Objectives

of Firm
Profit Maximization
profit maximization is the short run or long run process by which a
firm may determine the price, input and output levels that will lead to
the highest possible total profit (or just profit in short).
Profit maximization refers to a tendency of business firms to maximize
profits in the short or long run by using the most efficient methods and
equalizing the marginal cost and revenues. Its main purpose is to
increase the level of production of a firm or business that will grant it
the maximum profit on selling goods and services.
Optimal Output Decision Model

A systematic approach used to make the best decision

based on achieving desired results or outputs,
considering specific objectives, inputs, controllable
factors, constraints, and utilizing optimization
techniques to evaluate and refine subsequent decisions.
Economist Theory of the Firm

The theory of the firm encompasses various economic principles that

describe and anticipate the characteristics, behavior, and purpose of
firms, corporations, or companies. These entities play a vital role in
the economy by supplying goods and services in exchange for
financial compensation. Factors like organizational hierarchy,
motivation, worker efficiency, and data flow critically impact a firm's
effective functioning both within its boundaries and in the broader
economy. Hence, prominent economic models like Transaction cost
theory, Managerial economics, and Behavioural theory offer detailed
insights into different organizational and managerial styles.
Cyert and March’s Behavior Theory

According to Cyert and March, these groups participate in setting goals

and making decisions. Priorities and information may vary by group,
potentially creating conflicts. Cyert and March mentioned five goals
which real world firms generally possess: production; inventory;
market share; sales and profits. According to the behavioral theory, all
the goals must be satisfied, following an implicit order of priority
among them.
Cyert and March's behavioral theory of the firm suggests:

Satisficing behaviour The process of decision making

Top management decides the organization's
Cyert and March suggest that companies
main objectives. These goals are then
often aim for outcomes that are "good
pursued at both top and lower management
enough" rather than trying to achieve the
levels. When departments present their plans,
absolute best results. This idea, called
they're typically judged on two main factors:
"satisficing", comes from the concept of
whether there's enough money for the plan
"bounded rationality" by Herbert Simon.
and whether it benefits the organization.
"Bounded rationality" means making
Cyert and March note that making good
reasonable decisions within certain limits
decisions needs information, but collecting
or constraints.
that information also uses resources.
Cyert and March's behavioral theory of the firm suggests:

Organizational slack
Companies often pay more than the bare minimum to keep different groups within
the organization content. This extra amount is termed "organizational slack."
Traditional economic views believe this slack should be non-existent in a balanced
system. However, Cyert and March argue that this slack helps the company adjust
and remain stable. Examples of such slack include paying higher dividends, setting
prices lower than possible, or paying wages above the minimum needed.
Marris’ Growth Maximisation Model

Marris' Growth Maximisation Model suggests that firms aim for

balanced growth, considering both demand for their products and
capital supply. Robin Marris argued that while managers desire
growth for job security and prestige, shareholders want it for
increasing share value. However, growth must be balanced to
ensure sustainability and to meet shareholders' expectations. The
model accounts for both internal and external constraints on
growth, offering a comprehensive view of firm behavior beyond
just profit maximization.
Policy variables in Marris’s balanced growth model are as follows:

1. Financial Policy Choices 2. Diversification Rate

The firm has the autonomy to determine its
financial strategies. This is evident in how it
sets three financial ratios based on subjective
assessments:
• Liquidity Ratio: Reflects the firm's ability
to meet short-term obligations.
• Leverage/Debt Ratio: Indicates the extent
to which the firm is financed by debt
compared to equity.
• Retention Ratio: Represents the proportion
of net earnings retained in the business
rather than being paid out as dividends.
The firm can make strategic decisions about
diversifying its product range. This can be
achieved in two primary ways:
• By broadening the variety of its
products.
• By making stylistic changes to its
current product lineup. Moreover, a firm
can choose to implement both
diversification strategies simultaneously.
Policy variables in Marris’s balanced growth model are as follows:
3. Price as a Parameter, Not a Policy
Unlike other variables, the firm
doesn't decide on the price. Instead,
the price is a given, influenced by the
oligopolistic nature of the market.
Similarly, production costs are not
variables the firm can easily change;
they are taken as predetermined.
4. Advertising and R&D Decisions
Firms have discretion over their levels of
advertising and research & development
(R&D). With prices and production costs
already set, any increase in advertising and
R&D expenditures will likely lead to a
decrease in profit margins, and conversely,
reducing these expenses might increase
profit margins.
Baumol’s Static and Dynamic Models

William Baumol proposed an alternative to profit-

maximization theory, suggesting that managers are more
likely to maximize sales revenue rather than profits. This is
because sales revenue is often associated with personal
rewards like bonuses, promotions, and status. Further,
greater sales often mean a larger market share, which can
improve a firm's market power and stability.
William Baumol presented the idea that some firms prioritize maximizing sales revenue over profits. His
models are of two types:

Static Model Dynamic Model Reasons for these models: ‌

Firms aim to boost sales but Firms focus on increasing • They explain why
maintain a minimum profit their sales growth rate over companies spend on
level to please shareholders. time. advertising. ‌
• They shed light on why
firms have sales at
reduced prices to boost
revenue.
Baumol's sales revenue maximization theory suggests that firms prioritize sales growth
over profit. This can:

• Explain heavy advertising spends. ‌

• Justify pricing strategies, like sales or discounts.
• ‌Shed light on merger decisions. ‌
• Highlight potential overproduction.
• ‌Influence firms' financing choices. ‌
• Impact job creation and investment. ‌
• Inform economic policies. It provides a different lens to understand
firm behavior beyond just profit-maximization.
Williamson’s Managerial Discretionary Theory
Williamson's Managerial Discretionary Theory addresses the
potential conflict in large corporations due to the split
between shareholders, who seek profit, and managers, who
might have personal objectives. While managers aim to
maximize their own benefits, they must still ensure a
minimum profit to avoid external interventions or takeovers.
This highlights the tension between management's personal
interests and the profit goals of shareholders.
Thank you
for listening