Profit Maximisation And Business Behavioural Patterns
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Published: Mon, 11 Dec 2017
1) Every business holds ‘profit maximisation’ in high regards but ‘profit maximisation’ does not always influence a business’s behavioural patterns.
‘Profit maximisation’ is the process in which a company aims to have the best output and price levels, so that the business can receive the highest rate of return. Through this method one cannot explain business behaviour or managerial priorities, but there are a few managerial theories that can. One is the ‘agency theory’ and the second is the ‘organisation theory’.
The ‘agency theory’ is a theory showing the relationship between agents of a company and the company managers. It is used to solve the conflicts between the two, and to unite their interests for the company. ‘Agency theory’ argues that when there is uncertainty or lack of confidence amongst agents or restriction of information in a company then two ‘agency problems’ occur. One is called ‘moral hazard’ and the other is named ‘adverse selection’.
‘Moral Hazard’ is where the company manager does not believe that the agent has fully put 100% effort into their work. ‘Adverse selection’ is where the company manager does not believe that the agent fully has the ability to perform their work to the highest level.
The difficulties and complications of ‘moral hazard’ and ‘adverse selection’ mean that fixed wage contracts are not the best way to set up good relationships between company managers and agents. An agent may not like the fixed wage and may use it to be lazy in his work because his compensation will be no different, no matter his standard of work.
“The provision of ownership rights reduces the incentive for agents’ adverse selection and moral hazard since it makes their compensation dependent on their performance” (Jensen, 1983).
The other managerial theory is the ‘organisation theory’. This theory refers to those who want to get the best value out of a company. These people need to know how to achieve this goal and also they will need to monitor and control performance to understand how to achieve results by structuring activities and planning.
In using this theory people view a company as a firm trying to attain maximizing profits. It does not take notice of the possibility of negative relationships between owners, managers and employees. Organization theory sort of came into being due to competition being so focused on that there was a lack of recognition of other goals in organisation and organisation theory became prominent due to its reaction against such ideas. It was necessary to understand behaviour which seemed to be irrational.
The idea that profit maximization is the only goal of the firm and that it explains business behaviour is not accurate at all. Agency theory has shown us that firms may not take part in profit maximizing behaviours due to negative relations between owners and managers. As such it is unlikely that we will ever see profit maximisation even if there were unanimous views amongst owner, managers and employees. If we compare the business behaviour of owner-managed and professionally managed companies we can see that, against the agency theory, professionally managed firms are more likely than not to engage in profit-maximisation.
In conclusion, the validity of the statement that “since ownership no longer implies control, business behaviour and managerial priorities cannot be explained on the assumption of profit maximisation” is valid. Due to several different theories, firms/companies behaviour in business can depend on inter-business relationships, profit maximisation, performance control, activity structuring, etc and profit maximisation alone cannot show this.
It is not hard to see that if consumers start to go to smaller and cheaper chains of good producers that it will have a negative impact on larger chains. But using oligopoly pricing theories I will discuss the impact of consumers change of choice and set out the long and short run reactions of the larger chains.
An oligopoly is a market dominated by a few large suppliers. The degree of market concentration is very high. Firms within an oligopoly produce branded products, such as ‘nestle’, ‘Kellogg’s’ etc and there are also barriers to entry. Also within an oligopolistic market is interdependence between firms, i.e. each firm takes into account the lreactions of competing firms when they are making pricing decisions.
As consumers have decreased income due to the recession the popularity of chains such as Aldi and Lidl increased dramatically. As such Tesco and Sainsbury’s have made efforts to outclass Aldi and Lidl.
MICROECONOMICS ESSAY 2 ANTHONY STADDON 000457496 PAGE 3
Due to their small size, Aldi and Lidl are not seen up at the top with companies such as Tesco Sainsbury’s and Asda and their foreign status means that within the UK they are not monitored nearly as much as if they were local domestic companies. They are increasing popularity due to their cheap goods..
The way in which places such as Aldi and Lidl differ from larger chains is that instead of selling masses of different items that the larger supermarkets like Tesco sell, they sell a limited range. Also instead producing different brands of one item they offer just one. The large volumes that they should shift by selling just one brand means that they can sell them at very low prices.
In the short term, companies such as Tesco and Sainsbury would most likely drop their prices on their goods to compete with the smaller stores. However this might have a negative effect on them because they could lose money in doing this and still not regain the customers that have changed to Aldi or Lidl. Though in the short term, they could make vast profit in small time spaces even if it doesn’t last. For example, if Tesco, made offers on turkey around Christmas to battle that of Lidl’s pricing and they were able to sell turkeys at lower prices, then for a short period of time, ( the Christmas period), consumers would go to Tesco’s. Alas though, as soon as it is no longer Christmas, then the consumers would return to Lidl to continue on their cheap grocery shopping. Aside from festive occasions, Tesco could make little offers to compete with Lidl and Aldi throughout the year, and still make a little profit over the smaller chains.
To compete in the long-term, the larger chains reactions are going to have to be a lot more inventive and cunning. They will have to invent systems that allow them to sell goods all year round at low enough prices to beat the smaller chains.
For example, Tesco brought about ‘cash savers’ to compete with Lidl and Aldi in their prices. This system has resulted in the price slashing of thousands of goods and it is not a short term thing. Tesco intent to keep it and use it to muscle the smaller chains out.
Pareto efficiency is the concept of when one person cannot not be made better off or has a better position without making someone else worse off. A big problem that economics has to deal with is allocation of resources. Allocation of resources is when resources are distributed among producers and consumers. But to efficiently allocate them one must take into account the cost to attain the resources, to process them and how much of the resource there is to use.
Pareto efficiency may provide a weak method for comparing economic outcomes, but it is an important method. It’s a weak method due to the fact that there may be several efficient situations in an economy and this method does not help us choose between them. An example would be that two people are walking along a street when they see on the ground a ten pound note. If one of them picked it up and kept it, or the other person picked it up and kept it, or if one of them picked it up and gave it to the other person, then these would all be efficient outcomes. The fact that neither of them gains from finding the bill is not the point but they avoid the inefficient outcome of not picking up the tenner and keeping it.
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