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Alternatives to Profit Maximisation

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Firm Objectives

Maximising Goals

Profit Maximisation Achieved when marginal revenue = marginal cost

Maximum distance between total revenue and total cost

Assumes that owners control the management of thebusiness

Requires knowledge of cost and revenue conditions in themarket so that MR and MC can be found

Sales Revenue Maximisation Objective developed by the work of Baumol (1959) Focuses on behaviour of manager-controlled businesses

Salaries and other perks more closely correlated with sales

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Profit Maximisation where MC=MR

Output (Q)

Revenue

ARMR

MC

ATC

P1

Q1

AC1

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Profit Maximisation Using TR and TC

Curves

Output (Q)

Revenue

Cost andProfit

TR

TC

Fixed Costs Total revenue rises at a decreasing rate (falling AR and MR)

Total cost rises at an increasing rate once marginal cost starts to rise

(diminishing returns set in)

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Profit Maximisation Using TR and TC

Curves

Output (Q)

TR

TCRevenue

Cost andProfit

Q1Q2

Max Profit

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Different Objectives Illustrated

Output (Q)

TR

TCRevenue

Cost andProfit

Q1Q2

Max Profit

Q3

Q2: Max

Profit

Q1: Max

Revenue

Q3: Break

Even Output

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The Total Profit Curve

Output (Q)

TR

TCRevenueCost and

Profit

Q1Q2

Max Profit

Q3

Total Profit

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Alternatives to Profit Maximisation

Standard neo-classical assumption is that firms seek to produce an output where

MC=MR

If sales revenue maximisation is the main objectives, this is achieved when MR =

zero (I.e. maximum point of the TR curve)

If a business wants to maximise output subject to making at least normal profit

(I.e. the break-even output), then it will produce up to the output where AR = ATC

This gives three different outputs and prices (assuming a business faces a given set

of revenue and cost curves)

Shareholders may introduce a constraint on the price and output decisions of

managers this is known as constrained sales revenue maximisation

They may introduce a minimum profit constraint (see next slide)

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Constrained Sales Revenue

Maximisation

Output (Q)

TR

TCRevenueCost and

Profit

Q1Q2

Max Profit

Q3

Total Profit

Max Profit

Min Profit

Q4

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Non Maximising Goals for a Company

Traditional economic theory assumes there is a single goal.Behavioural economistsargue differently

Any corporation is an organization with various groups

Employees

Managers

Shareholders Customers

Each group may have different objectives / goals

Dominant group at any moment in time can give greater emphasis to their ownobjectives

Maximising behaviour may be replaced by satisficing I.e. setting minimum

acceptable levels of achievement Equity and Bond markets may play an important role in monitoring the

performance of managers in a company

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Conflicting Objectives?

Employees Managers Shareholders

High wages

Good working

conditions

Job Security

High salaries

Power

Prestige

Perks

Good dividends

Growth in share

valuation