Profit Maximisation (PM)

The point at which a firm achieves the greatest possible difference between Total Revenue (TR) and Total Cost (TC).

Formulaic Condition: Marginal Cost (MC) = Marginal Revenue (MR).

• If MR>MC, producing one more unit adds more to revenue than cost, increasing profit.

• If MR<MC, producing one more unit adds more to cost than revenue, reducing profit.

• Reasons for Pursuing PM:

  • Shareholder Returns: It maximizes dividends and increases the underlying share price, maximizing the wealth of the owners/shareholders.

  • Source of Finance: Retained profits are the cheapest and most reliable source of finance for future investment, expansion, and research and development (R&D).

  • Security: Higher profits provide a buffer against economic downturns and reduce the risk of hostile takeovers.

  • Neoclassical Assumption: Traditional economic theory assumes PM is the rational, short-run objective for all firms.

Revenue Maximisation (RM)

The point at which a firm achieves the highest possible Total Revenue (TR) from its sales.

• Formulaic Condition: Marginal Revenue (MR) = 0.

• Reasons for Pursuing RM:

  • Managerial Utility (Baumol's Theory): Managers' salaries, bonuses, and prestige are often linked more closely to the size and growth of the firm's revenue/sales than to its profit.

  • Market Power: Aiming for higher revenue often requires lower prices (compared to PM), which can deter new entrants and drive smaller competitors out of the market.

  • Cash Flow: Maximizing revenue helps to improve cash flow, which is crucial for internal operations and short-term liquidity.

  • Valuation: Firms (especially tech start-ups) often prioritize revenue growth to secure a higher market valuation or attract investors, even if profits are low.

Sales Maximisation (Volume)

The objective of selling the largest possible volume of output without making an economic loss.

• Formulaic Condition: Average Revenue (AR) = Average Cost (AC) (i.e., the firm earns normal profit or breaks even).

• Reasons for Pursuing Sales Maximisation:

  • Market Share: It is an aggressive short-term strategy to gain the largest possible market share, which can lead to higher long-run profits and market dominance.

  • Limit Pricing: The lower price associated with sales maximisation can be used as a form of limit pricing to keep out potential competitors.

  • Economies of Scale (EoS): Achieving maximum sales volume allows the firm to reach the minimum efficient scale and exploit all available EoS, leading to lower costs in the long run.

  • Clearing Stock: Used as a short-term goal to quickly clear excess inventory or stock.

Satisficing

A behavioral objective where firms aim to achieve a satisfactory or acceptable level of profit to keep shareholders content, while simultaneously pursuing other, non-profit goals.

• Reasons for Pursuing Satisficing:

  • Divorce of Ownership from Control (Principal-Agent Problem): Owners (principals) want PM, but hired managers (agents) want utility (high salary, security, perks). Managers pursue just enough profit to keep shareholders quiet and prevent a takeover, then focus on their own objectives (e.g., job satisfaction, CSR, ethical goals).

  • Information Constraints: In the real world, firms rarely have the perfect information needed to calculate the exact MC and MR curves, making PM impractical. Satisficing is a more realistic and pragmatic goal.

  • Conflict Resolution: It allows the firm to balance the demands of multiple stakeholders (shareholders, workers, customers, the community) who may conflict with strict profit maximisation.