Profit Maximisation

Topics: Profit maximization, Economics, Supply and demand Pages: 6 (2111 words) Published: November 7, 2007
Is Profit Maximisation always the major objective of a firm?

The production of goods and services in our economy today takes place within organisations, whether in the centrally planned economy or free market economy. Any firm within these societies all have the same tendencies to acquire a successful business. Attaining this succession through mission statements, goals and objectives is simultaneous through all businesses. Changes in these objectives can have forcible effects on the decisions that firms take day-to-day regarding pricing, output levels, the market and capital investment. Depending on the size of the corporation, objectives will evolve to meet changing economic conditions. The standard neo-classical assumption is that a business strives to maximize profits. Profit maximization is the process by which a firm determines the price and output level that returns the greatest profit, where marginal cost is equal to the marginal revenue. The theory of a firm tends to make this assumption because despite the growing importance for market survival and frequent calls for corporate social responsibility, creating a profit appears to be the most significant single objective of organisations in our market economy. Economists' have used the traditional profit maximization theory as a matter of debate whether the firm survives and develops in order to provide a profit or makes a profit by which it can survive and develop. Any firm has to take into account how the market determines the price for goods or services which they supply. Applying the theory of supply and demand helps organisations to reach decisions. Using a demand curve defines the price, total revenue and marginal revenue associated with each level of output, where price changes act as the mechanism whereby supply and demand are balanced. In 2000, Clark dictated that, "a supplier should stop when the revenue made on the last item produced is no more than it cost to provide." (Pg 52) Past this point, profits deteriorate relentlessly, as the law of diminishing returns prescribes that the costs involved in producing an extra unit of output go up, whilst the demand curve dictates that the revenue from each extra unit sold goes down. In turn, the firm should respond to the supply and demand signals (e.g. changes in costs) by adjusting its pricing policy, output or both. They should also be able to indentify values of revenue and cost, conjoined with each level of output and in so doing, identify a profit maximizing position. The concept of price elasticity allows the firm to analyze supply and demand with greater precision and is a measure of how much buyers and sellers respond to changes in the market. The principle assumes that a business needs to make at least normal profits in the long run to justify remaining in the market; however this is not a strict requirement in the short term. In the short run the firm should continue to produce as long as revenue costs covers total variable costs. Within our economy owners and managers represent two different groups of decision makers. It is implied that shareholders possess the desire of profit maximization to be the preferable target of any business with which they hold equity, thus providing them with more wealth. However in practice this is not always the case as the debate over the divorce of ownership and control comes into play. In theory; the shareholders being the owners of the firm will control its activities. However, in practice this can be difficult amongst larger corporations as control often lies in the hands of the directors. It can be tough for any firm to exact change for the thousands of shareholders, each with a small stake. Thus in many firms there is what is called the division of ownership and control. The separation of ownership and control raises worries that the management team may pursue objectives attractive to them but which are not necessarily beneficial to the...
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