More evidence that firms do not set their prices higher then market price to make an abnormal profit can be seen in a study by Shipley 1981 who has found that only 15. 9% of his samples of 728 UK firms were regarded as true profit maxi misers. According to Shipley, firms had to state that they maximised profit in his survey and also that they regarded profit as being of overwhelming importance. It must be stressed that this study was in the form of a questionnaire and that quantitative methods of study face criticisms of being selective.
The closed question formats where companies have a choice of about five options to answer from are accused of having a bias outcome on the results. Nevertheless there is evidence that the theory of profit maximisation in the world is limited to only a few able bodied companies and as Shipley has shown these companies may also try to limit price their product due to the contestability of the market and aim to make profits in the long run. As mentioned earlier, companies that are able to set a price high to profit maximise may not do so.
This is not down to limit pricing but due to the fact that the firms ownership differs from the firm’s control ship. The owners and controllers, the owners being the shareholders of a firm and the controllers being the managers appointed by the shareholders may cause the principle agent problem. Owners are motivated by high profits and large dividends whereas managers are otherwise motivated by their own goals. Managers may want an easier life and therefore they may employ more to reduce the workload for themselves.
Employing more will increase the costs of the business and therefore it may increase the prices of the good or services a company sells or it may reduce the profit level of a company. Managers may be on a commission based allowance, this type of scheme is set out to increase the sales of the company however it may be that increasing sales above the profit maximisation level actually goes against the shareholders objectives of profit maximisation. To maximise sales the manager may have to reduce the price as my diagrams show:
As mentioned earlier firms may limit price, this is when business take a conscious action to not charge a higher price then they are. These firms will be in a position to ‘price make’ but in fear of the contestability of the market which is the low amounts of barriers to entry they constrain themselves from charging a higher price. An example of this price setting behaviour is when a firm invents a new product and finds that it can make an abnormal profit. This firm, if it was a short run profit maxi miser may wish to price its goods at MR = MC.
However, this firm may wish to limit price and price take in the short run. This deters new entrants from entering leaving the firm time to brand the good, build up market dominance and then in the long run use its market dominance to ‘price make’ for the good. Other pieces of evidence that show the business price setting decisions of a firm being effected or influenced are by external factors such a the government. The laws and regulations of a country such as the law for minimum wage means that the costs of the firm will go up which may affect the price of it goods and services that it produces.
The Bank Of England has found that small companies are price sensitive to increases in costs. As costs increase for small firms, who adopt their mark up scheme to set prices, their prices increase. So far I have given evidence into maximising goals apart from the traditional theory of profit maximisation. However the behavioural viewpoint, according to the Applied Economics Book by Allan Griffiths and Stuart Wall 9th Edition, sees the firm as an organisation that has a set of goals.
A group within the organisation that is able to achieve dominance is able to influence pricing decisions. The organisation may also be classified as the stakeholders that also include the government. The traditional and managerial theories of the firm that propose a single goal being maximised is seen by the behaviour lists as being far-off the truth when it comes to the goals of an organisations. There are possibilities of many groups within the organisation to have differing goals and according to Stuart Wall the market structure can also affect the pricing objectives.
This leads to several goals waiting to be fulfilled; this is where the manager steps in to satisfice, meet the minimum goals for each objective. In conclusion it can be said that the traditional theory of the firm that explains the business price setting decisions as being a profit maximising one can no longer be applied to all firms. Businesses have other objectives that affect price. Lastly I have shown that the price setting decisions a company takes is not entirely down to the owners as external factors can also affect price.