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Discuss whether profit maximisation is the beststrategy in the long run for firms in different market structures. [13]

A level Cambridge november 2019 paper 4

Quick Answer:

Economic theory of firm assumes that in all differ ent market structures a firm’s behaviour is guided by the goal to maximise profit in the long run.

This assumption is particularly consistent with perfect competition and monopolistic competition for in both these markets the relative size of individual firms and absence of entry exit barriers leave little choice for the firms.

In a perfectly competitive market each individual firm faces a perfectly elastic demand curve for all the firm produce an identical product with none dominating the market.

As a result all the firms can sell their output at the market price and no individual firm has the power to distort market forces to its own advantage.

Hence survival of each individual firm depends on maximizing profit because the industry offers only normal profit in the long run.

Likewise perfect competition, a firm in a monopolistically competitive market can only earn normal profit in the long run and hence it cannot survive perusing any other objective but profit maximization.

However, in other market conditions such as monopoly and oligopoly there is room in the theory for different objectives in the long run.

Protected by entry barriers firms in both markets can earn supernormal profit in the long run.

Also, their relative large size allows them to influence the market conditions by adopting different strategies.

So, if firms are likely to move away from pure profit maximising behaviour, then there are numerous different strategies that can be employed.

Behavioural economists believe that modern cor porations made up of various groups or stakehold ers who have a vested interest in the activity of a business.

Examples of relevant stakeholders might include: Employees and managers employed by the firm, shareholders, customers, local community and the government.

Each of these groups is likely to have different objectives or goals at different points in time.

The dominant group at any moment in time can give greater emphasis to their own objectives, for example price and output decisions may be taken at local level by managers - with shareholders taking only a distant and imperfectly informed view of the company's performance and strategy.

In one such theory, it is argued that profit maximisation may be the dominant motive of the traditional owner-managed firm.

However, in large firms where managers are hired by the owners to perform management tasks may be more interested in increasing sales and maximising the revenues that arise from larger quantities sold.

This is particularly true for firms where the rewards for managers and employees are linked to increased sales rather than increased profits.

In other approaches it is assumed that firms may be interested in maximising their growth rather than their profits.

Growth is attractive for the following reasons.

Firstly, a growing firm can achieve econo mies of scale and lower its average costs.

Seondly, as a firm grows it can diversify into production of different products and markets and reduce its dependence on a single product or market.

Lastly, a larger firm has greater market power and increased ability to influence prices.

Some economists argue that the large modem enterprise cannot be looked upon as a single entity - 9 • with a single maximising objective; instead it is composed of many separate groups within the firm, each with its own objectives which may overlap or may conflict.

This multiplicity of objectives does not allow the firm to pursue any kind of profit maximizing behavior in the long run.

Firms there fore try to establish processes through which they can make compromises and reconcile conflicts to arrive at agreements, the result of which is the pursuit of many objectives that are placed in a hierarchy.

This behaviour was termed satisficing, referring to the idea that firms try to achieve satisfactory rather than optimal or 'best’ results.

Also, many firms are increasingly recognizing that the pursuit of self-interest need not necessarily conflict with ethical and environmentally respon sible behaviour.

A negative image of the firm held by workers and customers can cut deeply into lhe firm’s revenues and profits by lowering worker productivity and the firm's sales.

Therefore, firms face strong incentives to display corporate social responsibility by engaging in socially beneficial activities rather than simply trying to maximize profit.

Aiming for profits, sales, salaries, power, etc.

will be useless if the firm does not survive! Trying 4 ZD to maximise any of the various objectives may be risky.

For example, if a firm tries to maximise its market share by aggressive advertising or price cutting, it might invoke a strong response from its rivals.

The resulting war may drive it out of business.

Concern with survival therefore, may make firms cautious.

Contestable market is another maiket type where a * firm's objective deviates from long term profit maximization.

A market is perfectly contestable when the costs of entry and exit bv potential rivals arc zero.

So the sheer threat of this happening, so the theory goes, will ensure that the firm already in the market will keep its profit down in order to deter the entry of new firms.

Hence the firms facing oligopolistic or monopolis tic market structure are more likely to deviate from long term profit maximization.

This is because they usually earn supernormal profits in the long run and hence are less likely to face losses when they deviate from profit maximizaion.

Also, these firms have the incentive to deviate for increasing their influence on the market.

However, for firms oper ating in perfectly competitive or monopolistically competitive markets there is no scope for any other objective but profit maximization.

This is because there exists only normal profit in the long run and if those firms depart from profit maximization they may not survive.

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