Managerial Economics Theory and Practice - Webster

Page 36

How Realistic is The Assumption of Profit Maximization?

21

HOW REALISTIC IS THE ASSUMPTION OF PROFIT MAXIMIZATION? The assumption of profit maximization has come under repeated criticism. Many economists have argued that this behavioral assertion is too simplistic to describe the complex nature and managerial thought processes of the modern large corporation. Two distinguishing characteristics of the modern corporation weaken the neoclassical assumption of profit maximization. To begin with, the modern large corporation is generally not owner operated. Responsibility for the day-to-day operations of the firm is delegated to managers who serve as agents for shareholders. One alternative to neoclassical theory based on the assumption of profit maximization is transaction cost theory, which asserts that the goal of the firm is to minimize the sum of external and internal transaction costs subject to a given level of output, which is a first-order condition for profit maximization.5 According to Ronald Coase (1937), who is regarded as the founder of the transaction cost theory, firms exist because they are excellent resource allocators. Thus, consumers satisfy their demand for goods and services more efficiently by ceding production to firms, rather than producing everything for their own use. Still another theory of firm behavior, which is attributed to Herbert Simon (1959), asserts that corporate executives exhibit satisficing behavior. According to this theory, managers will attempt to maximize some objective, such as executive salaries and perquisites, subject to some minimally acceptable requirement by shareholders, such as an “adequate” rate of return on investment or a minimum rate of return on sales, profit, market share, asset growth, and so on. The assumption of satisficing behavior is predicated on the belief that it is not possible for management to know with certainty when profits are maximized because of the complexity and uncertainties associated with running a large corporation. There are also noneconomic organizational objectives, such as good citizenship, product quality, and employee goodwill. The closely related theory of manager-utility maximization was put forth by Oliver Williamson (1964). Williamson argued that managers seek to maximize their own utility, which is a function of salaries, perquisites, stock options, and so on. It has been argued, however, that managers who place their own self-interests before the interests of shareholders by failing to exploit profit opportunities may quickly find themselves looking for work. This will come about either because shareholders will rid themselves of 5

Transactions costs refer to costs not directly associated with the actual transaction that enable the transaction to take place. The costs associated with acquiring information about a good or service (e.g., price, availability, durability, servicing, safety) are transaction costs. Other examples of transaction costs include the cost of negotiating, preparing, executing, and enforcing a contract.


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Chapter Questions

0
page 428

Key Terms and Concepts

2min
pages 426-427

Game Theory

6min
pages 419-424

Measuring Industrial Concentration

5min
pages 397-399

Selected Readings

5min
pages 392-394

Short-run Monopolistically Competitive Equilibrium

1min
page 378

Characteristics of Monopolistic Competition

1min
page 377

Long-run Monopolistically Competitive Equilibrium

12min
pages 379-385

Chapter Questions

3min
pages 368-369

Welfare Effects of Monopoly

10min
pages 357-362

Key Terms and Concepts

4min
pages 366-367

Characteristics of Market Structure

5min
pages 328-330

Perfect Competition

2min
page 331

Chapter Review

2min
page 317

Key Terms and Concepts

4min
pages 318-319

Selected Readings

2min
pages 279-280

Chapter Exercises

1min
page 278

Key Terms and Concepts

3min
pages 275-276

Chapter Questions

2min
page 277

Chapter Review

2min
page 274

Long-run Cost

1min
page 265

The Functional Form of the Total Cost Function

3min
pages 256-257

Key Relationships:Average Total Cost,Average Fixed Cost,Average Variable Cost,and Marginal Cost

5min
pages 253-255

Learning Curve Effect

5min
pages 262-264

Short-run Cost

4min
pages 251-252

Chapter Exercises

1min
page 246

Chapter Questions

3min
pages 244-245

Selected Readings

1min
pages 247-249

The Relationship Between Production and Cost

1min
page 250

Chapter Review

1min
page 240

Key Terms and Concepts

6min
pages 241-243

The Three Stages of Production

2min
page 226

The Law of Diminishing Marginal Product

3min
pages 220-221

The Production Function

7min
pages 212-215

The Role of the Firm

3min
pages 210-211

Chapter Exercises

6min
pages 206-208

Chapter Questions

1min
page 205

Selected Readings

1min
page 159

Chapter Review

3min
pages 201-202

Key Terms and Concepts

4min
pages 203-204

Chapter Exercises

3min
pages 157-158

Chapter Questions

3min
pages 155-156

Key Terms and Concepts

4min
pages 153-154

Chapter Review

2min
page 152

The Allocating Function of Prices

1min
page 151

Determinants of Market Supply

6min
pages 129-132

Price Ceilings

7min
pages 145-148

The Law of Supply

1min
page 128

Price Floors

3min
pages 149-150

The Law of Demand

3min
pages 115-116

Chapter Review

3min
pages 107-108

Selected Readings

1min
pages 112-114

Market Demand Versus Firm Demand

1min
page 127

Profit Maximization:The First-order Condition

3min
pages 91-92

Partial Derivatives and Multivariate Optimization:The First-order Condition

0
page 96

Rules of Exponents

2min
page 67

The Slope of a Linear Function

1min
page 62

Selected Readings

2min
pages 56-58

Chapter Exercises

2min
pages 54-55

Chapter Questions

3min
pages 52-53

Key Terms and Concepts

3min
pages 50-51

Variations in Profits Across Industries and Firms

4min
pages 46-47

Normal Profit

1min
page 45

Chapter Review

3min
pages 48-49

Manager-Worker/Principle-Agent Problem

3min
pages 40-41

Owner-Manager/Principle-Agent Problem

4min
pages 38-39

What is Managerial Economics

1min
page 19

The Role of Profit

3min
pages 31-32

How Realistic is the Assumption of Profit Maximization?

4min
pages 36-37

The Role of Government in Market Economies

5min
pages 28-30

Theories and Models

5min
pages 20-22

Three Basic Economic Questions

3min
pages 24-25

What is Economics

3min
pages 16-17

Characteristics of Pure Capitalism

3min
pages 26-27
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