In many instances, the firm produces more than one product. These products might have common or joint costs such as the cost of premises. These would be seen as fixed costs and such overheads should be allocated between the different products. (Note, however, that fixed costs do not influence MC as they do not change with output.) Variable costs might also be shared, as when using the same operative to produce more than one product, again necessitating the allocation of such costs between products. This would not prevent marginal costing, yet it does present a complication. Accounting theory provides a basis for the allocation of shared costs through the principle of absorption costing.The firm might nevertheless choose its own method of allocation. For example, a strategic decision might be made to under-allocate shared costs to a newly launched good in order that it might be competitively priced to gain immediate market share.
Irrespective of whether a firm can or cannot identify MC and MR, would it anyway use these concepts when setting price? An early empirical test of this question was carried out in the 1930s by two American economists, Hall and Hitch (1939), who questioned a range of ‘well-organised’ businesses on how they set price. Their findings showed that most respondents were unfamiliar with marginal analysis, and anyway questioned whether firms would wish to maximise short-term profits on the groundsthat too frequent price adjustments might alienate customers and lead to retaliation from competitors. Their results also questioned whether firms implicitly attempted to calculate elasticity or take it into account in price setting.
Hall and Hitch’s results have received a good deal of criticism over the years, particularly as it is naive to expect businesses to be familiar with economic jargon. If you were to ask a business whether it used a marginalist approach to pricing, its likely reaction would be ‘no’ as it has no familiarity with the approach. Nevertheless, it is still possible that its price setting results in maximum profit, and if this is the case, then by definition MC must equal MR. It is possible that an established firm might approach a position of maximum profit through its experience of the market and through trial and error. We will also see in Chapter 9 that, under certain circumstances, profit maximisation can be achieved by cost-plus pricing, the favoured pricing method of many firms.
The complexity of the modern business organisation might also lead to difficulties in the firm achieving profit maximisation. Managers in different functional areas of the firm might start to pursue their own goals rather than profit. Coordination of common purpose can prove difficult in a large bureaucratic organisation. This will be further explored in Section 6.3.
In this debate, it is important to note that assuming the firm to be maximising profit does not imply it has no other goals, or that it will pursue profit to the ultimate degree in all circumstances. Instead, we assume profit to be so dominant an aim that for the purpose of our analysis and understanding of the firm other goals can be effectively ignored. That is, in assuming the firm has the sole aim of profit maximisation, the results of our analysis are still seen to be viable and realistic.
We will now consider the possibility of alternative goals to profit maximisation.
Would a firm wish to maximise profit?
Even where the firm is able to maximise profit, would it always wish to do so?
The traditional neo-classical approach to the firm assumes the existence of an ownermanager. In such circumstances the rewards from the firm’s performance come directly to the owner-manager and profit maximisation appears realistic. This assumption, however, could still be questioned. For example, an individual might set up in business on his/her own in order to provide customers with a valued service at minimal profit, at the same time maximising his/her opportunity to pursue such pleasures as golf or fishing.