- Profit Maximization
In the conventional theory of the firm, the principal objective of a business firm is profit maximization. Under the assumptions of given tastes and technology, price and output of a given product under perfect competition are determined with the sole objective of maximizing profits. The firm is supposed to act as one of a large number of producers which cannot influence the market price of the product.
It is the price-taker and quantity-adjuster. Thus the demand and cost conditions for the product of the firm are determined by factors external to the firm. In this theory, maximum profits refer to pure profits which are a surplus above the average cost of production. It is the amount left with the entrepreneur after he has made payments to all factors of production, including his wages of management.
- Marris Growth Maximization
Robin Marris in his book The Economic Theory of ‘Managerial’ Capitalism (1964) has developed a dynamic balanced growth maximizing theory of the firm. He concentrates on the proposition that modern big firms are managed by managers and the shareholders are the owners who decide about the management of the firms.
The managers aim at the maximization of the growth rate of the firm and the shareholders aim at the maximization of their dividends and share prices. To establish a link between such a growth rate and the share prices of the firm, Marris develops a balanced growth model in which the manager chooses a constant growth rate at which the firm’s sales, profits, assets, etc., grow.
If he chooses a higher growth rate, he will have to spend more on advertisement and on R & D in order to create more demand and new products.
He will, therefore, retain a higher proportion of total profits for the expansion of the firm. Consequently, profits to be distributed to shareholders in the form of dividends will be reduced and the share prices will fall. The threat of take-over of the firm will loom large among the managers.
As the managers are concerned more about their job security and growth of the firm, they will choose that growth rate which maximizes the market value of shares, give satisfactory dividends to shareholders, and avoid the take-over of the firm.
On the other hand, the owners (shareholders) also want balanced growth of the firm because it ensures fair return on their capital. Thus the goals of the managers may coincide with that of owners of the firm and both try to achieve balanced growth of the firm.
- Baumol’s Sales Maximization
Baumol’s findings of oligopoly firms in America reveal that they follow the sales maximization objective. According to Baumol, with the separation of ownership and control in modern corporations, managers seek prestige and higher salaries by trying to expand company sales even at the expense of profits.
Being a consultant to a number of firms, Baumol observes that when asked how their business went last year, the business managers often respond, “Our sales were up to three million dollars”. Thus, according to Baumol, revenue or sales maximization rather than profit maximization is consistent with the actual behaviour of firms.
Baumol cites evidence to suggest that short-run revenue maximization may be consistent with long-run profit maximization. But sales maximization is regarded as the short-run and long-run goal of the management. Sales maximization is not only a means but an end in itself. He gives a number of arguments is support of his theory. According to him, a firm attaches great importance to the magnitude of sales and is much concerned about declining sales.
If the sales of a firm are declining, banks, creditors and the capital market are not prepared to provide finance to it. Its own distributors and dealers might stop taking interest in it. Consumers might not buy its products because of its unpopularity. But if sales are large, the size of the firm expands which, in turn, means larger profits.
Output and TR/TC/Profit
Baumol’s model is illustrated in Figure 2 where TC is the total cost curve, TR the total revenue curve, TP the total profit curve and MP the minimum profit or profit constraint line. The firm maximizes its profits at OQ level of output corresponding to the highest point В on the TP curve. But the aim of the firm is to maximize its sales rather than profits.
Its sales maximization output is OK where the total revenue KL is the maximum at the highest point of TR. This sales maximization output OK is higher than the profit maximization output OQ. But sales maximization is subject to minimum profit constraint.
Suppose the minimum profit level of the firm is represented by the line MP. The output OK will not maximize sales as the minimum profits OM are not being covered by total profits KS.
For sales maximization, the firm should produce that level of output which not only covers the minimum profits but also gives the highest total revenue consistent with it. This level is represented by OD level of output where the minimum profits DC (=OM) are consistent with DE amount of total revenue at the price DE/OD, (i.e., total revenue/total output).
- Output Maximization
Milton Kafolgis suggests output maximization as the objective of a business firm. According to him, “The performance of firms frequently is measured directly in terms of physical output with revenue occupying a secondary position.” Thus Kafolgis prefers output maximization both to profit maximization and revenue maximization as the objective of a firm.
Given some minimum level of profits, a firm wants to maximize its output. It will spend its funds on increasing its production rather than on advertising. Thus the firm will produce a larger output and its revenue sales may be less than the sales-maximization firm.
- Security Profits
Rothschild has put forward the view that the firm is motivated not by profit maximization but by the desire for security profits. In his words, “There is another motive which is probably of a similar order of magnitude as the desire for maximum profits, the desire for security profits.”
Rothschild argues that so far as the objective of profit maximization is concerned, it is valid only under perfect competition or monopolistic competition in which the number of firms is very large, and the individual firm is not faced with the security problem, so is the case with the monopoly firm.
But under oligopoly, a firm is not motivated by profit maximization. It is engaged in a constant struggle to achieve and maintain a secure position in the market like a military strategist.
The desire to increase its security leads to the struggle for position and to the setting of a price which will not be so low that it provokes retaliation from rivals, nor so high that it encourages new entrants, and it must be within the range which will maintain a protection against the aggressive policies of the rivals and brine about a reasonable profit above its cost of production Rothschild’s security-profits motive is nothing else but profit maximization in a little different garb.
- Satisfaction Maximization
Scitovsky favours maximization of satisfaction in preference to the profit-maximization objective of the firm. He is concerned with managerial effort and the distaste that managers have for work. According to him an entrepreneur would maximize profits only if his choice between more income and more leisure is independent of his income. In other words, the supply of entrepreneurship should have zero income elasticity.