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"Discuss the assumption that the firm's main motivation is to maximise profits?"

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Introduction

"Discuss the assumption that the firm's main motivation is to maximise profits?" The traditional theory (neoclassical) assumes that firm's primary objective is to maximize profits. That is if the firm is owner controlled. This assumption is based on that firms makes the output and price decisions. Also, that firm takes all necessary actions to earn the greatest profit possible. The managerial theory assumes firms do not necessarily act in order to maximize profits. The basic tenet behind this is the separation of ownership from management, complexity of the organisation and the firm's manager maximizes his own utility and growth rather than profits. The reason for this is that managers may be judged by the level of sales revenue. I will be providing supporting arguments for and against this assumption "that the firm's main motivation is to maximise profits" and draw a conclusion by analysing the firms behaviour as well as further discussing the theories of firms. Profit maximising assumption is based on two premises, firstly that owner is in control of day-to-day management of the firm and secondly that the main desire of owners is to make a higher profit then the amount they invested in the firm. ...read more.

Middle

For firms to maximize profits they must have detailed knowledge of marginal analysis, where marginal cost (MC) equal marginal revenue (MR). However, marginal analysis doesn't tell us how to maximise profit but it simply tells us what the output and the price must be (Applied Economics 7th Ed). Moreover, to reach marginal analysis firms need information, on their consumers, their demand curve, the amount they produce and what price to sell their goods. In reality many of them will not have sufficient funds to spend on collating information alone. Nevertheless, firms do carry out market research on their targeted consumers. They also, have to decide the time period over which the firm should seek to maximize profits. The markets where the firms works constantly changing "firms operate in a changing environment" (J. Sloman. p195). Therefore, firms are unable to predict the market behaviour, hence, cannot set specific targets. Another example is when the firm should decide to replace its ageing equipments. If it does, its short-run cost will rise and its short-run profits will fall. But, by investing in new equipments quality of the product may increase, consequently resulting in hire demand in the long-run and hence maximizing profits (Sloman, J 2003). ...read more.

Conclusion

minus the cost of producing that quantity of output. Therefore, in practice profit maximization is desired in the long-run, if not in the short-run. The traditional theory of the firm assumes that its sole objective is to maximize profits. The other managerial theory assumes that where ownership and control of the firm is separated. The objective of these types firms will be those set by the managements. According to the short-run theory the firms favours sales revenues over profits, even though profit maximization is part of the goals. Research by the Strategic Planning Institute found that without the short-run sales revenue there will not be any long-term profit. Here, sales revenue is seen as paramount to long-term profits and survival of the firms. In the long-run viability of non-profit maximiser would find it very difficult to compete with other firms in a free market. As Alchian (1950) explicated that in the long-run, natural selection would results in the survival of the profit maximizers, as well as Friedman (1953 p21-22), argued that regardless of how actual firms may behave and constraints on rationality they may be subject to, the surviving firms are those who attained high profits. Due to the strength of these arguments, we tend to accept profits maximization theories are justifiable. ...read more.

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