Profit Maximization
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.
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