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Explain why managerial theories of the firm have developed, and how the predictions from these models differ from those of the profit maximising approach?

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Introduction

Explain why managerial theories of the firm have developed, and how the predictions from these models differ from those of the profit maximising approach? To start this essay I am going to explain a little about the history of the theory of the firm and why managerial theories of the firm have developed. Then I will go on to talk about various models regarded as being important in the evolution from profit maximising to more managerial based theories of the firm, and how the predictions of managerial theories of the firm differ from those of the profit maximising approach. Since the development of Adam Smith's early work on the competitive equilibrium paradigm, which resulted in the neo-classical model of the firm emerging during the second half of the 19th century, many other theories of the firm have developed and become established, which include; the principle-agent, transactions cost, and evolutionary theories as well as what has become known as management theories which are important in the context of the development of modern theories of the firm. The neo-classical model of the firm centres on its assumption that the objective of the firm is to maximise profits. ...read more.

Middle

small, owner managed and competing with a large number of similar firms, profit is a rational objective for two reasons. Firstly, maximisation of profits means maximisation of income for the owner, and secondly, because of the fierce competition in the market, any firm that did not maximise its profits would not be able to survive in business. Economic theory has been served well by the behavioural assumption of profit maximisation. "Because profit is the difference between revenue and costs, once revenue and costs are identified the assumption of profit maximisation enables predictions to be readily made about the consequences of any environmental change." (Hill, 1989, P50-51) Therefore, from a firms costs (derived from a firms production function), and revenues (derived from the demand schedule), the profit function and the output level at which profit is maximised can be obtained from the vertical difference between total revenue and total cost curves. The largest distance between marginal revenue and marginal cost being where profit is maximised, given by output Q. (see appendix 1) "According to this viewpoint, the true objective of the firm is closely related to profit." (Hill, 1989, P.53) As discussed earlier, there has been a move away from the profit maximisation theory of the firm towards more managerial theories, the three most credible ...read more.

Conclusion

happy by maximising their wealth or if there is an active threat of a take-over coming from a drop in share price resulting from a large number of unsatisfied shareholders selling their shares. Depending on how big this threat is and the relative preference of managers for job security and growth, will govern the slope of the supply growth curve. Overall we have seen that the profit maximisation theory and the models in managerial theory, depending on the objectives presumed and the form of constraints operating, generate substantially different comparative predictions. Although, "it has been argued by some economists that the alternatives to profit maximisation,.......... such as growth or sales, or even satisficing models, merely place the organisation in a better position to maximise profits in the long run." (Cook & Farquharson, 1998, P.74) There is little doubt about the attraction of the non-profit maximising theories, but "the assumption of profit maximisation has the enormous advantage of enabling decisions to be modelled simply and sufficiently, and allows decision rules to be developed to cope with a variety of changing circumstances". (Hill, 1993, P. 63) That's why to many people, regardless of the development of more modern theories of the firm, the profit maximising approach is still the most effective predictor of a firms behaviour. ...read more.

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