Maximizing Profits as the Main Goal

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Maximizing Profits as the Main Goal

The traditional theory (neoclassical) assumes that firm’s primary

objective is to maximize profits. That is if the firm is owner

controlled. This assumption is based on that firms makes the output

and price decisions. Also, that firm takes all necessary actions to

earn the greatest profit possible. The managerial theory assumes firms

do not necessarily act in order to maximize profits. The basic tenet

behind this is the separation of ownership from management, complexity

of the organisation and the firm’s manager maximizes his own utility

and growth rather than profits. The reason for this is that managers

may be judged by the level of sales revenue. I will be providing

supporting arguments for and against this assumption “that the firm’s

main motivation is to maximise profits” and draw a conclusion by

analysing the firms behaviour as well as further discussing the

theories of firms.

Profit maximising assumption is based on two premises, firstly that

owner is in control of day-to-day management of the firm and secondly

that the main desire of owners is to make a higher profit then the

amount they invested in the firm. Since this assumption is based on

two assumptions, therefore if these two premises don’t hold is it

understandable to believe that firms goals is not to maximize profits.

Well, this will depend on the motivation of individual firms.

If a firm’s ownership and control are in the hands of a single person

or small groups of people, then it’s reasonable to assume that the

firm’s owners’ goal is to maximize profits. But most of today’s firms

are owned by shareholders and other large cooperation, but day-to-day

control of the firm is under management. Therefore, the objectives of

managements may differ from the shareholders and conflicts may arise.

“For example Baumal (1959) suggest that the manager-controlled firm is

likely to have sales revenue maximization, as its main goal than

profit maximization favoured by shareholders” (Applied Economics 7th

ed. p54). Also, studies of 177 firms between 1985 and 1990 by Conyon

and Gregg (1994) found that the pay of top executive of large firms in

UK was mostly related to sales growth.

Other studies have found that profit was the most important

determinant of executive income. For example “A survey by Management

Today in 1990 asse...

... middle of paper ...

..., argued that regardless of how actual firms may behave

and constraints on rationality they may be subject to, the surviving

firms are those who attained high profits. Due to the strength of

these arguments, we tend to accept profits maximization theories are

justifiable.

Bibliography

Alchian, A (1950), “Uncertaintity. Evolution, and Economic Theory”,

Journal Of Political Economy. 58(3), 211-221.

Buzzel, R, & Gale, B. (1987). The PIMPS Priciples, Strategic Planning

Insitute.

Conyon, M & Gregg, P. (1994). Pay at the top: a study of the

sensitivity of top director remuneration to company specific shocks,

National Institute Economic Review, August.

Friedman, Milton (1953), Essay in Positive Economics, Chicago: Chicago

University Press.

Griffith, Alan & Wall, Stuart (1997). Applied Economics: An

Introductory Course. 7th Ed.

Lipsey & Chrystal (1999). Priciples of Economics. 9th Ed.

Marris, R. (1964) The Economic Theory of Managerial Italism,

Macmillan.

Sloman, J (2003).”Economics”. Prentice Hall. 5th ed

William, K. “Objectives”. Can be found on:

http://william-king.www.drexel.edu/top/prin/txt/MPch/firm2.html.

Accessed 4th of February 2005.

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