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Unit-18: Profit Maximization and Full Cost Pricing Theories

other last decisions, and it will affect the upcoming decisions of firms. This correlation is bypassed Notes
by neo-classical theory.
8. Not Applicable to Oligopoly Firm: Practically, in economic theory, the purpose of profit maximization
is for perfect competitor or oligopoly or oligopoly competitor firm. But in oligopoly firm, it is left
due to its criticism. Thus, the purposes added by the economists in this theory are mainly related to
oligopoly or two-oligopoly.
9. Varied Objectives: The difference base of neo-classical firm and modern corporation is that the aim
of profit maximization is related to producer’s behaviour while the aim of modern corporation is
basically related to various ambitions of shareholders and management. The shareholders do not
affect in management working arena. In 1932, Barle and Means told that the purpose of management
is far different from shareholders. The management has no interest in profit maximization. They
operate the firm in their own favour rather than for shareholders. Shareholders cannot affect them
any more due to having no knowledge of company. Most of the shareholders cannot present in
annual meetings. In this way, the modern firms are motivated from those purposes which are related
to internal organization.

The firms make profit maximization in short-term and long-term.

18.2 Theory of Full-Cost or Average Cost Pricing

In 1919, Hall and Hitch from Oxford University campaigned for profit maximization. For this, they
have created the base of questionnaire of 38 industrialists. In this 33 were producer, 3 were retailer,
and 2 were manufacturer. Hall and Hitch obtained the information about their efforts under estimated
maximum cost and income to make them similar, their demand flexibility. Information obtained from
those responses, most of them did not effort to estimate the demand flexibility or maximum cost directly
or certainly. They did not thought about the relevance of this in price decision process.
Hall and Hitch have concluded on the basis of their empirical study that many industrialists consider
the full cost on the basis of sales value, they do not justify the similarity of marginal cost and marginal
income, and they include the profit commission. This way the best price is based upon full or average
cost which should be made by view of correct competition under oligopoly.
But what is full cost? Full cost is full average cost in which the average changeable cost (AVC), deposited
average other cost (AFC), normal margin for deposit and profit. Thus, price (P) = AVC + AFC + profit
margin (normally 10%). According to Hall and Hitch, there are some reasons to follow the theory
of full cost pricing by firm: (i) silence or diplomat agreement between producers (ii) not succeed to
know the priorities of customers (iii) responses of competitors due to changes in price (iv) moral trust
of justification and (v) uncertainty of influences of price variations. These reasons stop the oligopoly
producers to decide others price except deciding the price of full cost.
Thus, firms fix the prices on the basis of full cost principle and sell according to market demand. They
saw that in spite of demand and cost changing in oligopoly, price is constant in market. They explained
the stability of price by kinkit demand curve. This kinkit on that point where in Fig. 18.3, the fixed price
OP (= OB) on full cost theory. Above from this level, the sell of firm will be reduced because competitors
will not follow to raise the price. Because PD part is flexible. On the other hand, firm reduces the price
from QP. Its is competitors will to reduce price. The sell rises but profit is less. Because PD is less
1
flexible. So in the situation of high or low price, non profitable condition is applicable to firms. So
whenever there is no changes in price of factors (like raw material etc.) firm will be constant on price QP.

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