Alternatives to Profit Maximisation

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 the business Requires knowledge of cost and revenue conditions in the market 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

Profit Maximisation where MC=MR

Revenue MC

P1 ATC

AC1

MR Q1

AR

Output (Q)

Profit Maximisation Using TR and TC Curves

Revenue Cost and Profit TC

TR

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)
Output (Q)

Profit Maximisation Using TR and TC Curves

Revenue Cost and Profit TC

TR

Max Profit

Q2

Q1

Output (Q)

Different Objectives Illustrated

Revenue Cost and Profit

Max Profit

TC

Q2: Max Profit Q1: Max Revenue Q3: Break Even Output
TR

Q2

Q1

Q3

Output (Q)

The Total Profit Curve

Revenue Cost and Profit

Max Profit

TC

TR

Q2 Total Profit

Q1

Q3

Output (Q)

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)

Revenue Cost and Profit

Constrained Sales Revenue Maximisation

Max Profit
TC

TR

Max Profit Min Profit

Q2 Total Profit

Q1

Q4

Q3

Output (Q)

Non Maximising Goals for a Company

Traditional economic theory assumes there is a single goal.Behavioural economists argue 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 own objectives 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

Conflicting Objectives?
Employees Managers Shareholders

High wages Good working conditions Job Security

High salaries Power Prestige

Good dividends Growth in share valuation

Perks