Profit maximization hypothesis

In a public corporation set up by statute with no share but only loan capital, the divorce of ownership from control is as complete as imaginable. The profit maximisation hypothesis is based on the assumption that all firms have perfect knowledge not only about their own costs and revenues but also of other firms.

The firm knows with certainty its demand and cost function. Profit maximization is necessary in both perfect and imperfect markets. It is asserted that the real world firms do not bother about the calculation of marginal revenue and marginal cost.

Conventional price theory is based upon profit maximisation hypothesis.

Revenue Maximization vs. Profit Maximization

Firms do not bother about MC and MR: This assumption has a long history in economic literature and the conventional price theory was based on this very assumption about profit making.

Avoiding any sort of clash between short run and long run profits in the business policy and maintaining proper balance between them. But it does not mean that the firm can set both price and output. It is the single most ideal model that can explain the normal behavior of a firm.

If it has any plans to produce more than OM1 it will be including losses, for the marginal cost exceeds the marginal revenue after the equilibrium point B. It is seen in many cases that growth of the firm through increased number of owners is profitable.

At this level of output marginal cost also equals marginal revenue. In the short run, a change in fixed costs has no effect on the profit maximizing output or price. This inter-dependence has been ignored by the neo-classical theory of the firm. Therefore, the demand curve for its product is downward sloping to the right, given the tastes and incomes of its customers.

Hypothesis of Profit-Maximization: Advantages, Disadvantages and Approaches

At the most, they may have a knowledge about their own costs of production, but they can never be definite about the market demand curve. Consequently, the profit maximizing output would remain the same. Therefore, the equilibrium output and the equilibrium price are determined at the same time.

On the other hand, if marginal cost is greater than marginal revenue, the firm is suffering a loss. A firm is in equilibrium when it finds no advantage in increasing or decreasing its output.

According to traditional economic theory profit maximisation is the sole objective of business firms. They manage firms in their own interests rather than in the interests of shareholders.

Approaches to the Equilibrium of a Profit Maximizing Firm: Companies that sell luxury items, such as designer clothes and expensive perfumes, to a small but affluent customer base often use profit maximization strategies.

This model gives a proper insight in to the working behavior of a firm. Let us explain these two conditions.

Profit Maximisation Theory: Assumptions and Criticisms| Economics

But profits are most uncertain for they accrue from the difference between the receipt of revenues and incurring of costs in the future. Firms do not bother about MC and MR: The Second condition of profit maximisation requires that MC be rising at the point of its intersection with the MR curve.

The profit maximisation theory is based on the following assumptions: 1.

Profit Maximisation Hypothesis of Traditional Economic Theory

The objective of the firm is to maximise its profits where profits are the difference between the firm’s revenue and costs. Profit Maximization Theory / Model: The Rationale / Benefits: Profit maximization theory of directing business decisions is encouraged because of following advantages associated with it.

Economic Survival: Profit maximization theory is based on profits and profits are a must for survival of any business. A classic profit maximizing strategy is skim pricing. This involves setting the price of products and services artificially high and selling only to customers who are not sensitive to price.

Companies that sell luxury items, such as designer clothes and expensive perfumes, to a small but affluent customer base often use profit maximization strategies.

Profit Maximization Model in Managerial Economics

Profit Maximization Theory / Model: The Rationale / Benefits: Profit maximization theory of directing business decisions is encouraged because of following advantages associated with it.

Economic Survival: Profit maximization theory is based on profits and profits are a must for survival of any business. Profit maximisation hypothesis helps not only in predicting the behaviour of business firms but also the price-output behaviour under different market conditions.

No other hypothesis can explain and forecast the behaviours of firms better than this hypothesis. The profit maximisation theory is based on the following assumptions: 1.

The objective of the firm is to maximise its profits where profits are the difference between the firm’s revenue and costs.

Profit maximization hypothesis
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Profit Maximisation Hypothesis of Traditional Economic Theory