What does a firm maximize? A simple explanation with regard to economic growth. (10th December 2018) - Mert, Merter
The purpose of this study is to explain the following proposition: Profit maximization objective is only an assumption, which is valid only when marginal cost is zero; a firm should maximize its total sales rather than its profit when marginal cost is not equal to zero. Using simple logical consequences, the study shows the following: (i) Cournot equilibrium occurs at total revenue maximization conditions rather than profit maximization conditions, even if costs are not neglected; (ii) if average costs of plants are not equal to each other, a multiple-plant monopoly cannot maximize its profit; it should maximize its total revenue, even if costs are not zero; (iii) a firm's goal should be total revenue maximization rather than profit maximization, when marginal cost is not equal to zero; (iv) profit maximization behaviour does not have to explain economic growth; however, total sales maximization behaviour clearly explains economic growth and (v) total sales maximization objective, at the producer's equilibrium conditions, guarantees stability under diminishing returns. The study concludes with nine simple results in order to support its claim. The results of the study emphasize that (i) an empirical analysis based on a strict theory should start to the analysis depending on a goal function which maximizes total sales rather than profit and (ii) a representative social planner who designs a growing economy, which grows thanks to total sales maximization behaviour of firms, should design the economy where price changes do not give advantage to the firms.