Objective of a Business Firm and Economy

During recent time, global economy is in turmoil. Eurozone is in crisis. America is trying to implement various schemes to improve internal economy. Asian market is low. India is far behind the expected economic growth. It is a scenario of virtual recession, globally. In this context, private companies naturally are going slowly for further investment. Lots of new projects are expected, but business firms are not taking decision to start such projects. Why companies are afraid of this poor economy? The main reason is that, nobody knows about duration of this turmoil. Nobody can predict that, whether the economy will deep into trouble in future. In that case, company will not be able to generate good revenue at short run after huge initial investment. Also, in poor market scenario, company will not be able to generate money from market for setting up new business.

What business firms expect from a business? What are the major economic objectives that business firms seek to achieve?

Truly speaking the major economic objectives of business firms are various and depends on nature of market and business organizational structure.

The major economic objectives that concern business firms are as follows:
      1)      Maximization of profit
      2)      Maximization of sales revenue
      3)      Maximization of firms growth rate
      4)      Maximization of managerial utility function
      5)      Making a satisfactory and standard profit
      6)      Long run survival and a larger market share
Naturally all these economic points are concern for any business firm. But it is equally true that, any particular firm may not seek all these objectives to be fulfilled. Rather any particular firm may seek fulfillment of few objectives among all these points. It depends on the level of the organization, business acumen of the organization, aim of the organization, demography of the organization, etc.

1)      Maximization of profit

As per conventional theory of business firm, profit maximization is the sole objective of a business firm.

Profit maximization conditions are as follows:

Total profit π is defined as,
π  = TR-TC…….equation (i) (where TR is Total revenue and TC is Total Cost)
By following the rule of calculus, two conditions must be fulfilled for profit maximization.

Condition 1:

First order condition is known as necessary condition.
Differentiating equation 1 with respect to Output of the firm, Q, we get,
(∂π /∂Q) = (∂TR/∂Q)-(∂TC/∂Q) ………equation (ii)
For profit maximization, first order derivative of profit function must be zero, i.e. (∂π /∂Q) = 0
i.e. (∂TR/∂Q)-(∂TC/∂Q) = 0
i.e. (∂TR/∂Q) = (∂TC/∂Q) ……..equation (iii)
Now, change of total revenue w.r.t. change of output is known as Marginal Revenue (MR), i.e. slope of total revenue curve.
i.e. (∂TR/∂Q) = MR
Also, change of total cost w.r.t. change of output is known as Marginal Cost (MC), i.e. slope of total cost curve.
 (∂TC/∂Q) = MC
From equation (iii), we can conclude that,
MR = MC.

Thus, to satisfy first order condition, it is obvious that, marginal revenue must be equal to marginal cost.

Condition 2:

Second order condition is known as secondary condition for profit maximization.

As per second order condition, for maximum profit, first order condition must be satisfied under rising marginal cost and decreasing marginal revenue.
In the curve of marginal condition of profit maximization, marginal revenue intersects marginal cost at two points, P1 and P2, which implies that marginal revenue is equal to marginal cost at two conditions.
As per calculus, the second order condition required that, the second derivative of the profit function should be negative for maximum profit.

Second derivative of equation (ii),
(∂²π /∂Q²) = (∂²TR/∂Q²)-(∂ ²TC/∂Q²)……equation (iv)
For maximum value of profit function, second derivative of profit function should be less than zero.
i.e. (∂²π /∂Q²) < 0
i.e. (∂²TR/∂Q²)-(∂ ²TC/∂Q²) < 0
i.e. [∂/∂Q(∂TR/∂Q)]-[∂/∂Q(∂TC/∂Q)] < 0
i.e. (∂MR/∂Q)-(∂MC/∂Q) < 0
i.e. (∂MR/∂Q) < (∂MC/∂Q)
i.e. ISlope of MRI = ISlope of MCI..where (∂MR/∂Q) = ISlopeof MRI and (∂MC/∂Q) = ISlope of MCI

It implies that, second order condition wil satisfy where marginal cost has steeper slope than marginal revenue.
At P2, this condition fulfilled, where MC is rising and MR is decreasing.
Under these two conditions profit of a business firm is maximized.

As per traditional concept, profit maximization is the sole objective of a business firm, because,

    a)      Profit is indispensable for the firm’s survival,

    b)      Profit is important to achieve other objectives,

    c)       Profit is more reliable measure of firm’s efficiency, etc.

However modern economists believe that firms has other objectives apart from profit maximization. So as per the modern economists, profit maximization is not the sole objective of the business firm.

2)      Maximization of sales revenue:

Some economist has opined that, maximization of sales revenue is an alternative to profit maximization objective. Dichotomy between managers and owner of the firm is reason behind this postulate. This difference in interest gives manager to set their own objectives rather than profit maximization.

The factors which prompted managers to set the objective of maximization of sales revenue, are as follows:

    a)      Salary and other benefits of managers are more closely related to sales revenue.
    b)      Bank and financial institutions look at sales revenue while financing for the business.
    c)       The trend of sales revenue is readily available indicator to measure firm’s present business position.
    d)      Managers find profit maximization is a difficult objective to fulfill consistency over time; and also, profit depends and fluctuates with changing business conditions.

Considering these points, many business firms prefer to maximize sales revenue as one of their prime objective, to sustain in the present business. Economist Baumol has highlighted this issue in bigger introspection.

3)      Maximization of firm’s growth rate:

According to economist Robin Marris, managers are keen to maximize firm’s balanced growth rate.
A firm’s balance growth rate (G_B) is as follows:

G_B = G_D - G_C ………where G_D is growth rate of demand for firm’s product and G_C is growth rate of capital supply to the firm.

So, firm’s growth rate is balanced when growth rate of demand for firm’s product is same as growth rate of capital supply to the firm.

4)      Maximization of managerial utility function:

As per some economists, managers seek to maximize their ability function, subject to a standard profit. A maximum level of profit is necessary for this condition, otherwise share holders will not be satisfied and manager’s job will be in danger. Economist Williamson has discussed this objective more in detail.

5)      Making a satisfactory and standard profit:

A section of modern economist believes that, real business world is full of uncertainty and inaccuracy. Under this condition, consistently maximize the profit is near to impossible job. So, under this condition, satisfactory and standard profit is more realistic objective. Also, under these uncertain adverse conditions, satisfactory growth is also desirable, instead of maximize growth. Instead of maximize profit, it is more natural and realistic to set a reasonable profit objective and try to achieve the same.

6)      Long run survival and larger market share:

According to some economists like Rothschild, primary objective of the business firm is long run survival. The managers therefore try to secure market share. That is why firms try to prevent entry of new firms into the industry. The motive behind entry level prevention is to profit maximization in long run, securing a constant market share and avoidance of risk caused by new entry.

Ofcourse, the advocate of profit maximization theory argue that only profit maximize firm can survive in long run and by profit maximization the firm can easily achieve all other objectives.

It is natural that, in today’s market scenario, setting up any particular objective is rare. Rather companies prefer to set multiple objectives. Also, many companies (especially in Indian scenario) try to avoid long run survival; rather they prefer to earn maximum profit at short run, considering market uncertainty. But there is no alternative of setting up target for balanced growth rate and long run sustainability. The companies which set long run sustainability and balanced growth as their prime object, are more humanist in approach, so far national interest is concern. In Europe we can find many such companies, which operate for more than 50 years in sustainable basis, which in a long run are able to set up a research orientated business approach. In long run this approach maximize and secure high level of profit and market share in a bigger perspective, if the firm’s management has capability to sustain the pain of initial business set up. Recession obviously stops firms to set up new businesses, but it is equally true that, recession is an opportunity for firms which eye for long run business opportunity. Economy never keeps itself in cold room. Economy is dynamic, and it is obvious that, after recession, again economy will move forward towards positive growth. In today’s volatile market scenario neither recession nor growth is permanent, sustainable and stable. So, business has to move in this volatile and unstable market. So, this market is good for both the firms: who look for long run sustainability or who look for profit maximization only. It is only the choice of the firm about their economic objective and social responsibility.



Nirjhar Chakravorti