Explain the possible alternative aims of firms. [25]

According to economic theory, firms are supposed to be profit maximising entities, where MC = MR. However, in real life, this does not seem to be always the case. Explain the possible alternative aims of firms. [25]

According to economic theory, firms are supposed to be profit-maximising entities, producing output where their marginal cost of production equals to marginal revenue (MC = MR). However, in real life, this does not seem to be always the case. This paper explains some of the possible alternative aims of firms: profit satisficing, sales maximisation, and growth maximisation. This is due to the central idea that firms may want to maximise profits, but either they do not know how to due to imperfect information, or they do not want to due to alternative goals and aims. This paper does not discuss those areas of analysis but instead focuses on a few alternative possible aims.

Alternative Aims of Firms: Profit Satisficing

One alternative aim of firms is profit satisficing. In many firms, there is separation of ownership and control. Those who own the company (the shareholders) often do not get involved in the day-to-day running of the company. This is a problem because although the owners may want to maximise profits, the managers, who run the company, have much less incentive to maximise profits because they do not get the same rewards as the shareholders do. Therefore, managers may create a minimum level of profit to keep the shareholders happy, but then maximise other objectives relevant to them such as enjoying work, maximising prestige, and other private goals. This is the problem of separation between ownership and manager and can possibly be overcome, to some extent, by giving mangers share options and performance-related pay to align their incentives, although in some industries it is difficult to measure performance.

Alternative Aims of Firms: Sales Maximisation

Sales maximisation is another possible goal and occurs when the firm sells as much as possible without making a loss, rather than maximising profits. Firms often seek to increase their market share by increasing their sales even if it means less profit. This could occur for various reasons. First, increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run. Secondly, managers prefer to work for bigger companies as it leads to greater prestige and higher salaries. Thirdly, increasing market share may force rivals out of business; for example, supermarkets have lead to the demise of many local shops. Some firms may actually engage in “predatory pricing” which involves making a loss to force a rival out of business. As long as their costs are covered, firms may reduce their prices to drive their rivals out of the market.

Alternative Aims of Firms: Growth Maximisation

Another possible aim of a firm other than profit maximisation might be growth maximisation. This is the idea of expansion and growth, and is similar to sales maximisation and may involve mergers and takeovers. A merger is a union of two companies, and can be hostile or friendly. A takeover is an acquisition of another company by a firm. First, similar to sales maximisation, increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run. Secondly, managers prefer to work for bigger companies as it leads to greater prestige and higher salaries. Thirdly, increasing market share may force rivals out of business; for example, supermarkets have lead to the demise of many local shops. Some firms may actually engage in “predatory pricing” which involves making a loss to force a rival out of business. As long as their costs are covered, firms may reduce their prices to drive their rivals out of the market.

Conclusions

In conclusion, while firms are supposed to be profit-maximising entities according to theory, producing where their marginal cost of production equals to marginal revenue, in real life, this does not seem to be always the case. This paper explained profit satisficing, sales maximisation, and growth maximisation as possible alternative aims of firms in the real world. However, in the long run, profit maximisation of theory should be the long term aim of firms, because if they do not maximise profits in the long run, they will find themselves outcompeted by firms that have followed a more rational pattern of behaviour, and in the competitive marketplace, “only the fittest survive”.

JC Economics Essays – Tutor's Commentary: Right off the bat, there are a few things missing from this particular "alternative aims of the firm" essay, which you should know and write about: the diagram of the Baumol model could be included. Furthermore, the standard Economics perfect competition diagram could also be added too. Let’s do an intellectual exercise here: think about how your Economics tutors in school would judge this Economics essay. What were its strengths and weaknesses, and why do you think those parts of the essay were strengths or weaknesses? If you were this student’s Econs tutor, how would you suggest advice so that you could make the student improve on his or her writing skills, and answering techniques? Be sure to ask critical and thinking questions; and always draw an Economics diagram (or two diagrams or more, if the need arises)! Thanks for reading and cheers.