Profit Maximization

Firms argon in business for a simple reason To befool m aney. Traditional economic theory suggests that unwaverings arrive their decisions on supply and yield on the basis of simoleons maximization. However many Economists and managerial Scientists in our days dubiousness that the sole aim of a firm is the maximisation of profits. The most serious critique on the theory of the firm comes from those who question whether firms even make an effort to exploit their profits. A firm (especially a large corporation) is not a single decision-maker but a army of people inside it.This implies that in order to understand the decision-making process within firms, we swallow to analyse who controls the firm and what their kindles are. The fact that most large companies are not run by the their owners is often brought forward to support this claim. A large corporation typically is owned by thousands of shareholders, most of whom have nothing to do with the business decisions. Those decis ions are made by a professional management team, institute by a salaried come along of directors.In most cases these managers will not own stock in the play along which may lead to strongly differing goals of owners and managers. Since ownership gives a somebody a claim on the profit of the firm, the greater the firms profit, the higher the owners income. pastcece the owners goal will be profit maximisation. When managers salary stays untouched by higher profits they may pursue other goals to recruit their personal utility. This behaviour strikes the critical observer regularly when for example class period or watching the financial media.Managers there often sort of nurture the rises in sales or the growth of their company rather thus the profits. Some economists like Begg (1996) argued that managers have an incentive to promote growth as managers of larger companies usually get higher salaries. Others like Williamson (1964) suggested that managers derive hike utility f rom perquisites such as big offices, many subordinate workers, company cars etc. Fanning (1990) gives a rather bizarre example When WPP Group PLC took all over the J. Walter Thompson Company, they found that the firm was spending $80,000 p. . to have a butler expect a peeled orange every morning to whiz of their executives.An supernumerary cost clearly from the military position of the company owners. But often it becomes challenging to identify and separate this amenity maximisation from profit maximisation. A unified jet for example could be either justified as a profit maximise response to the high opportunity cost of a top executive or an valuable and costly executive billet symbol. Baumol (1967) hypothesised that managers often attach their personal prestige to the companys revenue enhancement or sales.A prestige exploit manager therefore would rather attempt to maximise the firms total revenue then their profits. Figure 1 illustrates how the end product choices of revenue- and profit maximising managers differ. The figure plots the marginal revenue and marginal cost curves. Total Revenue peaks at x r , which is the meter at which the marginal revenue curve crosses the horizontal axis. Any measurement below x r , marginal revenue will be positive and the total revenue curve will rise as output goes up.Hence a revenue-maximising manager would continue to produce extra output regardless of its effectuate on cost. Given this development one might ask why the owners dont intervene when their appointed managers dont direct their actions in the interest of the owners, by maximising profits. First of all, the owners will not have the same rile to information as the managers do. Where Information relates to professional skills of Business administration as rise up as those of the firms inner structure and its market enviroment.Furthermore, when confronted with the owners demands for profit maximising policies, a clever manager laughingstock a lways argue that her engagement in activities, like a damaging price war or an expensive advertising campaign serve the long-run prospect of high profits. This free is very difficult to challenge until it is too late. Another aspect is that managers aiming to maximise growth of their company (expecting higher salaries, power, prestige, etc. ) often start with a profit bashfulness. A profit constraint is the minimum level of profit needed to keep the shareholders happy.The effects of such a profit constraint are illustrated in Figure2. Figure2 shows a total profit curve (T? ). T? is derived from the difference between TR and TC at each output level. If the minimum acceptable level of profit is ? , any output greater then Q3 will result in a profit below ?. consequently a sales-maximising manager will opt for Q3 which gives the highest level of sales at the minimum possible profit. This however would not be the profit maximising option. In order to maximise profits the manager wo uld have to chose an output level that creates Q2, where profits are highest but sales lower then in Q3.So given this conflict of interests between the owners and the managers of a firm? What are the possible solutions available to the owners, to make their agents work in their interest? It is often suggested that an effective way to control the managers behaviour and bring it in line with the owners interests, is to make the managers owners themselves by giving them a share in the company. However, research by De Meza & Lockwood (1998) suggests that even with the managers owning assets, their performance does not needfully become more profit raising.Rajan & Zingales (1998) assessed the impact of power and gateway to it on the behaviour and performance of managers. Their findings suggest that the power gained by access to critical resources is more contingent than ownership on managers or agents to make the right investment and decisions then ownership. They also report adver se effects of ownership on the incentive to specialise. Other ways to control managers complicate performance based pay, which can prove to be effective in the short but again, the long-run perspective of the firm may suffer, when managers thoughtlessness crucialLong-run investments into Research and Development, restructuring, equipment or advertising to raise short-run profits and hence their own salaries. In conclusion it is important to tune that profit maximisation fails to demonstrate a general validity when use as a theory of firm-behaviour. The real world businesses often operate on a multi-dimensional basis with many confronting interests and aims. As well as differing short-run and long run aims. Therefore profit-maximisation should be regarded as one possible goal of a firm but not necessarily its sole one.There is also a difference to be remark between the size of firms. A small family-run business for instance can easily adopt a pure profit-maximising approach, si nce the utility of its owners equals that of the labour-force and the management. In this setting, the income will equal profit. Therefore it is imperative to assess and develop a theory of firm behaviour on the different classes of firms with a perspective to their individual differences in management, ownership and market enviroment.