Basic Model of The Firm And Role Of Profits

The Firm’s Intention: Profit Optimisation

    The competent management of a business firm needs a best possible solution out of the reachable itineraries of action for a firm. This effectual or best possible judgement needs establishing the aim or objective to be accomplished. Whether a management pronouncement is best possible or not can be appraised aligned with the aim that the firm looks for to accomplish.

    In traditional fiscal model of the firm it is presumed that a firm’s aim is to optimise short run profits that are profits in the present phase which is usually taken to be a year. In several variety of market structure such as perfect rivalry, monopoly, monopolistic competition the traditional microeconomic thesis describes the ascertainment of price and productivity by presuming that firm’s objective is to optimise present or short run profits.

    This present short run profit maximisation model of the firm has offered judgement makers with useful framework with regard to efficient management and allocation of resources.

   Profits are a disparity among aggregate revenue and aggregate cost. It may be noted that the notion of cost used in economic thesis and managerial economics is different from the aspect of accounting cost used by accountants. The disparity in the aspects of costs makes the aspect of profits used in fiscal thesis difference from that used in its calculation by the accountant.

                        π = TR – TC

    Where, π stands for aggregate fiscal profits, TR for total revenue and TC for total fiscal costs. It is financial profits which firms try to optimise in their decision making about level of productivity and price to be charged for its commodity.

    The simple profit maximising model of the firm offers very useful guidelines for the decision making by the firm with regard to effective resource management. Therefore, any business decision by a firm will enhance its profits if the subsequent stipulations triumph:

  • It fetches about enhancement in total revenue more than enhance in costs.
  • It sources enhance in revenue costs remaining unaffected.
  • It decreases cost more than it decreases revenue.
  • It decreases costs, revenue staying the same.


    Inspite of the merits of the profit optimisation model of the firm, it has two significant restrictions. Primarily, it does not integrate time measurement in the pronouncement procedure by the firm. Next to it, it does not scrutinise the firm’s performance under stipulations of risk and uncertainty.

    The modern model of the firm known as “Firm’s value Optimisation Model or Shareholder’s affluence Maximisation model surmounts these restrictions by integrating time measurement into the managerial decision making procedure. This model also considers risk integrated in business pronouncement.

Value Optimisation Model of the Firm

     In recent managerial economics to make decision by supervisors are guided by the aim of optimising value of the firm. As in a corporate type of business it is the shareholders who are the owners of the firm, value of a firm correspond to shareholders affluence.

    Therefore, recent managerial economics isolates from the traditional economic thesis in which it is presumed that managers of corporate firms or owner mangers of self owned business enterprises look for to optimise short run profits. It has frequently been verified that firms forgo some short run profits for the sake of higher profits in the future years.

    That is they aspire at optimising long run profits. It is for the reason that this aim that business enterprises acquire huge outlay on research and development, new capital equipment and high priced promotional formats for their commodities.

    Thus, integrating of time in the scrutiny of decision making by managers of business is essential. Modern thesis of the firm presumes that primary aim of the firm or their managers is to optimise value of affluence or shareholders’ affluence.

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