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Is profit maximisation the key objective of a firm?

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Introduction

Economics for Business Is Profit Maximisation always the major objective of a firm? The production of goods and services in our economy today takes place within organisations, whether in the centrally planned economy or free market economy. Any firm within these societies all have the same tendencies to acquire a successful business. Attaining this succession through mission statements, goals and objectives is simultaneous through all businesses. Changes in these objectives can have forcible effects on the decisions that firms take day-to-day regarding pricing, output levels, the market and capital investment. Depending on the size of the corporation, objectives will evolve to meet changing economic conditions. The standard neo-classical assumption is that a business strives to maximize profits. Profit maximization is the process by which a firm determines the price and output level that returns the greatest profit, where marginal cost is equal to the marginal revenue. The theory of a firm tends to make this assumption because despite the growing importance for market survival and frequent calls for corporate social responsibility, creating a profit appears to be the most significant single objective of organisations in our market economy. Economists' have used the traditional profit maximization theory as a matter of debate whether the firm survives and develops in order to provide a profit or makes a profit by which it can survive and develop. ...read more.

Middle

Thus in many firms there is what is called the division of ownership and control. The separation of ownership and control raises worries that the management team may pursue objectives attractive to them but which are not necessarily beneficial to the shareholders. This conflict is what is known as the principal agent theory. As defined by Hornby, Gammie and Wall (Pg 164, 2001), the P-A theory, "considers the relationship between the owners of the firm and the managers and also the relationship between the managers and those they manage." The relationship occurs when one person, the principle, employs an agent to perform tasks on their behalf. It is assumed that each wants to maximize his or her profit but that each is subject to constraints. In this case, shareholders are the principals who employ the managers to maximize profits on their behalf. The concept of principal-agent can explore in greater detail the barriers imposed for each party involved. Recited from Worthington, Britton and Rees (Pg 41, 2001), "firstly there is an imbalance in power between the principal and the agent; secondly there is likely to be a divergence of interests between the principal and the agent and the possibility of opportunism exists." One problem in assuming that businesses set price and output to maximize profits is the decision-taking; where the divorce between ownership and control, can be difficult to monitor. ...read more.

Conclusion

The initial theory devised was known as the sales revenue maximization model, created by W J Baumol (1958). His theory implied that managers will seek to maximize the number of sales rather than profit. The reason for this is because the managers' salaries and power may depend directly on sales performance. Another constraint related to the maximization model insists that the shareholders will require a minimum profit level to keep them happy. Once the model has been applied there is continuing scope for managers to pursue their own goals. Another theory appointed by Williamson (1963) is known as the managerial utility maximization model. As defined by Brewster (1997), Williamson's theory "examined in detail the discretionary behaviour of managers" (Pg 184). Managers in any business are likely to seek their own satisfaction or utility, although according to Williamson, this is subject to obtaining a minimum level of profit. As with Baumol's model, Williamson dictates that there is a separation of ownership and control and the pressure to maximize profit is more relaxed. A manager's utility will hinge upon their power, status and role enjoyment. In turn these are enhanced by expenditure on discretionary items including: * Increasing personnel levels which increase the managers span of control and relative 'weight' in the firm. * Expenditure on 'perks' or non-pecuniary remuneration enhance the manager's status and power. * The size of the budget the manager controls and what interests rather than enhancing profit. Williamson also identified the concept of profit 'satisficing'. ...read more.

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