Profit maximisation is not the sole objective of business
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Profit maximisation has been one of the main aims of the firms. The generally accepted view is the long run will wish to maximize profit. Marginal Cost and Marginal Revenue can be used to find the profit maximising level of output. Marginal cost is the addition to total cost of one extra unit of output. Marginal revenue is the increase in total revenue resulting from an extra unit of sales. Economic theory predicts that profits will be maximised at the output level where marginal cost equals maginal revenue (MC=MR). This is the point where firms will decide to produce.
The control of firms is likely to lie with one or more of the firm’s stakeholders. It might seem obvious to state that it is the owners or shareholders of a company who control it. This is perhaps true for small businesses where the owner is also the director or manager of the business. The owner of a small local corner shop, for instance, who also runs the shop will make the decisions about the business. However, it is less obvious that owners control the business they own when there is a very large number of shareholders.
Apart from the shareholders, the are also other stakeholders in business. Shareholders in a public limited company elect directors to look after their interests. Directors in turn appoint managers who are responsible for the day to day running of the business. Therefore there may be a divorce between ownership and control. The only way in which owners can influence decision making directly is by sacking directors at the Annual General Meeting of the company. In practice the company needs to be going bankrupt to stir sufficient shareholders for this to happen. Shareholders can also sell their shares, forcing the share price down and making the company more vulnerable to a takeover bid. If there is a takeover the directors and managers may well lose their jobs and hence there is pressure on managers to perform well. The workers, particularly through their trade unions, may be able to exert strong pressure on a company.
They do not have the power to run the company in the way that shareholders or managers able to do. However, they can have an important influence on matters such as wages (and therefore costs), health and safety at work and location or relocation of premises. The state government provides an underlying framework for the operation of the company. Legislation on taxation, the environment, consumer protection, health and safety at work, employment practices, solvency and many other issues forces companies to behave in a way in which they might otherwise not do in an unregulated environment. The consumer, through organizations such as the Consumers’ Association or various trade organizations, can also bring pressure to bear on companies in an attempt to make them change their policies. This form of influence is often rather weak; consumer sovereignty is more important.
In a free market, consumers cast their spending votes amongst companies. Companies which do not provide the products that consumers wish to buy will go out of business whilst companies which are responsive to consumers’ needs may make large profits. According to this, it is the consumer who ultimately controls the company. This assumes that consumer sovereignty exists. In practice, firms attempt to manipulate consumer preferences by marketing devices such as advertising. Firms are therefore not the powerless servants which theory implies.
Firms are not always able to operate at a profit. They may be faced with operating at a loss. Neo-classical economics predicts that firms will continue in production in the short run so long as they cover their variable costs. Short run profit maximization implies that a firm will continue to produce even if it is not fully covering its total costs. It will only shut down production when its total revenue fails to cover its total variable cost.
Neo-Keynesian economists believe that firms maximize their long run rather than their short run profit. The price set and therefore the profit aimed for is based upon the long run costs of the firm. According to neo-Keynesians, rapid price adjustments may well damage the firm’s position in a market. Price cuts may be seen as a sigh of distress selling and large buyers may respond by trying to negotiate even larger price reductions. Price increases may be interpreted as a sigh of profiteering, with consumers switching to other brands or makes in the belief that they will get better value for money. Price changes also involve costs to the company because price lists need to be changed, sales staff informed, advertising material changed, etc. therefore it is argued that firms attempt to maintain stable prices whilst adjusting output to changes in market conditions.
In managerial theories, it is far from obvious that managers will wish to see profits maximized like shareholders. As workers they will attempt to maximize their own rewards. These may include their own pay and fringe benefits, their ability to appropriate resources, and the amount of effort they have to make. There is always the threat of takeover or bankruptcy leading to a loss of jobs, so managers have to make enough profit to satisfy the demands of their shareholders. This is known as profit satisficing. But once a satisfactory level of profits has been made, the managers are free to maximize their own rewards from the company.
It is simplistic to argue that all firms aim to maximize profit. However, there is much evidence to suggest that large firms whose shares are freely traded on stock exchanges, and which are vulnerable to takeover, place the making of profit very high on their list of priorities. Therefore it is not unreasonable to make an assumption that, in general, firms are profit maximisers.
There are also other alternative theories. The cost-plus theory, which is a neo-Keynesian model because it is demand led, involves firms looking at their overall production costs, and then supply adding a profit mark-up. The revenue maximization model suggests that rather than maximizing profit, many firms in the USA would prefer to maximize revenue, especially sales revenue. This would please managers, who have a big interest in looking good. In Managerial and behavioural theory, the profit maximizing model is to do with trying to please the key stakeholders in a business, especially shareholders, but others too. And the behavioural theory theory argues that it is not just shareholders and managers who determine business behavior- you need to take into account government trade unions, pressure groups, etc.(e.g. greenpeace)