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Study notes

Behavioural Theories of the Firm

  • Levels: A Level, IB
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

Behavioural theories of the firm consider alternatives to profit maximisation as a business objective. This study note explains.

Business objectives

Behavioural economists believe that large businesses are complex organisations made up of many different stakeholders.

Stakeholders are groups made up of people who each have a vested interest in the activity of a business. Examples include:

  • Managers employed by a business and other employees
  • Shareholders are people who have a stake in a business
  • Customers
  • The government and its agencies

Each group of stakeholders will have different objectives or goals.

The dominant group at any moment can focus on their own objectives. For example price and output decisions may be taken at a local level by managers, with shareholders taking only a distant view of the company's performance and strategy.

Examples of alternatives to profit maximisation

Satisficing behaviour

This happens when businesses aim for minimum acceptable levels of achievement in terms of revenue and profit.

Read more on satisficing behaviour

Sales (output) maximisation

Selling as much as you can without making a loss. At sales maximisation there are normal profits or no supernormal profits.

Sales (revenue) maximisation

The objective of maximising sales revenue rather than profits was developed by economist William Baumol whose work focused on the behaviour of manager-controlled businesses.

  • Annual salaries and perks are linked to sales revenue rather than profits
  • Companies geared towards maximising revenue are likely to make frequent use of price discrimination to extract extra revenue and marginal profit from consumers
  • A business might also aim to maximise sales revenue rather than profits because it wishes to deter the entry of new firms
  • If a firm decides to aim to maximise sales revenue rather than profits, one of the consequences might be a reduction in the price of the firm's shares since the rate of profit is likely to be lower

Read more about sales maximisation as a business objective

Managerial Satisfaction Model

If a firm's managers are looking to maximise revenue rather than profit, this will lead to a different price and output combination.

Assuming that the firm's costs remain the same, a firm will choose a lower price and supply a higher output when sales revenue maximisation is the main objective.

Consumer surplus is higher with sales revenue maximisation because output is higher and price is lower. Producer surplus is greater when profits are maximised.

3 reasons why a business may adopt objectives other than profit maximisation

  1. Desire the gain and protect market share
  2. Social / ethical / environmental objectives
  3. Need to generate cash-flow during economic recession

2 consequences of this for different stakeholders

  1. Possible fall in the share price and lower dividends in the short term for shareholders
  2. Consumers may pay lower prices if a firm moves away from profit maximisation

1 example of a business adopting such objectives

  1. Pubs having to focus on growing revenue and maintaining cash-flow when adopting to changing consumer spending patterns and preferences (e.g. competing with low-priced alcohol available from the supermarkets

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