Explain the meaning of the satisficing principle and how different objectives of a business
can lead to changes in a firm’s price output and profit
The standard assumption made when analysing the pricing decisions of a business is that a
businesses possesses the information, market power and motivation to set a price and output that
maximises profits in the short or long run. This assumption is now often criticised by economists
who have studied the complex organisation and objectives of corporations and in particular the
existence of a ‘divorce of ownership and control’ that is common to most modern businesses.
They find that there are often good reasons to depart from pure profit maximisation and one
example of this may be satisficing behaviour.
Satisficing involves the people taking key day-to-day decisions in a business choose to reach
some minimum acceptable target but not necessarily the maximum possible value. So for example
the business might set a target of achieving a rate of profit above normal profit, but slightly below
the pure profit maximisation output. This minimum profit constraint might be imposed by the
shareholders of a business as a way of giving the right incentives for managers, but at the same
time, leaving them room or freedom to pursue alternative aims in the short term.
A firm might for example be happy to set a slightly lower price and produce a higher output in the
short term if it wants to squeeze some extra market share out of their competitors, or perhaps
because they want to boost total revenue and cash flow rather than maximise the profit margin.
The word “satisfice” was coined by Herbert Simon in 1957 who was one of the first economists to
question the basic assumption of perfect information and self-interested rational behaviour by
people operating in business. He argued that many businesses did not have sufficient information
to make pure judgements about the profit maximising price and output. Indeed many operated
using “rules of thumb”, guided by what their competitors might be doing and by the experience of
having being in a market for some time.
The satisficing principle leads us to consider a range of different price and output possibilities and
these are shown in the diagram.
Profit Max at Price P1
Revenue Max at Price P2
If the firm decides to satisfice, then the likely price will be lower than P1 (where MR=MC) and the
output will be greater than Q1. Q2 would maximise total sales revenue (where MR is zero) and the
firm could continue to expand supply up to output level Q3 where AR=AC and thus normal profits
An alternative way of showing satisficing behaviour is to use total cost and total revenue curves. In
the example shown below the shareholders have introduced a minimum acceptable profit – giving
the managers in charge of price and output decisions, the freedom to operate between this and the
maximum profit level that they can achieve.
Total Cost (TC)
Min Profit Target
Most businesses today cannot and do not seek pure profit maximisation all of the time. There are
plenty of sound competitive business reasons why satisficing behaviour might well describe much
of what managers decide to do!