Generally, profits are the primary measure of the success of any business. It is the acid test of the economic strength of the firm. Economic theory makes fundamental assumption that maximizing profit is the basic objective of every firm. This assumption does not always hold true, as in practice, the firms may not always try to maximize profits. This may be due to a number of reasons:
(1) Achieving leadership: Firms often like to become leaders in the respective line of business. They would rather try to attain industrial leadership at the cost of profits. In those cases, the objective of profit – maximization is subordinated to the leadership – goal in the field. Leadership may connote either maximum sales or manufacture of maximum product lines.
(2) For avoiding potential competition: Firms may restrict the profit in order to discourage other firms from entering the field and competing with them. If the firm is maximizing profit, it will be an alluring proposition for the new firms to enter the field of production. The new entrants may snatch away the market, make infringement on patent rights on the existing firm and may also encroach on the firm’s resources of raw materials. In order to avoid such potential competition, the firms may adopt a policy of profit restriction, instead of profit – maximization. This is more so in the case of firms enjoying weak or slender monopoly.
(3) For preventing Governments’ intervention: Higher profits in business is considered as an index of monopoly power. The government’s attitude towards profit and the firm’s attitude towards profit will be different. Maximum profit may create an impression that the firm is exploiting the consumers and this may result in the public in the public demand for nationalizing the firm or firms. The government may also probe into the financial structure of the firm, make regulation of prices, profits and dividends. Just to woo the public and to restrain the zeal of nationalization, the firms may adopt a policy of restricted profit.
(4) For maintaining customers goodwill: In modern business, customers goodwill is valued more than anything else. In order to maintain that, the firms may adopt the policy of restricted profit and low price for the commodity. Even in times of increased taxes and excise duties, these firms may not increase the price, but reduce the profit margin and thereby win the approbation of the customers.
(5) For restraining wage demands: Higher profit is an indication of ability to pay higher wages by the firms. Organized Trade Unions advance their arguments on the basis of higher profits earned by the firm for increasing the wages of laborers, bonus benefit, etc. But in India this point has no validity as wages of laborers are fixed by wage Boards and payment of minimum bonus is a statutory obligation. Hence, the firms may have no elbow – room for making decisions in this matter.
(6) For achieving financial soundness and liquidity: Some firms may give greater importance to financial soundness and liquidity, rather than profit – maximization. Considerations of maximum profit may result in huge investment in fixed assets and consequently the liquidity of the firm will be reduced.
(7) For avoiding risks: Decisions regarding profit maximization may involve risks. Many new projects have to be worked through uncertainties. Generally, Business Managers will avoid taking those risks which may result even in losing their jobs or losing the image of the firm. Further, the rewards for Business Managers may not be directly proportional to the profits earned
From the foregoing analysis, we can see that all the factors enumerated, attempt to ensure profit – maximization in the long – run. But we cannot decisively say that the behavior of firms is always aimed at maximizing profit in the long – run.
The first duty of the business is to survive by avoiding losses. The guiding principle of business economics is not profit – maximization, but avoiding loss.
Business firms aiming at maximizing profits try to determine its output in such a manner as to obtain maximum net revenue. This is calculated either as a difference between total revenue and Total Cost or the difference between the Marginal Revenue and Marginal Cost.
We can find out the Total Revenue and total Cost of the firm for different levels of output. Where the difference between TR and TC is maximum, that level of output gives the maximum profit as shown in fig.
In the Fig. TR is Total Revenue and TC is Total Cost. AB is the maximum vertical distance between TR and TC and it shows maximum profit. CM is the Output which makes maximum profit.