Satisficing Business Objectives


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Revision note on satisficing as a business objective

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Satisficing Business Objectives

  1. 1. 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. Costs Profit Max at Price P1 Revenue Max at Price P2 AC P1 MC P2 AC1 AC2 AR (Demand) Q1 Q2 MR Q3 Output (Q)
  2. 2. 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 are made. 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. Revenue Cost and Profit Total Cost (TC) Profit Max Revenue Max Normal Profit where TC=TR Total Revenue (TR) Max Profit Total Profit Min Profit Target Q2 Q1 Q4 Q3 Output (Q) 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!