Objectives of a Firm

Business is a human activity which runs with the basic objectives. In modern days,
a firm may have multiple objectives. The objectives may be growth of the business,
its survival, earning profits, or/and social welfare. To achieve these objectives, the
step is to identify and recognize the interest of the concerned parties involved in
the business. There are usually three parties involved in the business.

A. Investors/Shareholders
Their interest is to maximize the value of their investment.

B. The Firm
Managers' and employee's interest is long run survival growth and
maximizing benefit.

C. Consumers
They always look for maximum utility in the form of satisfaction from product
for the price they pay.

The objectives of the firm must be consistent with the interest of investors,
consumers and government as well.

Conventional Theory of firm assumes profit maximization, as the sole objective of

business firm. Recent researches on this issue reveal that the objectives which
business firms pursue are more than one.
- Profit maximization
- Sales revenue maximization
- Value maximization
- Maximization of manager's utility function
- Satisficing behavior theory
- Cyert and March behavior theory

Profit maximizing model

Profit maximizing is a business objective developed in 19th century. Profit

Maximization means maximizing the income of the firm. Traditionally business
environment was characterized by unlimited liability and single entrepreneurship.
Therefore, the only aim of the single owner was to maximize the profits.

At that time business runs with the following assumptions:

i) Profit maximization is one of the important assumptions of economic

theory.
ii) The entrepreneur acts rationally.
iii) Each firm produces only one commodity.
iv) The price of each factor of production is given and constant.
Firm which aims at maximizing profits tries to determine its output in such a
manner as to obtain maximum possible net revenue. The net revenue of the firm is
calculated as:
i) Total Revenue (TR) & Total Cost (TC) approach; and
ii) Marginal Revenue (MR) = Marginal Cost (MC) approach

i) Total Revenue (TR) & Total Cost (TC) approach

Profit (π) is the difference between Total Revenue (TR) and Total Cost (TC).
Hence, greater the difference between the total revenue and total cost higher is
the amount of profit.
π = TR - TC
Where, TR = f (Q)
TC = f (Q)

Profit maximization could be explained under different market situations.

Profit maximization under Perfect Competition

Under perfect competitive market a firm is only price taker. Price is fixed by the
industry. Individual firm will not be in position to affect price. That is why total
revenue (TR) curve of the firm is upward sloping.

- TR of the firm is increasing with the increase in production at the same ratio.
- Total cost of the firm falls at the initial stage and then starts rising.
- TR starts from the origin which means that when no output is produced,
revenue is zero.
- Total cost (TC) curve starts from a point R which lies above the origin.
- OF is the fixed cost which the firm has to incur even if it stops production for
a short time.

The figure below illustrates the workings of TR and TC in a firm:

 In the figure:

B = zero profit where TR and TC are intersecting each other.

OM = profit maximizing output.

The vertical distance PN is the maximum between TR & TC curves. At output M,

the total profit curve is having a maximum at point S.

Profit maximization under Imperfect Competition

Under imperfect competition a firm is a price maker. Under Imperfect

competition a firm can sell larger output only at falling price. Therefore, TR
curve continues to rise from left upwards to the right but the rate of rise
continues to fall as output sold increases.

Profit is vertical distance between the TR & TC. The firm chooses that level of
output where the vertical distance between TR & TC is the maximum.

Defects of TR & TC Approach

a) It is very difficult to find the maximum vertical distance between TR & TC
curves.
b) It ignores per unit cost of an output.
c) It becomes difficult to find out the equilibrium of an industry with the help
of this approach.
ii) Marginal Revenue (MR) = Marginal Cost (MC) approach

According to this principle, a firm earns maximum profits when its marginal cost
is equal to its marginal revenue (MC = MR). The marginal cost is the net
addition made to the total cost by producing an extra unit of the product and the
marginal revenue is the net addition made to the total revenue by selling that
extra unit of the output.

A rational producer determines output so as to equalize marginal revenue and

marginal cost. Following two conditions are necessary for a firm to be in
equilibrium.

a) MR and MC should be equal

b) MC curve must cut MR curve from below

Profit maximization through could be explained MR and MC approach under

different market situations.

Profit maximization under Perfect Competition

Profit maximization Under Perfect Competitive market could be explained with

the help of figure below:

The first condition is fulfilled at OM1 level of output. The second condition for
equilibrium is that MC curve should cut MR curve from below. Hence, both
conditions have been fulfilled only at point E. In figure, OM is the profit
maximizing output where MR & MC are equal. The firm earns PETR profits.
 Profit maximization under Imperfect Competition

Profit maximization under imperfect Competitive market could be explained with

the help of figure below:

At point E marginal revenue and marginal cost are equal and MC curve cuts MR
from below. Hence, the firm gets profit equal to area PRTC and selling OM
quantity at OP price.

Defects of MR and MC approach on profit maximization

The marginal principle of equalizing MC & MR has not been found to the decision
making process to the firm.

The firms aim at limited instead of maximum profits on account of a number of

reasons. Professor Joel Dean has classified the reasons for limiting profits in the
following manner.

1. To discourage potential competitors

2. To maintain public relations and to avoid bad political impact.
3. To restrain wage demands of organized labour and maintain good labour
relationship.
4. To maintain customer good well.
5. To maintain pleasant working conditions.

Hall and Hitch conducted an empirical study on profit maximization. They

interviewed about 39 entrepreneurs on price policy. The study revealed that
business did not try to maximize profits by equating MC & MR. The businessmen
charged prices according to full cost principle.