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Managerial Economics and The Firm
Explain what is the principle of profit maximization?
Profit maximization is when a firm's primary objective is to make the most amount of profit possible when trading within its market .The traditional theory of the firm is based on the assumption of short-run profit maximization (Sloman, 2004). But there is an alternative theory which assumes that managers aim to shift cost and revenue curves so as to maximise profits over a long period. Many believe that the long run profit maximization theory would be a good alternative to the short run theory, but realistically it is very difficult to test.
Profit maximizing is based on two assumptions; that owners are in control of the day-to-day management, and the main aim of the owners is for higher profit. Profit is maximised where marginal revenue equals marginal cost. Shareholders (principles) employ managers (agents) to act on behalf of them to run the day-to-day business. As it is the managers that run the firm and not shareholders a conflict of goals and targets may occur, 'principal-agent problem' which can drastically affect the outcome of profit maximization.
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