Managerial Economic

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Introduction (graphics not included)

What is the major objective of an organisation? The concept of profit maximisation has survived for many as the major objective for an organisation for a long period. Is this still true in modern business today? Most large firms are being run and operated by management instead of the owners, how they manage the firm? Still maximising the profit, maximising sales turnover or something else?

In this essay, I will briefly outline the key points underpinning the economics of a profit maximising firm and evaluate the management model of Baumol (1959) on sales revenue maximisation to examine the modern management’s behaviour.

Profit maximisation

The neoclassical model of profit maximisation was first aroused from classical economist, Adam Smith (1776), who believed that the markets would settle on a position of natural equilibrium. He claimed based on this, the organisations will do all in their power to gain maximum benefit for themselves.

In economics, profit maximisation is the process by which a firm determines the price and output level that returns the greatest profit. The neoclassical model of profit maximisation tells us that the objective of the organisation is to optimise profits where MC=MR.

Profits are shown as a profit locus, π locus showing the zero profit level, the maximum profit level and all intermediate points. The quantity associated with the maximum profit level is Qπmax – the production quantity associated with the greatest distance between the revenue and cost curves. The quantity associated with the maximum profit level is Qrevmax – TR then declines as revenue for each unit sold as a result of discounts made to consumers to encourage them to purchase.

Profit maximisation model is based on several assumptions.

 The organisation should be certain about the future, which included competitive conditions, direct relationship between pricing and profit. However, such assumption is difficult to attain by firm as the future is changing all the time.

 In long term strategy, the organisation has to achieve the highest net present value.

 The management’s attitude to risk is neutral.

 The analyst should have highly accurate information about the organisation’s total costs and revenue, or marginal costs and revenues, or both.

Profit maximisation has been adopted by management in the company mainly because of several reasons. In order for an organisation to survive against competition in goods, services and financial market, it requires profits. Such competition forces management to pay close attention to profits. In addition, the compensation of management is closely related to profitability.

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