Profit Maximization

Firms ar in business for a simple reason To defend money. Traditional economic theory suggests that firms crystalize their decisions on supply and output on the basis of meshing maximisation. til now m whatever Economists and autobusial Scientists in our days question that the sole lay of a firm is the maximisation of lucres. The most serious critique on the theory of the firm comes from those who question whether firms even make an effort to tap their bread. A firm (especially a large corporation) is non a private decision-maker and a collection of people within it.This implies that in coordinate to understand the decision-making process within firms, we hand to analyse who chequers the firm and what their interests are. The feature that most large companies are not run by the their owners is a lot brought forward to support this claim. A large corporation typically is owned by thousands of shareholders, most of whom bring forth nothing to do with the business d ecisions. Those decisions are made by a professional management team, appointed by a salaried board of directors.In most cases these managers will not own stock in the familiarity which whitethorn lead to placefully differing goals of owners and managers. Since ownership gives a person a claim on the profit of the firm, the greater the firms profit, the spirited the owners income. Hence the owners goal will be profit maximisation. When managers salary stays unaffected by higher profits they may pursue other goals to agitate their personal utility. This behaviour strikes the critical perceiver regularly when for example reading or watching the financial media.Managers there often rather mention the rises in sales or the emersion of their company rather then the profits. Some economists like Begg (1996) argued that managers have an inducing to promote growth as managers of larger companies usually get higher salaries. Others like Williamson (1964) suggested that managers der ive further utility from perquisites such as pornographic offices, many subordinate workers, company cars etcetera Fanning (1990) gives a rather curious example When WPP Group PLC besidesk over the J. Walter Thompson Company, they found that the firm was spending $80,000 p. . to have a butler deliver a peeled orange any morning to one of their executives.An unnecessary cost clearly from the perspective of the company owners. But often it becomes difficult to identify and separate this amenity maximisation from profit maximisation. A corporate jet for example could be all justified as a profit maximize response to the high opportunity cost of a top executive or an pricey and costly executive status symbol. Baumol (1967) hypothesised that managers often attach their personal prestigiousness to the companys receipts or sales.A prestige maximising manager therefore would rather attempt to maximise the firms tot revenue then their profits. Figure 1 illustrates how the output choices of revenue- and profit maximising managers differ. The understand plots the bare(a) revenue and marginal cost creases. Total Revenue peaks at x r , which is the quantity at which the marginal revenue edit crosses the horizontal axis. Any quantity 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 additional output regardless of its effects on cost. Given this information one might ask why the owners arrogatet 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 access to information as the managers do. Where Information relates to professional skills of transaction administration as strong as those of the firms inner structure and its grocery enviroment.Furthermore, when confronted with the owners demands for profit maximising policies, a clev er manager can of all time argue that her engagement in activities, like a damaging price war or an expensive advertising campaign serve the long haul prospect of high profits. This excuse 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 operate with a profit shyness. 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 ?. Thus a sales-maximising manager will choose 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 would have to chose an output level that creates Q2, where profits are highest but sales lower then in Q3.So given this mesh 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 agree the managers behaviour and bring it in line with the owners interests, is to make the managers owners themselves by heavy(p) them a share in the company. However, research by De Meza & Lockwood (1998) suggests that even with the managers owning assets, their carrying out does not necessarily become more profit raising.Rajan & Zingales (1998) assessed the impact of power and access 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 re port contrary effects of ownership on the incentive to specialise. Other ways to control managers include performance based pay, which can prove to be effective in the short-run but again, the long-run perspective of the firm may suffer, when managers neglect 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 significant to note that profit maximisation fails to demonstrate a general hardness when applied 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 noted between the size of firms. A small family-run business for exemplar can easily adopt a pure profit-maximising appro ach, since 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 devise a theory of firm behaviour on the different classes of firms with a perspective to their individual differences in management, ownership and market enviroment.