Question

Business Economics:

1- Reasons for the existence of firms and the meaning of transaction costs

2- Explain the economic goals of the firm and optimal decision making

3- Describe the ‘principal-agent’ problem

4- Distinguish between “profit maximization” and the “maximization of the wealth of shareholders”

5- Demonstrate the usefulness of Market Value Added® and Economic Value Added®

Answer 1

Solution 1:

Firms exist to minimize transactions costs. Transaction costs are generally costs which are made when firm participates in Economic trade in particular market .

Solution 2:

Economic goals of firm include maximise growth and revenue and market share to stay in long run. Optimal decision making happens when decisions lead to atleast one good or known expected outcome from set of alternatives available. This maximises the profits.

Solution 3:

Principal agent problem arises when one person makes decisions and action on other person's behalf or which directly impacts that person. This generally happens between employer and employee where one party works for another in order to get incentives.

Solution 4:

Profit maximization in short run or long run is determined by firm using various factors like input, price and output levelswhich leads to maximization of profits.

Shareholders wealth maximization occurs when company intends to maximise wealth creation or returns in terms of dividend to shareholders  

Solution 5:

Market value added is addition of all capital claims held against company and its debt and equity. It is more lf external management control.

Whereas economic value added is the difference of net profit and equit cost of firms capital.

It is more of internal management control.