Economics – Differing objectives and policies of firms | e-Consult

The traditional profit-maximising objective of firms is to maximise the difference between total revenue (TR) and total cost (TC). This means firms aim to achieve the highest possible profit, which is calculated as Profit = TR - TC. Essentially, firms strive to produce at a level where marginal revenue (MR) equals marginal cost (MC). This is because producing one additional unit only adds value if the revenue generated from that unit (MR) exceeds the cost of producing it (MC). If MR MC, the firm should increase production.

Assumptions underlying this objective include:

• Rationality: Firms are assumed to be rational actors, meaning they make decisions that they believe will maximise their profit.
• Perfect Information: Firms have complete and accurate information about market prices, costs, and consumer preferences.
• Stable Demand: Demand conditions are relatively stable and predictable.
• Homogeneous Products: Products are homogenous, meaning they are perfect substitutes for one another.

Two potential limitations to the effectiveness of the profit-maximising objective in practice are:

• Difficulty in accurately measuring costs: Calculating true costs, especially opportunity costs, can be challenging. This can lead to suboptimal decisions. For example, accounting costs may not fully reflect economic costs.
• Market Imperfections: In reality, markets are often imperfect. This can include monopolies, oligopolies, and externalities. These imperfections can distort MR and MC curves, preventing firms from achieving true profit maximization. For instance, a monopoly may restrict output to increase price and profit, even if that output level is not profit-maximizing from a societal perspective.