profit and sales revenue maximisation using total cost and total revenue curves
One way of showing the differences in output that can come from different business objectives is to use total revenue and total cost curves. If we assume that a business faces a downward sloping demand curve, the total revenue curve will rise at a decreasing rate until marginal revenue = zero. The shape of the total cost curve depends on what happens to marginal cost, if we assume that diminishing returns occurs in the short run, then the total cost will eventually start to rise at an increasing rate. The profit maximising output occurs at the greatest vertical distance between the TR and TC curves. However, revenue maximization occurs at a higher output level.
Shareholders might decide that a minimum level of profitability is required – so we might include in our analysis the effect of such a constraint on the output choice. This is shown in the diagram below
An alternative way of showing the differences in price and output that come from varying the objectives of the firm is by using average and marginal revenue curves together with average and marginal cost curves. These are shown in the diagram below. The profit maximising output (where MC=MR) is Q1 which can be sold at a price P1, whereas a firm seeking to maximise revenue will produce at output Q2 (where MR = zero) which requires a lower market price. You can then work with the average total cost curve to show the different levels of profit that will exist at each price and output combination.
The Divorce between Ownership and Control
Any corporation is an organization with various groups
The dominant group at any moment in time can give greater emphasis to their own objectives. In corporations where there is a clear divorce between ownership and control, the managers within a business may use their discretionary powers in deciding on price and output in different segments of markets over which they have some control to meet their own objectives.
Maximising behaviour may be replaced by satisficing – a process which involves setting minimum acceptable levels of achievement (such as a minimum acceptable rate of return on capital). The Equity and Bond markets may play an important role in monitoring the performance of managers in a company. Companies that under perform in the longer term will find their share price coming under selling pressure and as the market value of a quoted company declines, so the business becomes ripe for a hostile takeover. The stock market is not a perfectly efficient judge of company performance relative to others in specific industries, but overall, the market for “corporate control” does exercise some constraint on the management decisions of listed companies
Profit Maximisation in the Long Run
Plenty of businesses depart from pure profit maximisation in the short run in order to achieve alternative objectives. Indeed the highly cyclical nature of many industries and the lack of full and accurate information on costs and demand make this virtually inevitable. There are plenty of good reasons for believing that revenue maximisation is a legitimate and realistic objective for businesses in the short to medium term, perhaps with the constraint of a satisfactory rate of profit at the same time. In the long run though, the desire to reach a high commercial rate of return becomes more important. Companies may choose to depart from the textbook assumption of profit max for particular periods, but return to it over a longer time horizon.
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