Page 319 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Microeconomic Theory

Notes

The security of job of manager depends upon the satisfaction of shareholders, whose
main purpose is to maximize the share price as well as the profits.

Marris has mentioned the relation between growth and profit by diversification of new product. The
relation between growth and profit is different in various levels. In this growth-profit relation, growth
is determined to profit. When the growth rate of a firm is low, the relation between them is positive.
When new products are created, firm advertises and profit creates. The growth-profit relation gets
negative when the growth rate rises by diversification of new products. This happens due to managerial
Constraints which prevents the further growth of firm. The managerial ability is limited to face more than
extra changes in firm. To promote and marketing of the new product, there is no possibility to develop a
big team of administration. For the high rate of diversification, the R&D and advertisement cost is more.
As a result, after a fixed growth rate, there is lower profit rate by high growth rate. It is shown in Fig. 19.1
where GD curve rises first, goes to high point M and downs further. Another factor of growth-profit is
the growth rate of capital supply. The purpose of shareholders is to maximize the growth rate of capital
stock. The main source for its growth is profit. So the profit determined towards supply. It collects more
funds from capital market. Thus it provides funds for high growth rate. It gives negative and positive
relation between profits and growth. It is shown by a straight line GS from original in Fig. 19.1.
For equilibrium of a firm, the profit growth and growth supply should be satisfied. It happens when
both the curve GD and GS cut on a point where growth-profit is optimum. Suppose that in Fig. 19.1 GS
2
curve cuts GD curve on point M, then profit maximization happens. This point does not give optimum
solution because it needs more growth which does not match with profit in long run. As long they take
growth curve to point M, it shows the desire of his job security. His job security is in danger positive
while shareholder feels that the price of share and profits is decreasing and another firm will take over
this firm. It will affect the growth rate of capital supply (GS).
According to Marris, Reciation Ratio determinesd the growth rate of capital supply. If reciation ratio is low,
it means all profits are distributed among shareholders. As a result, there is limited fund for firm growth
available to managers and the growth rate will be very low. The growth-supply curve will like GS curve. The
1
equilibrium point of firm will L, where GS curve cuts GD curve. This is also not the optimum equilibrium
1
point of firm because on this point, the growth rate is low and profit is low from its maximum level.

Fig. 19.1

GS GS
1 2
GS
3
M
E
L
Profit Rate GD

O
Growth Rate

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