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Efficient market hypothesis

When firms become large, they require to engage in very many. The firms require agents to minimize the costs. The agent acts on behalf of the principal to engage a third party in a contract with the principal. In every country there are laws that regulate the agents, third and principal relationships. The agents have been found to engage in some deals where the principal loses but they gain. This means that laws have to protect the principal from ill motives of the agents. The laws should also protect agents when business deals turn sour when they actually acted in the interest of the principal.

The big firms should evaluate the country’s laws to better understand the form of operation. Failure to do this may lead to numerous laws suits which would cost the business (Davidson, 2002). In line with principal agent are issues of information symmetric. This is the case where two people enter into a contract but one party has more information that may affect the contract and the other party is unaware. The complexity of this scenario is that one party to the contract may avoid some danger. This creates room for swindling to happen.

The party who has the information will avoid costs and always acts as though they are ignorant. The contracts that are entered to under such circumstances have hidden costs involved. The information asymmetric contributes to consumers restraining to buy some goods in fear that they may get ripped of (Voga, 1994). Efficient market hypothesis is a theory on stock markets. The theory suggests than an investor cannot beat the market since the share prices always incorporate and reflect all relevant information.

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This means that stocks trade at their fair values and it is therefore impossible for investors either to purchase undervalued stocks or sell stocks at inflated prices. This also means that business performance is reflected by the performance of the firm’s stocks. It would be impossible for firms to be sold at values below their real values. This theory offers protection to the firm. Cross elasticity is the effect on the change in demand or supply of one goods as a result of a change in some other related goods. If goods are complementary price increases in one reduce demand in both products.

If goods are substitutes an increase in price in one commodity causes demand to increase in the other. Income elasticity of demand measures the relationship between a change in quantity demanded and a change in income. Normal goods in this case have a positive income elasticity of demand. As income increases, the demand for the normal goods increases. However as the income levels decrease, the normal goods record decreased demand. The firm dealing with the production of the normal goods needs to check people’s levels of income.

Point elasticity of demand is computing the price elasticity of elasticity of demand at a specific point on the demand curve instead of over a range. Differentials are used in this computation since the very small changes are of interest. A very small arc is used to calculate the gradients. The analysis assists the firm in determining the point at which change in prices would affect the demand. The firm could therefore increase prices so long as it does not adversely affect demand to reduce it. Marginal revenue is the extra revenue that an additional unit of product will bring to a firm.

The computation of marginal revenue assists a firm in determining its potential. The firm is able to expand its operations by increasing its output with the confidence that such expansion would bring certain level of revenues. Marginal cost is the change in total cost that arises when quantity produced changes by one unit. If increasing produce would reduce the cost of production, a decision to increase output may be made. A firm should also know the total fixed costs it incurs in the course of production. Such costs are those that remain the same irrespective of the amount of output.

Variable costs are the costs that depend on the amount of output. Addition of both costs gives the total costs of productions. As we have seen in the discussion, there are numerous economic theories that explain the interaction of market forces with forces with firms. The economy has evidently been shown to deal with products from firms emphasizing the notion that the firm is the basic unit of production. Countries intending to grow their economies should focus on the expansion of their firms. When favorable conditions are set, the firms would engage in production of goods and services.

Governments would realize revenue in taxes and build more industries. Economies cannot be separated from firms. It is also important that appropriate laws be put in place to regulate business. Unfair competition can harm growing businesses and they need to be protected.


Davidson, P (2002). Financial markets, Money and the Real World. Celtenham: Edward Elgar Publishing Ltd. Friedman, M (2007) Price Theory. New Jersey: Transaction Publishers. Garvey, M. D (2004). The Nature of the Firm. Available on 26/10/2007 from World Wide Web www.ssc.edu/

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