Profit Maximization Model in Managerial Economics

Profit-making is one of the most traditional, basic and major objectives of a firm. Profit-making is the driving-force behind all business activities of a company. It is the primary measure of success or failure of a firm in the market. Profit earning capacity indicates the position, performance and status of a firm in the market. It is an acid test of economic ability and performance of an individual firm. There is no place for a firm unless it earns a reasonable amount of profit in the business. It is necessary to stay in business and maintain in tact the wealth producing agents. It is a widely accepted goal and there is nothing bad or immoral about it. Earlier profit maximization was the sole objective of a firm. This assumption has a long history in economic literature and the conventional price theory was based on this very assumption about profit making. In spite of several changes and development of several alternative objectives, profit maximization has remained as one of the single most important objectives of the firm even today. Both small and large firms consistently make an attempt to maximize their profit by adopting novel techniques in business. Specific efforts have been made to maximize output and minimize production and other operating costs. Costs reduction, cost cutting and cost minimization has become the slogan of a modern firm.

Profit Maximization Model

Profit Maximization model helps to predict the price-output behavior of a firm under changing market conditions like tax rates, wages and salaries, bonus, the degree of availability of resources, technology, fashions, tastes and preferences of consumers etc. It is a very simple and unambiguous model. It is the single most ideal model that can explain the normal behavior of a firm. It is often argued that no other alternative hypothesis can explain and predict the behavior of business firms better than profit-maximization hypothesis. This model gives a proper insight in to the working behavior of a firm. There are well developed mathematical models to explain this hypothesis in a systematic and scientific manner.

Profit-maximization implies earning highest possible amount of profits during a given period of time. A firm has to generate largest amount of profits by building optimum productive capacity both in the short run and long run depending upon various internal and external factors and forces. There should be proper balance between short run and long run objectives. In the short run a firm is able to make only slight or minor adjustments in the production process as well as in business conditions. The plant capacity in the short run is fixed and as such, it can increase its production and sales by intensive utilization of existing plants and machineries, having over time work for the existing staff etc. Thus, in the short run, a firm has its own technical and managerial constraints. But in the long run, as there is plenty of time at the disposal of a firm, it can expand and add to the existing capacities, build up new plants, employ additional workers etc to meet the rising demand in the market. Thus, in the long run, a firm will have adequate time and ample opportunity to make all kinds of adjustments and readjustments in production process and in its marketing strategies.

It is to be noted with great care that a firm has to maximize its profits after taking in to consideration of various factors in to account. They are as follows:

  1. Pricing and business strategies of rival firms and its impact on the working of the given firm.
  2. Aggressive sales promotion policies adopted by rival firms in the market.
  3. Without inducing the workers to demand higher wages and salaries leading to rise in operation costs.
  4. Without inducing the workers to demand higher wages and salaries government controls and takeovers.
  5. Maintaining the quality of the product and services to the customers.
  6. Taking various kings of risks and uncertainties in the changing business environment.
  7. Adopting a stable business policy.
  8. Avoiding any sort of clash between short run and long run profits in the business policy and maintaining proper balance between them.
  9. Maintaining its reputation, name, fame and image in the market.
  10. Profit maximization is necessary in both perfect and imperfect markets. In a perfect market, a firm is a price-taker and under imperfect market it becomes a price-searcher.

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