CHAPTER 11
What Should the Firm Do?
CHAPTER SUMMARY AND TEACHING OBJECTIVES
The idea of corporate social responsibility suggests that a firm has a responsibility to more than just its
shareholders. This chapter shows that being responsible to shareholders is also being responsible to
stakeholders.
IMPORTANT TERMS
Stakeholders everyone connected with or affected by a firm
Fixed Costs costs of production unrelated to the level of production
TOPICS AND TEACHING SUGGESTIONS
1. Stakeholders and Shareholders
2. Maximizing the Power of the Firm
The goal of a manager should be value maximization. If this is the guide followed by
3. Competition and Price
Managers must understand that competition is a process. One must constantly add value if a firm
it will exit the market.
ANSWERS TO EXERCISES
1. The technology exists for a consumer to be able to purchase electricity from any producer.
In fact, a computer could be installed in a consumer’s electrical box so that electricity would
be acquired automatically from wherever it is least expensive. What does this mean for an
electrical producer?
2. What types of products are phone service and electricity?
3. Services marketing is a current business buzzword. It is a branch of marketing that focuses
on services. Why would it be different from the marketing of goods?
4. Why does a firm spend an enormous amount on advertising when the ads provide consumers
virtually no information? For instance, what does the advertisement showing the Rock of
Gilbraltar and suggesting that we should “own a piece of the rock” tell us?
5. Why do firms build enormous buildings or skyscrapers when they could rent a less
pretentious structure for a lot less money?
6. Why do consumers pay twice as much for Bayer aspirin than for generic aspirin when they
know that the two are chemically identical?
7. Why do firms hire celebrities to advertise their products—why care whether Shaquille O’Neal
(basketball player) eats at Taco Bell or whether Tiger Woods (golfer) wears Nike shoes?
8. What does it mean to say that a firm should devote resources to an activity as long as society
values that activity more than it values the resources allocated to that activity?
9. Explain the relationship between fixed costs, variable costs and revenue for determining when
a firm should temporarily shut down.
Firms generate revenue by selling products. This revenue is used to pay all the costs of
Chapter 11: What Should the Firm Do? 51
10. Using the following Marginal Revenue and Marginal Cost, determine the profit maximizing
price and quantity.
Output MC MR
11. Is it possible to earn positive economic profit in the long run?
12. What economic role do brand names play in the economy? Why do firms devote resources to
developing a brand name?
13. Explain why the rule MR=MC defines profit maximization.
The goal of the firm is to add value. Profits are maximized when the greatest value has been
14. What is the abnormal net income model? Where does the entrepreneur show up in this model?
Abnormal net income is when economic profits are greater than zero. This occurs when the
15. Explain why the argument that a manager should focus on short-term performance rather than
long term performance might be invalid. In what sense might it be valid?
16. How long has Wal-Mart made positive economic profits? How long has Starbucks earned
positive economic profits? Have entrepreneurs been able to innovate and otherwise compete
with Wal-Mart and Starbucks? Explain.
17. What should the firm do, maximize profit or maximize stakeholder value? Explain
18. The owner of Whole Foods Markets, John Mackay, argues that firms should maximize
stakeholder value. He uses his firm as an example. Mackay takes money from the profits
and allocates it to community charities and other good works and his firm is very profitable.
Explain why Mackay is wrong.
19. Milton Friedman once said that the social responsibility of a company is to earn a profit.
Explain whether Friedman is correct or not.
20. Does a firm maximize profits today or the present value of the profit stream? How far out
does a firm look to determine its profit stream? If a CEO could be fired at any time for poor
performance, why would he focus on the long term rather than the short term?
Markets are forward looking. Managers should attempt to maximize the present value of expected