Introduction
A firm well established in the market with impressive revenue returns and profit cannot consider its challenges to be over. A firm has to long-sighted in planning its operation strategies. A firm has to face a number of changes in its exogenous environment. Such changes can be brought about from a number of sources. There can be increased competition from entry of other firms into the industry. This entry can eat upon the profit of the incumbent firms. Government policies related tax, subsidy and market control also affects the firm. Even the policies related to foreign trade can affect the interests of the firm. There can be other unforeseen circumstances that can affect the production adversely like technical snag in the production process that can reduce production for some time. Supply of inputs can be cut off or reduced due to a number of reasons. This can affect production. The demand can also fall due to change in consumers’ tastes, changes in fashion trends and even demographical changes can affect demand. Apart from these external changes there can be conflicts within the firm that can affect its productivity. It can suffer losses due to inefficient production technique, incompetent management and myriad other problems. In this article we attempt to discuss some of the challenges a firm might face in the long term and discuss the possible ways in which it can overcome such problems. The firm in consideration is the producer of a low-calorie frozen food product. We have already analyzed the demand and supply conditions and market structure of the industry in the previous assignments. We begin with the problem of increasing input prices and the actions that the firm might take. Then we go on to discuss the effect of government policies on the firm. We also discuss whether the market requires government regulation at all. Long term investment decisions may give rise to complex situations within the firm. We also study the principal agent problem in this context and suggest possible remedial measure to remove such conflicts.
Condition of Rising Prices
Let us consider a situation where the firm is facing rising costs. Our firm is a producer of low calories frozen food. A crop failure due to some natural calamity or bad weather conditions can lead to the fall in the supply of agricultural inputs that are required by the firm. The fall in supply of agricultural products will push up the price of such products. The firm will now be faced with a condition of increased prices. The firm has to be prepared beforehand for such situations. There are a number of steps that the firm can take. Let us discuss some of them.
An improvement in the efficiency of the production technique can make more economic use of the inputs . Improvement in productive efficiency implies that the inputs can be used in a productive manner so that more output can be obtained from a given amount of inputs. A firm should allow constant flow of information so that it can have the knowledge of new innovations in technique of production. It should constantly update its production system based on new technological innovations and discoveries. If a firm keeps on using the same machineries and production technique it loses on productivity. Obsolete technique leads to inefficiency. So some part of the investment should be allocated for updating the production technique time and again so that inefficiency does not creep in.
In the event of rising price of some inputs the firm should modify the production technique so that some cheaper substitute can be used as an input. Thus the production system used by the firm should be flexible enough to allow alternative forms of input to be used. This can reduce the cost of production on the occasion of rising price of some inputs.
The firm should also constantly invest in research and development to innovate new products. This will increase the market size of the firm as the firm can cater to different types of consumers with varying tastes and preferences. There should be a constant eye on the nature of demand so that the products can be modified to the changes in the choices of the consumers.
In addition to product innovations the firm should also launch effective sales promotion campaigns. With better advertisement procedures the market power will increase as the consumers will be able to view the firm’s product as unique. The demand will tend to be inelastic in such a situation. Thus a rise in price due the increase in input costs will not lead to any revenue loss for the firm. With inelastic demand a rise in the rice will lead to a small fall in demand. Thus the revenue will tend to increase.
Government Policies
There are two major forms of policies that the government uses to maintain growth, stability and control the price level. The two forms of policies are fiscal policy and monetary policy. Through the fiscal policy the government aims at fostering growth of the economy and to improve the level of employment. The tax policies, government expenditure and income policies are the tolls of fiscal policy of the government. A reduction in the tax rates increases the disposable income in the hands of the people . This increases the aggregate demand as consumer expenditure increases thus pushing up the price level. The higher price level induces the producers to produce more. Thus output increases leading to the increase in employment and income. An increase in government expenditure also increases the aggregate demand leading to rise in output and employment.
The monetary policy tools in the hands of the monetary authority that is, the central bank, are the rate of interest, cash reserve ratio and open market operations . When the rate of interest is increased investment will fall as there will be less credit flow in the economy. People would rather save than take loans to buy goods. Aggregate demand will fall leading to the fall in prices. But it will also reduce output and employment. Similarly when cash reserve ratio is increased the commercial banks have to keep more cash with the central bank and hence can advance fewer loans. Invest will fall leading to lower aggregate demand and lower prices. Open market operations pertain to the buying and selling of government bonds by the central bank. When the central bank purchases bonds in the open market money is pumped out of the economy. Purchasing power of the people gets reduced. Thus inflation is reduced. So we see that as the rate of interest is increased growth and inflation is reduced but if interest rate is reduced it will induce growth though there will be some inflationary pressure on the economy. Similarly, reduction in the CRR will increase credit flow and lead to further growth. Through open market operations also the monetary authority attempts to put a control on the price level and output.
If the taxes such as the corporate profit tax are reduced the firm will be induced to produce more. The reduction in sales tax will also boost production as the price of the good will be reduced and thereby increase demand. Taxes or subsidies on inputs will also affect the firm. A tax on input will raise the input price and hence the cost of production for the firm will increase. If the government subsidizes the production of some inputs the cost on that input will be reduced. The firm will face lower production cost. Monetary policy actions will also affect the firm. If the central bank increases the rate of interest the firm will face with a crunch of investible resources as people would prefer to keep their money in the banks than buying shares and equities. If the central bank starts selling bonds in the open market the private bonds and equities will get crowded out. In such a case also the firm will have a shortage of funds. Thus fiscal and monetary policy of the government has a considerable impact on the firm’s operations.
Government Intervention in a Market Economy
The advocates of free market or laissez faire economy maintain that in a free market the demand and supply forces automatically arrive at the basic economic decision taking. The price of the product and the amount to be produced and the distributional aspect is also arrived at through the market forces. In spite of this automatic adjustment the role of the government cannot be undermined even in a free market economy. The government has to intervene in times of a market failure or when the objectives of social welfare are at stake. In case of goods that are harmful for the society such as consumption of tobacco the government has to impose restrictions in the marketing of the product by making the firms put up statutory warnings on the product label. When the production of certain goods has adverse impact on the environment the government has to impose restriction on the production of such goods through environmental clearance obligations, pollution taxes etc. In markets where there is a tendency of monopolization the government intervenes to protect the interests of the consumers. The government may promote goods that are beneficial for the society or have positive environmental or health effects. These are merit goods that receive government subsidies. For example in many countries at present the governments are subsidizing solar photovoltaic cells to promote the use of solar energy which is a renewable and non-polluting source of energy.
The low-calories frozen food firm that we are discussing here is operating in an oligopolistic form of market. If the government finds some amount of monopoly concentration through the formation of cartels or through mergers or acquisition the government will intervene to bring in competition in the market. The government can also help in the promotion of the product as it is a health food given that it is a low-calorie food.
There are instances of such government intervention in the real world. For example the anti-trust laws in the US are aimed at curbing the attempts of firms to increase their market power and gain monopoly position in the market. The government has taken punitive measures against erring firms under this law. Another instance of market intervention is the clause of putting statutory warning on the tobacco companies on their product that is cigarettes, to make people aware about the harmful health effects of smoking.
Impending Conflicts within the Firm
We have suggested at the beginning of this paper that the firm should make investments to introduce new improved techniques of production, for product innovation and also for sales promotion purposes. The decision to take up long term capital projects may lead to internal strife. First of all the investment may be risky, the possible returns from the capital project may be uncertain as there can be a number of unforeseen challenges confronting the firm in future. Moreover future projections about demand and costs can also be faulty raising questions about the viability of the long term investment.
The decision of long term investment often creates a difference of opinions between the managers and stockholders. A typical principal agent conflict arises in such a situation . The managers aim at popularizing the brand. Hence their main interests are in expanding the market and increasing sales. Increased sales also increase the reputation of the managers. The managers also aim at increasing the income of the managerial team. The stockholders on the other hand prefer higher profits for the firm so that their income increases. Higher retained earnings of the firm that can be reinvested will not be distributed in the form of dividends and thus does not add to the income of the stockholders. Thus the aim of the managers and stockholders are quite contrary to each other. We can clearly see that this situation results in a principal agent conflict. The managers aim at sales promotion and hence prefer long-term investments where as the stockholders prefer lower output and higher profits.
Solution to the Conflict
In the previous section we have discussed how the long term investment decision results in a principal agent problem with the interests of the managers and stockholders move in different directions and so they advocate different strategies for the firm. The solution to this problem is to make the interests of the managers and stockholders to converge. One way to do this is to make the managers shareholders of the company. Many firms give bonuses or rewards to their managers in the form of shares of the companies. If the managers are also stockholders then the managers would also aim at maximizing profit thus increasing the income of the shareholders.
Conclusion
In this article we have discussed a number of challenges facing the firm. We have also suggested long term solution to the hurdles that may arise in the long term. Constant vigil on the changes in the market structure, government policies and changes in the demand will make the firm withstand the calamities that may arise in future. We have suggested that the firm should constantly invest in research and development activities to be prepared to face the future challenges. The decision to invest in research and development will lead to conflict within the firm. The conflict arises due to conflicting interests of different stakeholders involved with the firm. We have suggested some solution to these conflicts. We have also discussed the effect of government policies on the firm’s activities. The possibility of government intervention in the functioning of the firm has also been discussed in this paper. Thus out low calorie frozen food firm can be prepared for the future by proper forecasting, constant research and development and removing internal conflicts.
References
Koutsoyiannis, A. (2008). Microeconomics. Macmillan Press Ltd.
Mankiw, G. (2013). Macroeconomics. Macmillan.
Pindyck, R., & Rubinfield, D. (2009). Microeconomics (7th ed.). Prentice Hall.
tutor2u. (2015, December). Government Interventions in Markets. Retrieved from tutor2u: http://www.tutor2u.net/economics/reference/government-intervention-in-markets
