Outline briefly the managerial criticisms of the profit maximising firm - Compare and contrast the Neo-classical profit maximising model with the management model of Baumol.

Topics: Economics, Supply and demand, Profit maximization Pages: 8 (2374 words) Published: April 9, 2007
Since the 12th century and the escalation of separate owner / managed business organizations, the assumption that firms maximises profits has been at the forefront of economic theory. Cyert and Hedrick (1972) stated:"The unmodified neoclassical approach is characterised by an ideal market with firms for which profit maximisation is the single determinant of behaviour. Thus predictions can readily be made by combining the description of the market with the results of maximisation of the relevant Lagrangian."In recent years their has been extensive literature by economists questioning the theory of profit maximisation, given that the standard "theory of the firm" is based upon rigid assumptions which can only exist in a perfect market. Tollison (2003) stated:'The debate about whether firms maximise profits serves as a purpose of forcing scholars to be more careful in framing maximisation hypothesis, and as a consequence, the profit-maximisation hypothesis is basically a non-issue today."Perhaps the most controversial assumption that compromises the neo-classical hypothesis is that firms always maximises profits (and minimise costs). This is further explored by incorporating more recent managerial models in particular Baumol.

There are however a number of other generic managerial criticisms of the Neo-classical model, all of which have been widely investigated by economic literature.

The first criticism concerns the inevitable conflict of interest between management and shareholders. In the modern economy, where ownership and control of firms often lie with different groups of individuals economists have found that each stakeholder group has conflicting objectives, regarding the use of resources by the organisation.

Managers employed by companies have a contractual relationship with the owners of the company i.e. they are the shareholders agents. However if the interests of shareholders and managers differ, then management are likely to be selective in the information they provide to their shareholders, resulting in managers having discretion to peruse their own objectives which may not be profit maximising; thus not conforming to the Neo-classical profit maximising model.

Friedman (1980) found that individuals always follow their own interests depending on what they value and what goals they wish to pursue, thus the assumption that individuals act rationally may be viewed as ignoring important aspects of human behaviour. In order for a firm to profit maximise all parties must hold the same values and goals, which is extremely unrealistic, with the exception of an owner managed sole business.

Another managerial criticism of the theory of profit maximisation is the existence of natural constraints within in the market (forces of demand and supply) and rules and regulations imposed by third parties such as the government (trading quotas, tax etc.). These limit the ability of firms to maximise profits, e.g. The Canadian government controls its domestic alcohol industry by price, distribution and trading cap's, thus taking away a firms ability to maximise profit in comparison to a perfect marketplace.

Today's increased emphasis on social responsibility to limit negative externalities provides another barrier for firms wishing to profit maximise. Amaeshi (2005) highlighted that the rise of social responsibility helps strengthen the already prevalent view that the pursuit of profits is wicked and immoral and must be curbed and controlled by external factors.

The direct conflict between profits and morals has had a large impact for today's economy in particular petro-chemical, pharmaceutical and energy industries. One such example is Huntingdon Life Sciences, which has been directly forced to change its strategy of profit maximisation and concentrate on increasing sales, primarily due to being targeted by animal protestors which resulted in its capital funding being severely restricted.

Neo-classical models...

References: Amaeshi, Kenneth M. (2005). Exporting Ethics, World Bank Institute and the Zicklin Centre of Business Ethics Research, Wharton School of Business.
Anderson, William L. (2005). Profit maximizing versus revenue maximizing firms? Only time will tell. Frostburg College of business, Frostburg State University.
Baumol, William J. (1967). Business Behaviour, Value and Growth, rev. ed. New York: Harcourt, Brace and World.
Cyert, Richard M. and Charles L.Hedrick. (1972) "Theory of the firm: Past, Present, and Future; An Interpretation," Journal of Economic Literature 10, 389-412.
Davis, H et Lam Pun Lee. (2001). Managerial Economics, An Analysis of business issues. The Hong Kong Polytechnic University.: Prentice Hall.
Hirshleifer, J., 1980, Privacy, its origin, function, and future, Journal of Legal Studies, 9,649-666.
Friedman, M. (1980): Capitalism and Freedom, ChicagoMcNutt, Patrick. (2006). Management Objectives and Stakeholder Value. Manchester Business School.
Rothbard, Murray N. (1993) Man, Economy and State, Auburn, Alabama: Ludwig von Mises Institute.
Tollison, Robert D. (2003). Book review on Amartya Sen, Rationality and Freedom. Cambridge, Mass.: Harvard University Press, 2002. Reviewed for EH.NET, January.
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