What are the main objectives of businesses? Why might businesses depart from the standard textbook aim of profit maximisation? This study note helps you to answer these questions.
The UK is a mixed economy with private and public sector businesses operating in markets:
Some businesses have recently been part privatised – Royal Mail in 2013, for example. Watch a revision presentation on the privatisation of Royal Mail
Conventional theory of the firm makes an assumption that businesses have enough information, market power and motivation to set prices for their products that maximise their total profits
This assumption is criticised by economists who have studied the organisation and objectives of modern-day corporations both large and small. Most businesses have a wide range of objectives.
Not only do businesses often move away from pure profit-seeking behaviour, many are deliberately organised and operate in a way where profit is not the only objective.
An increasing number of companies are moving away from profit maximisation and are refocusing their priorities towards the welfare of their suppliers, employees and the planet:
It's hard for a business to pinpoint their precise profit maximising output, as they cannot accurately calculate marginal revenue and marginal cost
Day-to-day pricing decisions are taken on the basis of “estimated demand" or “rules of thumb". Businesses can also take advantage of their market experience when setting prices
A business might look to add a profit margin on top of average cost – this is known as “cost-plus pricing." When demand is price inelastic, the profit margin can be higher.
Most businesses are multi-product firms operating in a range of markets across countries and continents – the sheer volume of information that they have to handle is vast. And they must keep track of the ever-changing preferences of consumers.
The idea that there is a neat, single profit maximising price is now largely redundant
Here are some behavioural theories of the firm that explain why companies depart from profit maximisation.
Profits are maximised at an output where marginal cost = marginal revenue
Revenues are maximised at an output where marginal revenue = zero
Producing the largest amount possible consistent with earning normal profits
Satisficing involves the owners of a business (shareholders)setting minimum acceptable levels of achievement in terms of revenue and profit.
Businesses with profits reinvested for social aims – profit, people and planet