Alternatives to Profit Maximisation Explained
- A-Level, IB
- AQA, Edexcel, OCR, IB, Eduqas, WJEC
Last updated 23 Dec 2021
Do all firms necessarily aim to maximise profits? The answer is probably no at least in the short term.
Many businesses are profit seeking but that is not the same as profit maximisation.
In this revision video we explore some of the reasons why many businesses are not profit maximisers when they make key decisions on price, output, investment and so on.
Many exam questions invite you to challenge the assumption that firms are profit-maximising businesses. When a firm chooses a different objective, then this has consequences for their pricing and also for consumer welfare.
What is profit maximisation?
Profit is the difference between revenue and cost and profits are maximised at an output when marginal revenue = marginal cost. This is also where marginal profit is zero.
Why is profit important for businesses and the wider economy?
- Profit provides an incentive to take risks by starting & operating a business in a market economy – it is a reward to entrepreneurship
- Provides funds for investment in new technologies and innovation
- Profit provides a source of income, such as dividends for pensioners
- Profit is a signalling device for high growth industries, to promote the efficient allocation & reallocation of resources within an economy
- Profit is a key source of tax revenue for the government for example through corporation tax which brought in £63 billion in 2019-20
Identify reasons why many firms are not profit maximisers
- Ownership of the firm affects behaviour and performance - for example, the divorce of ownership from control and the principal-agent problem often leads to profit satisficing
- Limitations to feasibility of pursuing profit maximisation, for example the difficulty firms face in accurately calculating marginal revenue and marginal cost across many different products and markets
- Increasing emphasis on non-financial objectives such as environmental goals and corporate social responsibility (CSR) although these are often good for corporate brands and long-term profits
- Profits often constrained by government intervention and by regulatory policies such as price caps
- Market structure matters - for example in an oligopoly, building and protecting market share might have a greater emphasis for firms
- Macroeconomic conditions fluctuate - businesses may switch towards revenue maximisation during a recession
- Public sector firms such as Network Rail have different objectives to privately owned, stock market listed businesses
I’ve heard about profit “satisficing” but what does it mean?
Satisficing means that a business is making enough profit to keep shareholders happy, or it is sufficient for investors to maintain confidence in the management they appoint.