Outline briefly the managerial criticisms of the profit maximising firm - Compare and contrast the Neo-classical profit maximising model with the management model of Baumol.
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Since the 12th century and the escalation of separate owner / managed business organizations, the assumption that firms maximises profits has been at the forefront of economic theory. Cyert and Hedrick (1972) stated:"The unmodified neoclassical approach is characterised by an ideal market with firms for which profit maximisation is the single determinant of behaviour. Thus predictions can readily be made by combining the description of the market with the results of maximisation of the relevant Lagrangian."In recent years their has been extensive literature by economists questioning the theory of profit maximisation, given that the standard "theory of the firm" is based upon rigid assumptions which can only exist in a perfect market.…show more content… However profit maximising models rely on short term modelling, which in itself implies that profits for one period depend upon profits for another, which may create conflict between the two objectives.
Finally neo-classical economics rely heavily on complex mathematical models, in an attempt to model the modern economy. Realistically the nature of today 's evolving economy means it 's completely unfeasible to use outdated calculations to try to evaluate and predict firm 's objectives in an evolving market, whether profit maximising or not.
In order to investigate the relevance of profit maximisation in today 's society it is necessary to compare and contrast the Neo-classical profit maximising model with more recent managerial models in particular Baumol.
Figure 1. Diagram to illustrate the Neo-Classical model. (Source: Author)Figure 1 illustrates the standard Neo-Classical approach. Profit maximisation occurs when the marginal cost [MC] of producing an additional unit equals the marginal revenue [MR] from the sale of an additional unit.
In the Neo-classical model, the goal of the firm is to maximise profits, assuming that sales volume and output are always equal. In imperfect competition the firms market power enables it to face a downward sloping demand curve allowing it to set a price of Pm at a quantity of qm, regarded as profit maximising (MC=MR) [X1].