made in any particular organization or firm are mainly or are all aimed at ensuring that the organizations make maximum profit. Therefore we can say that according to the theory of the firm, the main goal of any organization is to make maximum profits (Nicolai 256).

The theory of the firm explains the reasons why firms take actions which according to the society may seem not okay and may not even be right to the laws of the country, but as long as the actions are beneficial to the organization in terms of the amount of profit the firm is making, then the firm will continue with such operations. An example is when a firm is polluting the environment and not checking on the safety and the health measures of its employees as long as it is not spending a lot of money on that, the firm will go ahead doing its work with no consideration on such, according to the firm theory. If the same firm as well as to pay for penalties on environment pollution, and fines that are much more, then the organization would consider such a decision as not profitable, and according to the theory of the firm, such an organization would not go ahead with its operations, as this is not maximizing the profits of the company (Cohen 34).

According to the case provided, we shall first analyze both the benefits and consequences of either retaining or giving away the ownership of pediatric home care. According to the consultants, most industries go for the “buy” rather than the “make” option. This is because the buy option offers the organization the chance for flexibility.

According to Ronald Coase, “when businessmen are deciding on what to produce have to take into account transaction costs … In fact, a large part of what we think of as economic activity is designed to accomplish what high transaction costs would otherwise prevent” (Coase 24). Therefore, in this case, if MemHospital decides to retain the ownership of the pediatric home care, it will get the benefit of a good reputation, as it is serving low-income individuals. This is because when compared to the other hospitals such as the Homecare Health industry, which rarely accepts Medicaid, MemHospital takes the lead. Therefore the MemHospital is seen as one that is of preference to the poor or the low-income earners (Berle 71). The Homecare Health industry does not want Medicaid because they contribute very little as they are low-income individuals and only want to concentrate with the high-income earner’s individuals. Consequently, the MemHospital will not be making a lot of profits as it accepts Medicaid who does not make large contributions to the hospital in terms of finances or in increasing the profits of the organization (Jensen 305).

The theory of the firm however states that the main goal of every firm is making maximum profits, therefore we find that the main goal of MemHospital should be making maximum profits and not necessarily having a good reputation (Michael 26) (Richardson 327).

The MemHospital does not benefit much with the operation of the pediatric home care, given that most of its patients are the Medicaid, yet the main goal of the hospital is to make maximum profits. This means that the hospital has to look for ways of outsourcing the pediatric services in order to ease the burden of costs incurred in the hospital for running it and only making low profits. This would help to reduce the costs for MemHospital in the long run. Since the MemHospital has other competing hospitals although they work together as subsidiaries, it needs to ensure that it makes as much profit as it can (Coase 386). For a firm to go by the theory of the firm it has to equate its marginal costs to its marginal revenues.

Profit Maximization for the Competitive Firm

The other benefit that MemHospital will get out of giving out the ownership of the pediatric home care is the flexibility that the management of the organization will get. The flexibility will come as a result of the hospital referring its patients to other hospitals such as the home health care industry. Although the home health care industry is reluctant to accept Medicaid, Memorial Health care would be a good option for the MemHospital. This is because MH Health Care accepts patients from so many other hospitals (Crowder 24).

Flexibility would also arise in that the MemHospital would be in a position to provide better services in the other areas. In this case, the hospital will be in a position to maximize its profits as it will have reduced the costs it incurs in providing services to low-income individuals who are many and who give the hospital fewer returns. In this case therefore the quality of services to be provided at MemHospital would be improved and the hospital would therefore gain a much better reputation. Therefore following the concept of the theory of the firm, the MemHospital should maximize on ways that ensure the organization is in a position to make maximum profits, and it can do this by equating the marginal costs and the marginal revenues of the organization (Wise Geek, Par 6).

In conclusion, we have seen that the theory of the firm is a process of looking at the behaviors of various organizations in terms of the prices of their product’s output, the methods that they use for production, and the input materials that they use. The theory of the firm can be looked at in terms of the kind of decisions that firms make so as to make more profit. From these decisions, the businesses are able to interact well with the market. With the knowledge of demand and pricing, the firms are able to allocate the resources of the firm well hence ensuring that maximum profits are achieved (Gregory, paragraph 2). With regard to the choice of MemHospital, it does not benefit much with the operation of the pediatric home care, given that most of its patients are the Medicaid, yet the main goal of the hospital is to make maximum profits (Hall paragraph 4).

This means that the hospital has to look for ways of outsourcing the pediatric services in order to ease the burden of costs incurred in the hospital out of running it and only making low profits. This would help to reduce the costs for MemHospital in the long run. Since the MemHospital has other competing hospitals although they work together as subsidiaries, it needs to ensure that it makes as much profit as it can. Therefore we have seen that the theory of the firm holds a lot of strength towards each firm that is operating with the aim of making profits (Peter 10). This is because the theory explains that the profits made must be maximum profits and irrespective of what, a firm should always consider making maximum profits as a priority (Michael 6).

References

Berle, Adolph and Means, Gardiner. The modern corporation and private property. New York: Macmillan, 1993.

Coase, Ronald. The Nature of the Firm. Economica, 4.16 (2002): 386–405.

Cohen, Russell. Theory of the firm: Resource allocation in a market economy. USA: Prentice-Hall, 1969.

Crowder, Michael. Theory of the firm. UK: Longman, 1975.

Fiocchi, Nicolai. The theory of the firm: critical perspectives on business and management. Taylor & Francis, 2000.

Gregory, Michael. Make or buy? Using cost analysis to decide whether to outsource public services. 2004. Web.

Hall, Rice. Price Theory and Business Behaviour”. USA: Oxford Economic, 1939.

Jensen, Michael and Meckling, William. Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure. Journal of Financial Economics 3.4 (1994) 305–360.

Peter, Craig. The theory of the firm. UK: Macmillan, 1976. Press, 1996.

Putterman, Drake. The Economic Nature of the Firm. Cambridge: Cambridge University Richardson, Brian. The Organization of Industry. The Economic Journal 82 (1982): 327.

Wise Geek. What is Theory of the firm? 2006. Web.

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