Alternatives to Profit Maximisation Explained
- A-Level, IB
- AQA, Edexcel, OCR, IB, Eduqas, WJEC
Last updated 18 Mar 2023
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.
While profit maximization is a common objective for businesses, there are many other objectives that a business may adopt. Here are three reasons why a business may adopt objectives other than profit maximization:
- Social responsibility: A business may adopt objectives that are focused on social responsibility and sustainability, rather than solely on profit maximization. This can involve setting objectives related to reducing carbon emissions, improving working conditions for employees, or supporting local communities. By adopting these objectives, a business can build a positive reputation and enhance its brand, which can help to attract customers and employees who share similar values. For example, Patagonia is a clothing company that has adopted environmental sustainability as a key objective, and has built a loyal customer base as a result.
- Employee satisfaction: A business may adopt objectives that are focused on improving employee satisfaction and engagement, which can lead to higher productivity and better customer service. This can involve setting objectives related to employee training and development, work-life balance, or workplace culture. By prioritizing employee satisfaction, a business can create a more motivated and committed workforce, which can help to drive business success over the long-term. For example, Google is a company that is known for its focus on employee satisfaction and engagement, and has consistently ranked highly as a top employer.
- Long-term growth: A business may adopt objectives that are focused on long-term growth and sustainability, rather than short-term profit maximization. This can involve setting objectives related to investing in research and development, expanding into new markets, or developing new products or services. By prioritizing long-term growth, a business can position itself for sustained success over time, even if it requires forgoing short-term profits. For example, Amazon is a company that has prioritized long-term growth over short-term profits, and has invested heavily in new technologies and business models that have helped to fuel its success over the long-term.
These are just a few examples of why a business may adopt objectives other than profit maximization. By focusing on social responsibility, employee satisfaction, and long-term growth, businesses can create value in a variety of ways that go beyond simply maximizing profits.