Maximizing Profits as the Main Goal Essay -- Economics Business Manage

Maximizing Profits as the Main Goal The traditional theory (neoclassical) assumes that firm’s primary objective is to maximize profits. That is if the firm is owner controlled. This assumption is based on that firms makes the output and price decisions. Also, that firm takes all necessary actions to earn the greatest profit possible. The managerial theory assumes firms do not necessarily act in order to maximize profits. The basic tenet behind this is the separation of ownership from management, complexity of the organisation and the firm’s manager maximizes his own utility and growth rather than profits. The reason for this is that managers may be judged by the level of sales revenue. I will be providing supporting arguments for and against this assumption â€Å"that the firm’s main motivation is to maximise profits† and draw a conclusion by analysing the firms behaviour as well as further discussing the theories of firms. Profit maximising assumption is based on two premises, firstly that owner is in control of day-to-day management of the firm and secondly that the main desire of owners is to make a higher profit then the amount they invested in the firm. Since this assumption is based on two assumptions, therefore if these two premises don’t hold is it understandable to believe that firms goals is not to maximize profits. Well, this will depend on the motivation of individual firms. If a firm’s ownership and control are in the hands of a single person or small groups of people, then it’s reasonable to assume that the firm’s owners’ goal is to maximize profits. But most of today’s firms are owned by shareholders and other large cooperation, but day-to-day control of the firm is under management. Therefore, the objectives of managements may differ from the shareholders and conflicts may arise. â€Å"For example Baumal (1959) suggest that the manager-controlled firm is likely to have sales revenue maximization, as its main goal than profit maximization favoured by shareholders† (Applied Economics 7th ed. p54). Also, studies of 177 firms between 1985 and 1990 by Conyon and Gregg (1994) found that the pay of top executive of large firms in UK was mostly related to sales growth. Other studies have found that profit was the most important determinant of executive income. For example â€Å"A survey by Management Today in 1990 asse... ..., argued that regardless of how actual firms may behave and constraints on rationality they may be subject to, the surviving firms are those who attained high profits. Due to the strength of these arguments, we tend to accept profits maximization theories are justifiable. Bibliography Alchian, A (1950), â€Å"Uncertaintity. Evolution, and Economic Theory†, Journal Of Political Economy. 58(3), 211-221. Buzzel, R, & Gale, B. (1987). The PIMPS Priciples, Strategic Planning Insitute. Conyon, M & Gregg, P. (1994). Pay at the top: a study of the sensitivity of top director remuneration to company specific shocks, National Institute Economic Review, August. Friedman, Milton (1953), Essay in Positive Economics, Chicago: Chicago University Press. Griffith, Alan & Wall, Stuart (1997). Applied Economics: An Introductory Course. 7th Ed. Lipsey & Chrystal (1999). Priciples of Economics. 9th Ed. Marris, R. (1964) The Economic Theory of Managerial Italism, Macmillan. Sloman, J (2003).†Economics†. Prentice Hall. 5th ed William, K. â€Å"Objectives†. Can be found on: http://william-king.www.drexel.edu/top/prin/txt/MPch/firm2.html. Accessed 4th of February 2005.