Analysis of Profit Maximization and Consumer Sovereignty in Competitive Economy

This article discusses the concept of consumer sovereignty and its link to profit maximization in a competitive economy. It also examines market structure, demand and supply, and the environmental policy of the UK government. The article concludes with a discussion on the difference between profit maximization and wealth maximization, and the benefits of wealth maximization over profit maximization.

FELM 4026
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Contents
Part 1: Analysis of statement that profit maximization is linked or consistent with the consumer
sovereignty in the competitive economy.........................................................................................3
Part 2: Critical examination of market structure, demand and supply where consumers buy goods
or services from several companies to fulfil the requirement..........................................................4
Part 3: Profit Maximization and Wealth Maximization..................................................................6
Part 4: Environmental Policy of the UK Government.....................................................................7
Part 5: Financial Calculation.........................................................................................................10
References......................................................................................................................................11
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Part 1: Analysis of statement that profit maximization is linked or consistent with the
consumer sovereignty in the competitive economy
Consumer sovereignty is defined as the ability and freedom of the customers to decide
their own of range of different goods and services. In another words, consumers are ones that
decide regarding how the resources has to be allocated and what exactly it is needed to be
produced. Consumer sovereignty is regarded as the most important concept of today’s classical
economy. As per this concept, consumers have their own discretion power to choose between the
list of suppliers and firms. Consumers will prefer those suppliers that are ready to supply best
quality goods at cheapest price as compared to other market players. The economic theory
related to consumer sovereignty helps to ensure the proper functioning of free market. It helps to
promote the healthy competition in the market and companies tries to solve the needs of
consumers through providing best in class products or services and charge consumers on the
basis of value added to the goods or services provided (Nipun, 2018). In this context, the concept
of market economy defines invisible hand which means consumers prefer certain goods over the
list of goods available in market place. It means those entities will be rewarded that produces
goods and services that are in demand. Companies that fail to provide goods that are in demand
or win the hearts of consumers will either have to improve the quality of goods they are offering
or they have to exit the market (Pettinger, 2018).
In economics there is great importance to the competitive market as term competitive
market helps to understand the market position and level of consumer sovereignty exists in the
particular market. Competitive market refers to the market place where there are large numbers
of producers who compete with each other in order to satisfy the requirements of consumers. It
means in the competitive market there is no single producer and no single customer but there are
group of producers who compete with each other to satisfy the needs of customers who exists in
that market place. The competitive economy or free market is regarded as the profit motive as it
is the reason that forces the companies to enter in this market. The most basic economic theory in
this regard states that profit is earned by the company when they gain the sales or revenue and it
exceeds the total cost of production (Economics Online, 2019).
Below diagram illustrates the consumer sovereignty in more detail:
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(Source: http://www.economicsdiscussion.net/goods/concept-of-consumers-sovereignty-goods/
25147)
The above diagram clearly shows profit maximization can be only be achieved when
company satisfy the needs of generated in the market place. For example, if customers wants
product X and company is delivering product Y than it is not possible to achieve the profit
maximization motive by the companies that exist in the competitive economy. So, it can be said
that objective or requirement of profit maximization is very closely linked with the consumer
sovereignty and this phenomenon exists more in the competitive environment (Tadajewski,
2018).
Part 2: Critical examination of market structure, demand and supply where consumers
buy goods or services from several companies to fulfil the requirement
A market place where there exists large number of sellers that provides differentiated
products and they are close substitutes to each other is called monopolistic competition or
Contestable market. In this market place, there exists large number of sellers selling products or
services that are similar but not identical. It goods and services sold by sellers compete with each
other regardless of price. In the current economic market place, mostly there exists the
monopolistic competition market structure as companies believe to add some unique
characteristics to their products or services that made their offerings different from other. It is the
main feature of the monopolistic competition. The products and services offered in monopolistic
market structure remain very close substitute for each other and it is main reason why price of
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such goods or services cannot be priced very differently from each other. Companies can charge
for any value addition to their product that no other similar product provide in the current market
place but they cannot charge very high for such value addition as consumer will not accept that
price and will disregard the product or service due to high pricing. Under monopolistic market
structure there exist large number of firms and there lies stiff competition between them. The
main difference between monopolistic competition and perfect competition is that in seller
produce identical goods under perfect competition and differentiated goods but similar goods
under monopolistic competition. It means there is perfect competition among the players but not
pure competition. The competition in monopolistic market place is real and tough as each player
wants to put ahead a differentiated product with unique quality and feature so that they can
dominate the market. Pricing of goods or services also remains very competitive and seller
charge only for the quality and value they are offering to their customer (Asche and Bjørndal,
2011).
In monopolistic competition, demand depend upon price and quality of goods that seller
is placing in the market. Under monopolistic competition, demand curve is slightly moves
downwards as the number of quantity in increases in the market. It price of goods shift slightly
lower when number of quantity increases in the market. It means under monopolistic
competition, seller can raise price without losing all of its customers and can also gain customers
through lower the price of such goods. Since in monopolistic competition, there are various
substitutes available for the particular goods, the demand curve is more elastic than as compare
to demand curve in monopoly market as there is no close substitute available.
(Source: https://opentextbc.ca/principlesofeconomics/chapter/10-1-monopolistic-competition/ )
The above graph explains how the profit maximization works under the
monopolistic competition market place. Under this market state, firms decide the profit
maximization through balance ratio of quantity and price. So the demand curve is depends upon
the quantity supplied and price charged for the goods or services. Under monopolistic each firm
takes the decision regarding the price and output on the basis of market condition, its product
features and its total cost of production (Riley John, 2012).
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Part 3: Profit Maximization and Wealth Maximization
Difference between profit maximization and wealth maximization
Profit maximization is linked with business objective to earn the larger amount of profit
and minimise the inputs required to deliver the same. On the other hand, wealth maximization is
linked with improving the market value of shares to provide maximum return to the
shareholders. Profit maximization is short term objective of the company while wealth
maximization is the long term objective of the company. Profit maximization is adopted for the
short duration of time and under this objective increase of profit is the most important aspect for
the company and management is not willing to pay for discretionary expenses such as
advertising, maintenance cost, research cost and other expenses that have long term impact on
the company wealth (Davies and Crawford, 2011). Although, under wealth maximization
approach management is happy for paying the discretionary expenses in order to increase the
brand value and in turn improving the value of shares and customer satisfaction. In case of profit
maximization, company is less likely to think about the risk, so it is not certainly ready to pay for
hedges that will help to reduce the organization risk profile. On the other hand, wealth focused
company will work on the risk mitigation strategies in order to control the risk and to improve
the changes of profitability. Pricing strategies plays a significant role on both the cases because
high product pricing is followed under profit maximization approach in order to increase the
profit as much as they can but in wealth maximization approach, management always tries to
gain maximum market share through using the pricing strategy that attracts maximum number of
customers (Schlichting, 2013).
Wealth maximization is superior to the profit maximization
Wealth maximization is what companies prefer over the profit maximization due to its
perceived benefits that company receive during the long term plan of the company. Profit
maximization cannot help to achieve the long term business objectives of the company while
wealth maximization helps to all the business goals and objectives. Wealth maximization
improves the company overall value for long period of time while profit maximization does not
concentrate to increase the value of the business (Moles and Kidwekk, 2011). Management
always wants to focus on long term goals and objectives in order to make sure the survival of the
company but it is not possible until management focus on wealth maximization instead of profit
maximization. It can be understood through the hypothetical example. Think about the company
XYZ that plans on profit maximization and charges very high prices for its good and receive
good amount of profit in short run. In this case, eventually the customer will start disliking the
product due to high pricing and will concentrate on subsequent product to satisfy the needs. The
result is that XYZ will succeed in shorter period and fail in long run (Arnold, 2013).
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Part 4: Environmental Policy of the UK Government
The environmental policy is being drafted by the UK government to restore and water
quality and identification of future environmental threats for developing consecutive strategies
for overcoming the environmental risks. The OECD (Organization for economic Cooperation
and Development) has determined the major goals of the UK environmental policy that includes
reducing the pollution, conserving natures and integration of environment and economic
decision-making. The development and incorporation of integrated pollution control (IPC) is a
major component of environment management that has been adopted by the UK government for
protecting the environment. The empirical evidence of the benefits achieved by the development
of environmental policy by the UK government to protect the environment can be displayed as
on the basis of following parameters:
Carbon dioxide emission
(Source:
https://www.parliament.uk/documents/Environment/Carbon_emissions_March_2018.pdf)
Recycling of Waste Materials
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(Source:
https://www.parliament.uk/documents/Environment/Carbon_emissions_March_2018.pdf)
Gas Consumption
(Source:
https://www.parliament.uk/documents/Environment/Carbon_emissions_March_2018.pdf)
It can be stated on the basis of legitimacy and agency theory that the environmental
policy of the UK government is helping it to seek economic prosperity. This is because it is
helping in promoting the transparency in business operations and thus improving the legitimacy
of its operations in the mind of the investors. This is also helping in reducing the agency conflict
between the business managers and the owners and thereby maximizing the organizational
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performances. Thus, it can be said on the basis of these theories that environmental policy is
seeking to drive economic growth of the country.
Fiscal Policy
Fiscal policy of the UK government is intended to achieve a balance between aggregate
demand and aggregate supply by having a control over the government spending and taxation.
The policy mainly seeks to resolve the issues related with unemployment and economic
recessions by influencing the tax levels that provides direct aid to states and firms in the form of
grants, contracts and loans for the purpose of new investment. The federal government is
increased its spending, states, households and offset the prices.
Supply side policies
The supply side policies seek to increases the aggregate supply by enhancing the
productive capacity of an economy while improving quality and quantity of the four factors of
production. The empirical evidence related to the use of supply side policies by the UK
government to reduce the unemployment rate can be depicted as follows:
(Source: https://www.tutor2u.net/economics/reference/reducing-unemployment-supply-side-
policies)
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Part 5: Financial Calculation
Calculation of ratio
Data 2017 2018
Current Assets £ 3,277.00 £ 2,460.00
Current Liabilities £ 2,833.00 £ 2,097.00
Inventory £ 250.00 £ 208.00
Sales £ 7,653.00 £ 6,876.00
Account Receivables £ 2,168.00 £ 1,945.00
Cost of goods sold £ 5,778.00 £ 5,342.00
Ratio Formula Working Result
2017 2018
Current Ratio
Current Assets/Current
Liabilities 3277/2833 1.16 1.17
Quick Ratio
Current Assets less
Inventory/Current
Liabilities (3277-250)/2833 1.07 1.07
Debtors
Payment Period
(Account
Receivables*365)/Sales (2168*365)/7653 103.40 103.25
Stock Turnover
Cost of Goods
Sold/Inventory 5778/250 23.11 25.68
(Krantz, 2016)
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References
Arnold, G., 2013. Corporate financial management. USA: Pearson Higher Ed.
Asche, F. and Bjørndal, T. 2011. The Economics of Salmon Aquaculture. Management. London:
Wiley-Blackwell.
Davies, T. and Crawford, I., 2011. Business accounting and finance. USA: Pearson.
Economics Online. 2019. Competitive markets. [Online]. Available at:
https://www.economicsonline.co.uk/Competitive_markets/Competitive_markets.html#The_profi
t_motive [Accessed on: 24 April, 2019].
Krantz, M. 2016. Fundamental Analysis for Dummies. USA: John Wiley & Sons.
Moles, P. and Kidwekk, D. 2011. Corporate finance. USA: John Wiley &sons.
Nipun, S. 2018. Concept of Consumer’s Sovereignty and Goods. [Online]. Available at:
http://www.economicsdiscussion.net/goods/concept-of-consumers-sovereignty-goods/25147
[Accessed on: 24 April, 2019].
Pettinger, T. 2018. Producer and Consumer Sovereignty. [Online]. Available at:
https://www.economicshelp.org/blog/917/economics/producer-and-consumer-sovereignty/
[Accessed on: 24 April, 2019].
Riley, John G. 2012. Essential Microeconomics. USA: Cambridge University Press.
Schlichting, T. 2013. Fundamental Analysis, Behavioral Finance and Technical Analysis on the
Stock Market. Australia: GRIN Verlag.
Tadajewski, M. 2018. Critical Reflections on the Marketing Concept and Consumer Sovereignty.
London: Routledge.
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