Profit Maximization

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Profit maximization: The ethical mandate of business Journal of Business Ethics Authors: Primeaux, Patrick Authors: Stieber, John Volume: 13 Issue: 4 Start Page: 287 Subject Terms: Profit maximization Models Ethics Economic theory Profit maximization Abstract: A model is proposed for business ethics which arises directly from the business practice. This model is based on a behavioral definition of the economic theory of profit maximization and situates business ethics within opportunity costs. Within that context, it is argued that good business and good ethics are synonymous, that ethics is at the heart and center of business, and that profits and ethics are intrinsically related. Full Text: In the contemporary world of commerce, the very term "business ethics" creates a kneejerk reaction in executive suites signaling negative, defensive responses. Why? Partly because "business ethics" has become associated with abuse and mismanagement. Partly because "business ethics" is a relatively new term, a misunderstood concept, which frightens managers. There also exists a tendency by detractors of the present economic system to universalize exceptions and to think that all men and women in business are seeking greed and power for its own sake. Basic to our argument is a sense of faith and trust in humanity, that the vast majority of men and women in business are struggling to do the right thing in the pursuit of good ethics. Also basic to our argument is a faith and trust in private enterprise and its inherent tendency towards equilibrium and balance. A few exceptions, a few mistakes do not reflect the good ethics of the majority. That same positive, optimistic view of humanity and of the open market is not shared by the traditional voices of morality and ethics - philosophy, religion, and law--at least not to the practical degree of the business enterprise. Consider the virtually impossible task of a Defense Department contractor trying to keep informed and updated on rapidly changing government specifications and regulations. The minute a failure is detected, a red flag is thrown into the air and charges of unethical cheating and over-charging the public become headlines in our newspapers. Once the charge is made the damage is done. Human and financial resources are immediately directed coward clearing the charges through a


bewildering maze of litigation. Cleared of deliberate or intentional wrong-doing, it is often said that the contractor is lucky to read a fifth-page, small-print announcement. In this hypothetical case, as in so many others, there exists an implicit mythology on the part of the media (and on the part of the public) which assumed that business is inherently unethical. The business enterprise is besieged by popular misconceptions as well as by legal, religious and academic theorists anxious to prove that business seeks only self-serving aggrandizement, i.e., to maximize its profits and to do so at any cost to the consumer, the community and the environment. Constantly besieged by these kind of assertions, it is little wonder that business is defensive in matters concerning ethics. There are two ways in which business theory and practice can respond to negative ethical allegations. First, there is a need for business to clarify its function within society as a whole, i.e., to define its role along side those other social entities concerned with ethics in general and business ethics in particular such as academic philosophy, religion and law. Second, there is a need for business to situate ethics within the heart and center of its very self-identification, i.e., within private enterprise and profit maximization. 1. BUSINESS WITHIN SOCIETY What is the role of business within society as a whole? In an earlier essay, John Stieber addressed that question and answered it directly and simply: "to provide the goods and services the consumer wants ..."(1) The word "wants" is deliberately used to distance business from the judgmental implications of personal or communal "needs." The implication here is that judgment or choice belongs to the individual consumer. This question of judgment demands explanation. Decidedly, the "open market" or "private enterprise" system rests in individual decision-making. The "judge" within this economic frame of reference is any individual who possesses the freedom to produce or not produce, to purchase or not purchase any product he or she so desires. According to the private enterprise purist, the market will regulate itself without any need for externally induced controls. Likewise, in questions of judgment, ethical decisions about the purchase or sale of a product will be determined and/or regulated by the market in compliance with the free choice of individuals. Ideally, there would be no need for external ethical controls. Who determines whether there exists a "want" for guns? The individual consumer does. Were the individual consumer to judge that he or she had no "want" for this particular product, it would not be produced. On the other hand, if the producer judged, in conscience, that he or she should not produce this item, it would not be produced, at least not by that individual. It could, however, be produced by another individual whose ethics would allow him or her to do so.


There is, then, integral to the private enterprise economic system a bias towards individual ethics and judgments. This bias is grounded in a positive evaluation of individual human dignity and the capacity of the human spirit to choose what is best for itself. That decision or judgment is, accordingly, made by the individual who may or may not, to one degree or another, be influenced or not influenced by implicit or explicit philosophical, religious or legal tenets. Even though free market theory and business practice focus on the individual as the locus of judgment or choice, that individual judgment or choice is influenced or tempered by social, communal factors, i.e., by the judgments and choices of others. It is precisely through genetic and environmental development factors (influenced by philosophical, religious, and legal concerns) that this social dimension is realized. These factors and influences situate the individual within society and provide a context for individual decision-making. Business and free enterprise have always valued that social dimension and have always realized its practical significance. In practice, both the producer and the consumer have also been conscious and aware of social customs, values and beliefs when buying and selling. Stieber recommends an economics based not simply on "providing goods and services the consumer wants," but doing so within the "ethical mores of society."(2) If the individuals who comprise a particular society perceive birth control methods to be unethical, those particular items would not be bought. Nor would any producer, sensitive to the ethical mores of that particular society, attempt to produce or market them. Or, perhaps he or she would attempt production and distribution thereby moving to change ethical mores. That change could not or would not occur unless a significant number of individuals would themselves choose to do so. Is that not one way in which change is realized? We can, of course, continue to discuss the relationship between the individual and the community in an abstract manner, questioning to what degree any particular relationship is more or less individualist or communal. We can also question to what degree the individual or the community has precedence in moral, ethical judgment. However, inquiries of that kind fall within the realm of philosophy which is at least two, if not three, steps removed from practical decision-making in business. 2. PROFIT MAXIMIZATION AND BUSINESS ETHICS Perhaps an analogy may help to substantiate the argument. The individual athlete approaches a game of football with his or her own personal sensibility to a certain philosophical perspective, religious commitment, and adherence to the law. That sensibility may even define the individual athlete and his or her relationships with others. In practice, however, that sensibility is "bracketed" or suspended as the rules of the game assume precedence. Of course, the individual can make a prior choice to play or not to play, and perhaps philosophical, religious or legal commitments may inspire that choice. But once that choice has been made the rules of football dictate


a certain behavior. We would argue, as in the case of a game of football, that there are rules of business which, in practice, take precedence. We would also argue that the rules of business actually constitute the basis for a business ethics which is both internally consistent and externally valid. Essentially, we would define business ethics in terms of neo-classical economic theory and its advocacy of profit maximization. Integral to our understanding of profit maximization is a behavioral dimension which reaches beyond an exclusive preoccupation with bottom-line profit and, at the same time, presumes a social or communal dimension as integral to business. In other words, we would not define business exclusively in terms of individualist self-aggrandizement or self-interest but, rather, in terms of a behavioral efficiency of benefit to both individuals and society that is embodied, but usually overlooked, in the behavior of profit maximization. The neo-classical theory of economic efficiency is rooted in a dual realization: (1) that men and women in business are managers and (2) that managers allocate scarce resources of land, labor-time, capital, and human creativity in a world of unlimited human wants. The success or failure of a manager is measured by the amount of goods or services produced from a given sec of scarce resources. Those who produce the most are efficient; those who produce less are inefficient. The human behavior driving this efficiency is prescribed in the paradigm of profit maximization. When business men and women profit maximize, i.e., allocate resources efficiently, people have more of the things they want, and that is good. When they do not profit maximize, i.e., allocate scarce resources inefficiently, people have less of the things they want, and that is bad. This is especially true if the things they want are food, health care, education, and other necessities of life. Since ethics is basically a study of good and bad activity, then the decision to profit maximize or not to profit maximize becomes a question of applied or practical ethics. Unfortunately, the ethical considerations prescribed in the profit-maximization paradigm are much more complex than one might readily perceive. The simple choice to profit maximize or not to profit maximize is deeply rooted in behavioral tenets which tie the allocation of scarce resources to good business as well as to good business ethics. The origins of profit maximization, with its own ethical considerations and its own tenets, originated in antiquity. When Adam and Eve were evicted from the Garden of Eden they discovered how once upon a time, in illo tempore, inside the garden they had unlimited resources. They could have anything they wanted. Evicted from the garden, they discovered that resources were scarce and that survival and prosperity demanded efficient management of these scarce resources. Because they did survive, it is safe to presume that they had learned the basic tenets of profit maximization.


There are two ways to examine the tenets of profit maximization. One is from a technical perspective; the other from a behavioral perspective. Technically, profit maximization is defined as that set of conditions where the marginal revenue of the firm is equal to its marginal cost (MR = MC)(3) and the marginal cost curve must intersect the marginal revenue curve from below. For the manager of the firm, these conditions mean that the firm will continue to produce as long as the revenues from each unit sold exceed the cost. As more units are produced, the scarce resources used reach diminishing returns hereby causing marginal cost to increase. Eventually, marginal cost will equal marginal revenue. At that point, and only at that point, the firm will be operating at a level of output that guarantees the community the maximum amount of goods and services the firm can produce with the given set of resources it has. If the firm produces at a point where marginal revenue is greater than marginal cost (MR > MC), it is choosing a level of output that is less than the profit maximizing output, and the community will have fewer goods and services. Inasmuch as more homes, more education, more health care, etc. from a given set of resources are good, and less of these goods and services from a given set of resources are bad, there is an ethical dimension associated with any decision to produce at an output level where marginal revenue is greater than marginal cost (MR > MC). If the firm produces at a point where marginal revenue is less than marginal cost (MR < MC), it is choosing a level of output that is greater than the profit-maximizing output, and the community has more goods and services. The problem with this decision is that it costs more to make these additional units of output than the revenues they generate, and the company will lose money. It is axiomatic that any firm continuing to produce at a loss will eventually go out of business. Therefore, what first appears to be a windfall for the community turns into a disaster. The firm shuts down, all of the things it once produced, including the windfall, disappear; and the community has fewer goods and services. As before, there is an ethical dimension associated with the decision to produce where marginal revenue is less than marginal cost (MR < MC). Everyone would be hurt: managers, employees, stockholders, consumers and the community as a whole, i.e., less taxes, employment and philanthropy. Since more is better than less from a given set of scarce resources, producing where marginal revenue is equal to marginal cost (MR = MC), profit maximizing, is efficient and ethical. Producing where marginal revenue is greater than or less than marginal cost, not profit maximizing, is inefficient and unethical. That ethical judgment rests first and foremost within practical economics and has consequences for individuals as well as for society as a whole. Today there is a tendency to think of profit maximization from a purely technical perspective. Milton Friedman's well-known statement that "the social responsibility of business is to increase profits"(4) belongs to this technical perspective and probably


would never have occurred to Adam and Eve. For them, the social responsibility of managers would go beyond bottom-line profits. They would have been concerned, however, with Friedman's understanding that the responsibility of the corporate executive "is to conduct the business in accordance with [the owner's] desires which will be to make as much money as possible."(5) They would not have understood that imperative to refer exclusively to bottom-line profits or individual aggrandizement without considerations of its effect on others. Nor would they have agreed with Friedman's injunction that the corporate executive "makes as much money as possible while conforming to the basic rules of society, both those embodied in law and those embodied in ethical custom."(6) They would have thought Friedman was confusing the issue. Rather than identifying business as integral to society, Friedman sets business apart to be judged or regulated by society's standards: philosophical, religious, and legal. Adam and Eve would have perceived profit maximization at the very heart and center of society, and its values consistent with those of society. >From a behavioral perspective, profit maximization is defined as the act of producing the right kind and the right amount of goods and services the consumer wants at the lowest possible cost (within the legal and ethical mores of the community).(7) The phrase "within the legal and ethical mores of the community" is placed in parentheses because, as we shall soon see, they are already contained within the costs of the firm Businesses know they are producing the right kind of goods and services if there is a market demand for them, i.e., if consumers are willing to pay a price for them. The use of the word "right" in this phrase implies ethical considerations, which, as we mentioned earlier, are rooted in the individual conscience of the producer and consumer. In North America, where consumers are becoming more aware of the medical difficulties associated with smoking, cigarette sales have declined. In other areas, where information is not as readily available or where different cultural factors take precedence over the medical, cigarettes are in greater demand. Is it the role of business to decide that cigarettes should not be supplied to them? According to the rules of private enterprise, that decision should be made by the (even unenlightened) consumer and producer who is willing to supply the product. Businesses also know when they are producing the right amount of good and services. It is, as we have just demonstrated, that level of output where marginal revenue is equal to marginal cost (MR = MC). Any other output level would be inefficient and, consequently, unethical. Producing at the lowest cost is probably the most recognizable tenet of business behavior. Failure to be cost-reduction sensitive could jeopardize the ability of the firm to survive. Other firms in the industry are keenly aware that lower costs give them an advantage in the marketplace. Low-cost advantage, maintains the highly acclaimed


British economist Alfred Marshall in his Principles of Economics, "permeates all the economic adjustments of the modern world."(8) The costs of production for any firm can be, and usually are, systematized into three general categories: fixed, variable, and opportunity costs. Fixed costs can be defined as those costs which do not vary with output, such as plant and equipment costs. Variable costs can be defined as those costs which do vary with output, such as labor-time and materials. Opportunity costs can be defined as the foregone goods and services that could have been produced from a given set of resources that were used to produce some other goods and services. Because managers are constrained by statute to certify only the fixed and variable costs of the firm, he opportunity costs incurred by the firm seldom appear in its financial statements. When they do, one must look for them in footnotes. On the other hand, managers are not subject to the constraints of statutes when they examine the opportunity costs of their decisions. Many of them are aware (and if not, should be aware) that opportunity costs can be significant for any decision. They are also aware that philosophical, religious, and legal considerations represent some, but not all, of the opportunity costs to which they must be sensitive. There are two key phases in our definition of opportunity costs that should help us understand their role in business decisions and how ethical considerations, or lack thereof, bring about opportunity costs for the firm. The two phases are "the foregone goods and services" and "from a given set of resources." Assume that a business has a fixed amount of money from the earnings it has retained to invest for its owners. Further, suppose it decides to start a used car lot in an Amish town. Once these resources ("a given set of resources") are committed to the project, they can never be used to produce any other goods and services for the community such as health care, education or housing ("foregone goods and services"). Besides the usual business considerations associated with this decision (location, lease costs, hiring, taxes, etc.), there is a serious ethical consideration that must be addressed. The Amish do not drive cars. Were management insensitive to this ethical behavior, the project would fail and the resources would be lost. If the project were to fail because the management of this firm was insensitive to the ethics of the situation, the opportunity costs for the community would be that a whole set of scarce resources was used to produce something consumers did not want. Furthermore, these wasted resources can never be used to produce anything else. The opportunity cost for the firm is a loss of money from a set of scarce resources that could have been used for another project.


>From a broader perspective, what we see in this example is that managers who do not examine the ethical dimensions of their decisions create negative economic consequences which represent opportunity costs for their companies and consumers. These managers would not be profit maximizing because they failed to consider the opportunity costs associated with the ethical dimensions embodied in any and every decision-making situation. Usually the ethical considerations associated with a business decision are more complex than trying to sell used cars in an Amish town. In November of 1976, a customer of General Motors took his 1977 Oldsmobile Delta 88 to a mechanic for servicing.(9) The mechanic discovered a Chevrolet engine under the hood. Reporters for the mass media became interested in the story, and a flood of adverse publicity led to a storm of public indignation and class action against GM. There were charges of fraud and unethical behavior. In its defense, General Motors claimed it did no wrong, that interchanging parts was a common practice in the industry. The automobile manufacturer tried to explain the practice and demonstrated that its behavior was in the best interest of the consumer because it reduced costs. Five months later, in an attempt to stop public controversy and reduce its legal liability, GM offered a settlement to the affected car buyers. It has been estimated that the settlement was forty million dollars. There were also extensive legal costs which have never been revealed. These were dollars that could never be used again to develop or produce other goods and services. There were, to be sure, other opportunity costs. Incalculable human resource hours and energy were lost. Rather than directing these hours and energies to enhance the interests of stockholders, employees, and customers, they were used to put out fires. In addition, no one knows how many customers were driven off or what it might cost to bring them back. The important question here is whether management followed the prescribed behavior required by profit maximization and examined the ethical considerations of this decision. If not, they were not profit maximizing and, a priori, were not ethical. Be that as it may, what if management did follow the prescribed behavior of profit maximization and concluded that its choice to interchange automobile parts was consistent with the ethical mores of the community? Even though its judgment proved to be wrong, GM management had at least cried to evaluate the ethical dimensions of its decision. We would argue that the very behavior of considering the ethical mores of the community would, of itself, meet the minimum requirements of profit maximization In effect, the decision required an evaluation of GM's opportunity costs and a projection that the opportunity costs of interchanging automobile parts would equal zero.


The difference between examining the ethical considerations of a decision and not examining them is absolutely crucial. No one expects managers to be omnipotent. We can, however, expect managers to consider ethical mores as they would any other opportunity cost when making decisions. If they do that, they are profit maximizing. Sometimes we forget that the nature of decision-making is such that managers, in good faith, can examine all of the available data and still make wrong decisions. Good ethics does not guarantee perfection, and good business ethics does not guarantee perfect decisions. However, by examining the opportunity costs of ethical considerations, managers are realizing that there are behavioral options which surpass individual self-aggrandizement or bottom-line profits. That is, they are realizing the existence and significance of the social dimension within the business enterprise that goes beyond a regulatory agency standing outside of and apart from business. They are also realizing that within the practical, behavioral dimension of profit maximization there exists an objectivity that can and does play a pivotal role in business ethics. The objectivity of profit maximizing, while recognizing individual differences, surpasses and grounds these differences. 3. INDIVIDUAL ETHICS AND PROFIT MAXIMIZATION As the rules of a football game assume precedence over individual ethical sensibilities, so do the rules of profit maximizing in business assume precedence over individual ethical differences. In business, as in football, individual values and beliefs become suspended or bracketed, especially those that are at odds with the game. Furthermore, even though philosophical, religious and legal considerations may influence one's choice to play the game, once the decision is made to enter the playing field, the rules of the game take precedence. On a more practical note, how does one respond to a situation where there is a conflict between the personal ethics of the manager and the ethical considerations of a business decision? Suppose the senior management representative on a committee of managers considering a potential business decision must approve or disapprove the recommendation of the group. All of the fixed and variable costs have been calculated, the opportunity costs (including the ethical considerations) have been examined, and the consensus of the group is to proceed. However, the senior manager cannot reconcile his or her own personal ethics with the consensus of the group. What does the profit maximization model require? Profit maximization does not include personal ethics; only the opportunity costs of not being sensitive to the ethics of the community. However, it does include the inefficiencies that can be created by the manager if this conflict leads to paralysis of ineffectiveness. The manager has no recourse but to resign. When, in 1978, Holiday Inn decided to open up a hotel and casino in Las Vegas, Nevada, the president of the company faced a dilemma. His personal ethics were at


odds with that of the community's acceptance of gambling. He knew the decision was in the best interest of the company, but he could not reconcile it with his own aversion to gambling, so he resigned. To have given up all of the economic advantages and prestige of being president of a major corporation indicate the depth of commitment this man had to his personal ethics as well as to the profit maximization objectives of the company. To his unending credit, his behavior was consistent with profit maximization.(10) If, on the other hand, managers are able to reconcile conflicts between their personal ethics and those involved in any profit maximization decision, there is no problem. They will continue to be effective, and their behavior will be consistent with the demands of profit maximization. However, any time this happens, the manager has essentially changed his or her ethics because, a priori, one cannot enter into a process of reconciliation without changing one's values. From an economic perspective, it could be argued that the individual manager sold all or part of his or her ethics for another set of ethics. One of the major postulates of economics is that personal attributes and talents such as self-respect, decency and ethics are also economic goods as are food, shelter and health care. Like all economic goods, they also are bought and sold. Usually, the practice of buying and selling involves an explicit price. Sometimes, though, economic goods are bought and sold for other economic goods, i.e., bartering. Like other people, managers barter with their ethics. They trade, as everyone does, their childhood ethics for adult ethics. If they didn't, they wouldn't mature. They also sell their ethics for a money price, even putting aside/reconciling their personal ethics for a good-paying job. Whether the behavior of buying and selling one's personal ethics is right or wrong is the realm of the philosophical or religious moralist. We know that people do it and that the discipline of economics describes how they do it. However, we also know that the paradigm of profit maximization refers to personal ethics only to the extent that any conflict between the ethics of the manager and that of the company which leads to personal inefficiency requires that he or she resign. What we have tried to demonstrate in this essay is that the behavior of profit maximization includes an examination of the opportunity costs associated with all business decisions and that ethical considerations represent some, but not all, of the opportunity costs of a given decision. We have also argued that our behavioral paradigm of profit maximization provides an objective basis for business ethics, i.e., a basis for business ethics which is inherent to business itself. Contrary to popular misconceptions, profit maximization doesn't encourage flagrant disregard for community standards of pollution, safety, exploitation of human and natural resources, etc. Profit maximization demands that the ethos and mores of the


community become integral to the decision-making process. In fact, issues raised by philosophical, religious and legal Concerns are also the concerns of business and its required sensitivity to the community embodied in opportunity costs. As we mentioned earlier, managers do make mistakes in their evaluation of ethical issues that relate to business, but so do lawyers, college professors, physicians and ministers with regard to their own professional ethics. We all know that there are business men and women who abuse the ethics of business, but so do other professional men and women. That doesn't mean that profit maximization is bad. It means that people who deliberately violate the precepts of this economic behavior are bad. As it relates to personal ethics, profit maximization is clear. It does not include them in the model. However, it does recognize the inefficiencies that can be generated in the event of a conflict between the personal ethics of the manager and the ethics of the company. NOTES 1 Stieber, J.: 1987, 'The Role of Profit in our Social Organization', Handbook of Business Strategy, 1986-87 Yearbook (Warren, Gorham, and Lamont, Boston), Ch. 8. 2 John Stieber, Ch. 8. 3 Profit (pi) = Total Revenue (TR) - Total Cost (TC) pi = TR - TC = f(x) = g(x). The first-order conditions for profit maximization are: d(pi)/dx = f'(x) - g'(x) = 0 Or f'(x) = g'(x) That is, MR = MC The second-order conditions must show: d(d)(pi)/d(x)(x) < 0. 4 Friedman, M.: 1988, 'The Social Responsibility of Business is to Increase Its Profits: in T. Donaldson and P. H. Werhane (eds.), Ethical Issues in Business: A Philosophical Approach (Prentice Hall, Englewood-Cliffs, NJ), p. 218. 5 Milton Friedman, p. 218. 6 Milton Friedman, p. 218. 7 John Stieber, p. 8. 8 Marshall, : 1962, Principles of Economics (Macmillian & Co., London), p. 335. 9 Steiner, G.A. and J.F. Steiner: 1980, Casebook for Business, Government, and Society (Random House, New York), pp. 124-126.


10 Letter from Kemmons Wilson to John Stieber, August 13, 1990, private papers of John Stieber. Department of Theology and Religious Studies, St. John's University, Jamaica, New York, U.S.A. Department of Finance, Edwin L. Cox School of Business, Southern Methodist University, Dallas, TX 75275-0033, U.S.A. Marist Father Pat Primeaux is a Professor of Theology at Saint John's University, (New York). John Stieber is a Professor of Finance and Economics at Southern Methodist University's Edwin L. Cox School of Business (Dallas). They have collaborated on several articles on the behavioral dimension of economic efficiency. They have also designed and taught courses in business ethics at both the graduate and undergraduate level.

Profit Maximization

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