Master of Business Administration

EAST AFRICAN COLLAGE

Individual Assignment of Managerial Economics

Name:- Mohammed Abdukadir Hassen

IDNO:- PGR/00205/15
1. Why Managerial Economics is relevant for managers?
In a civilized society, we rely on others in the society to produce and distribute nearly all
the goods and services we need. However, the sources of those goods and services are
usually not other individuals but organizations created for the explicit purpose of
producing and distributing goods and services. Nearly every organization in our
society—whether it is a business, nonprofit entity, or governmental unit—can be viewed
as providing a set of goods, services, or both. The responsibility for overseeing and
making decisions for these organizations is the role of executives and managers.
Most readers will readily acknowledge that the subject matter of economics applies to
their organizations and to their roles as managers. However, some readers may question
whether their own understanding of economics is essential, just as they may recognize
that physical sciences like chemistry and physics are at work in their lives but have
determined they can function successfully without a deep understanding of those
subjects.
Whether or not the readers are skeptical about the need to study and understand
economics per se, most will recognize the value of studying applied business disciplines
like marketing, production/operations management, finance, and business strategy. These
subjects form the core of the curriculum for most academic business and management
programs, and most managers can readily describe their role in their organization in terms
of one or more of these applied subjects. A careful examination of the literature for any
of these subjects will reveal that economics provides key terminology and a theoretical
foundation. Although we can apply techniques from marketing, production/operations
management, and finance without understanding the underlying economics, anyone who
wants to understand the why and how behind the technique needs to appreciate the
economic rationale for the technique.
We live in a world with scarce resources, which is why economics is a practical science.
We cannot have everything we want. Further, others want the same scarce resources we
want. Organizations that provide goods and services will survive and thrive only if they
meet the needs for which they were created and do so effectively. Since the
organization’s customers also have limited resources, they will not allocate their scarce
resources to acquire something of little or no value. And even if the goods or services are
 of value, when another organization can meet the same need with a more favorable
exchange for the customer, the customer will shift to the other supplier. Put another way,
the organization must create value for their customers, which is the difference between
what they acquire and what they produce. The thesis of this book is that those managers
who understand economics have a competitive advantage in creating value.
2. Managerial Economics belongs to the class of Positive Economics than Normative
Economics. Do you agree? Justify your answer.
Positive and Normative Economics is rightly known as the two arms of Economics. Positive
economics deals with various economic phenomena, while normative economics focuses on
what economics should be, this branch of economics talks about the value of the company’s
fairness. In lucid language, positive economics answers the ‘what’ factor, whereas normative
economics mandates the ‘should be’ or ‘ought to be’ section of economics.

Well, this was only a preface about the entire discussion. We will look forward to discussing
‘What is Positive and Normative Economics?’, we will take up the point of conflict between
these two studies and also update ourselves with other knowledgeable facts on the same topic.

What is Positive Economics?

Positive economics is the stream of economics that has an objective approach, relied on facts. It
concentrates on the description, quantification, and clarification of economic developments,
prospects, and allied matters. This subdivision of economics relies on objective data analysis and
relevant facts and figures. Therefore, it tries to establish a cause-and-effect relationship or
behavioral relationship that can help determine as well as test the advancement of economic
theories.
Here, the study of economics is more objective and focuses more on facts. Moreover, the
statements are precise, descriptive, and measurable. Such reports can be quantified with respect
to noticeable evidence and historical references.
A positive economics example is a statement, “Government-funded healthcare surges public
expenditures.” This statement is based on facts and has a considerable value judgment involved
in it. Therefore, its credibility can be proven or dis-proven via a study of the government’s
involvement in healthcare.
What is Normative Economics?

Normative economics deals with prospective or theoretical situations. This division of economics
has a more subjective approach. It focuses on the ideological, perspective-based, opinion-
oriented statements towards economic activities. The aim here is to summarise the desirability
quotient among individuals and quote factors like ‘what can happen’ or ‘what ought to be’.
Normative economics statements are subjective and rely heavily on values originating from an
individual opinion. These statements are often very rigid and perceptive. Therefore, they are
considered political or authoritarian.
A normative economics example is, “The government should make available fundamental
healthcare to every citizen”. You can understand that this statement is based on personal
perspective and satisfies the need for ‘should be’ or ‘ought to be’.
Difference between Positive and Normative Economics

Positive and Normative Economics do have some underlying differences between them. We will
analyze the differences between them in terms of meaning, perspective, and function, area of
study, testing, and economical clarification. Now, let us delve into it right away.
Meaning

Positive economics means more focus on data, facts, and figures rather than personal
perspectives. The statements here are to the point and supported by relevant information. On the
other hand, normative economics focuses more on personal perspectives and opinions rather than
facts and figures. Here the statements are based on an individual’s point of view, and ample data
is always available to support such claims.
Perspective

The perspective of these two concepts is a significant point of difference between them. Positive
economics is objective, whereas normative economics is subjective. The focus of positive
economics is on presenting relevant and more focused statements backed by actual data.
Contrarily, normative economics focuses on presenting statements that may or may not be
possible in the future. Moreover, in some cases, such statements do not have any credible data to
back them up.
Function
Their functions can distinguish between positive and normative economics. Positive economics
describes the cause and outcome of the relationship among variables. On the other hand,
normative economics provides value judgment.
Area of Study

Positive economics is the study of ‘what is’; whereas normative economics describes ‘what
should be’. One branch relies on a factual approach supported by data. Contrarily, normative
economics relies more on personal opinions rather than actual data.
Testing

Every statement of positive economics can be tested scientifically and either proven or
disregarded. However, normative economics statements cannot be tested scientifically. It entirely
depends on the belief of an individual.
Economical Clarification

Positive economics provides a more scientific and calculated clarification on an economic issue.
However, normative economics also provides such solutions but ones that are based on personal
values.
Case in Points of Positive Economics – Examples

 Monopolies have proved to be inefficient

 The desired rate of return on gambling stocks are higher compared to others

 The relationship between wealth and demand is inverse in the case of inferior goods

 House prices reduce once the interest rate on loans get higher

 Car scrap page schemes can result in a fall in the prices of second-hand cars
Case in Points of Norma tics Economics – Examples

 The government should implement strict wealth tax laws to decrease the uneven
distribution of wealth

 No individuals should be entitled to inheritances as it belongs to society

 Import duties should be increased on goods coming from nations with humble human
rights record
  Investors ought to be more socially responsible and stop investing in vice stocks

 Developing countries should only accept democracy when their entire population is
educated and liberated
What is the Importance of Positive and Normative Type Economics?

Even though normative economics is a subjective study, it acts as a base or a platform for out-of-
the-box thinking. These concepts will provide a basic foundation for the innovative ideas that
will ignite to reform an economy.
However, all the decisions cannot rely on them altogether. On the other hand, Positive
economics is needed to provide an objective approach. Positive economics is focused on the
facts and analyses of the effects of such decisions in society and thereby it helps by providing a
statement that comprises the necessary information to make a sound economic decision.
Normative economics is thus useful in creating and generating newer ideas from another or
different perspectives, also note it cannot be the only basis for making decisions on important
economic issues, and here the positive economics come into action thus complementing each
other.
So, Positive economic theory can help the economic policymakers to implement the normative
value judgments. Like - it can describe how the government is in power to impact inflation by
printing more money or restructuring the banking reforms, this economics can support that
statement with strong facts and analysis with relationships between inflation and growth in the
money supply of an economy.

3. The economic theories used in managerial economics are analyzed and discussed
largely in neo classical framework. Explain the neo classical approach
Neoclassical economics is a broad theory that focuses on supply and demand as the driving
forces behind the production, pricing, and consumption of goods and services. It emerged in
around 1900 to compete with the earlier theories of classical economics.

KEY TAKEAWAYS

 Classical economists assume that the most important factor in a product's price is its cost
of production.
  Neoclassical economists argue that the consumer's perception of a product's value is the
driving factor in its price.
 The difference between actual production costs and retail price is the economic surplus.
 Neoclassical economic theory can impact how businesses operate gov and financial
institutions operate, as well as how governments regulate markets.
 Critics argue the theory doesn't account for other factors that impact consumer decisions,
such as limited information, resource inequality, or emotional thinking.
One of the key early assumptions of neoclassical economics is that utility to consumers, not the
cost of production, is the most important factor in determining the value of a product or service.
This approach was developed in the late 19th century based on books by William Stanley
Jevons, Carl Menger, and Léon Walras.

Neoclassical economics theories underlie modern-day economics, along with the tenets of
Keynesian economics. Although the neoclassical approach is the most widely taught theory of
economics, it has its detractors.

Understanding Neoclassical Economics

Neoclassical economics emerged as a theory in the 1900s.1 Neoclassical economists

believe that a consumer's first concern is to maximize personal satisfaction, also known as
utility. Therefore, they make purchasing decisions based on their evaluations of the utility of a
product or service. This theory coincides with rational behavior theory, which states that people
act rationally when making economic decisions. In other words, people make a logical choice
between two options based on their perception of which one is better for them.

Further, neoclassical economics stipulates that a product or service often has value above and
beyond its production costs. While classical economic theory assumes that a product's value
derives from the cost of materials plus the cost of labor, neoclassical economists say that
consumer perceptions of the value of a product affect its price and demand.2

Finally, this economic theory states that competition leads to an efficient allocation of resources
within an economy. The forces of supply and demand create market equilibrium.
In contrast to Keynesian economics, the neoclassical school states that savings determine
investment. It concludes that equilibrium in the market and growth at full employment should
be the primary economic priorities of government.

These principles can be summed up in three assumptions that underpin neoclassical economic
theory:

1. Rational thinking: People make rational choices between options based on the value
that they identify in each choice.
2. Maximizing: Consumers aim to maximize utility, while businesses aim to maximize
profits.
3. Information: People act independently based on having all the relevant information
related to a choice or action.2

Criticisms of Neoclassical Economics

Critics of neoclassical economics believe that the neoclassical approach cannot accurately
describe actual economies. They maintain that the assumption that consumers behave
rationally in making choices ignores the vulnerability of human nature to emotional responses.

Neoclassical economists maintain that the forces of supply and demand lead to an efficient
allocation of resources.

Other critiques of neoclassical economics include:

 Distribution of resources: Resource distribution impacts how people make decisions,

but resources are not distributed equally. There are important differences, especially
between those whose income comes from performing labor and those whose income
comes from owning capital.
 Appropriation of resources: Resources are often claimed by those with economic or
military power, regardless of whether they were previously owned by people or groups
with less power.
  Available choices: People may attempt to make rational decisions, but they can only
choose between the available choices. For example, choosing between a job that
endangers your health or losing your family home is not the same as choosing between a
dangerous job and a safe one.
 Irrational decisions: People do not always make the most rational decision, or only
consider the benefit to themselves as an individual when making choices. They may be
influenced by social pressure, the needs of others, available choices, income restraints,
imperfect information, or existing power structures to make choices that don't maximize
utility to themselves.
 Pursuit of profit: Maximizing profit is not the only or best way for markets to function,
as this can exacerbate inequality, exploit workers, and damage the environment or
community. Markets or businesses structured around solving a problem, such as non-
profit organizations or single-payer healthcare systems, can often function with equal
levels of efficiency and effectiveness.
 Standards of living: Producing more goods and services (having a higher GDP) does
not always equal a higher standard of living. Neoclassical economics equates standards
of living with "amount of goods and services consumed," but consuming more does not
always improve measures such as health, life expectancy, social equality, economic
stability, or other factors in quality of life.
Some critics also blame neoclassical economics for inequalities in global debt and trade
relations because the theory holds that labor rights and living conditions will inevitably
improve as a result of economic growth.

Neoclassical Economics In the Real World

Neoclassical economic theory is important because of how it affects both markets and economic
policy.

Business

The principles of neoclassical economics can be used by companies to set prices and grow their
business.
A business that understands neoclassical economics, for example, won't just look at the cost of
making a product when setting a price. It will also consider what competitors are charging, what
customers are willing to pay, and how to use branding to increase what customers are willing to
pay. A savvy business owner, for example, could create a marketing campaign that positions
their product as the favorite choice of popular figures on social media. By influencing customer
perception of their brand, the business will be able to charge more for their products.

Governments and Banks

Governments and banks can also follow neoclassical principles, which will impact economic
policy and market regulation. Followers of neoclassical economics believe that there is no upper
limit to the profits that can be made by smart capitalists since the value of a product is driven by
consumer perception. This difference between the actual costs of the product and the price it is
sold for is termed the economic surplus.

This type of thinking was evident in the lead-up to the 2008 financial crisis. Modern economists
believed that synthetic financial instruments had no price ceiling because investors in them
perceived the housing market as limitless in its potential for growth. As a result, many
investment banks and lenders continued to grow the market for subprime mortgages, assuming
that continued growth in the market would prevent investment instruments that included these
mortgages from losing value.4 These financial instruments were mostly unregulated by the
federal government, allowing lenders and investors to drive growth in the subprime mortgage
market.

Both the economists and the investors were wrong, and the market for those financial
instruments crashed. The housing market did eventually stop growing and begin to decline.
Subprime lenders found themselves underwater on mortgages that they could not afford. They
began to default in large numbers.6 This not only left huge numbers of borrowers unable to
afford their homes, but it also undermined the stability of the banks and lenders who had backed
their mortgages.7 The entire global economy suffered and required government intervention to
stabilize.

What Are the Main Elements of Neoclassical Economics?

The main assumptions of neoclassical economics are that consumers make rational decisions to
maximize utility, that businesses aim to maximize profits, that people act independently based
on having all the relevant information related to a choice or action, and that markets will self-
regulate in response to supply and demand.

What Is the Difference Between Neoclassical and Keynesian Economics?

Neoclassical economic theory believes that markets will naturally restore themselves. Prices,
and therefore wages, will adjust on their own in response to changes in consumer
demand. Keynesian economic theory does not believe markets can adjust naturally to these
changes. It encourages using fiscal and monetary policy to impact the economy, specifically by
slowing the economy during booms and stimulating it during recessions.

The Bottom Line

Unlike classical economists, who believe the cost of production is the most important factor in a
product's price, neoclassical economists state that prices should be based on how consumers
perceive the value of a product. They also believe that consumers make rational decisions to
maximize utility.

Under neoclassical theory, markets are self-regulating. Competition leads to efficiently

allocated resources. The interaction of supply and demand creates equilibrium, which allows
markets to adjust to changes without needing to be rebalanced by fiscal or monetary policy.

Critics of neoclassical economics argue that it does not take into account real-world factors that
influence consumer decisions. These can include limited access to information, unequal
distribution of resources, social constraints, and emotional thinking. Critics also point to the
dangers of businesses attempting only to maximize profit or looking at GDP as the best
indicator of standard of living.
 4. Distinguish between Economic Versus Accounting Measures of Cost and Profit
using relevant example.
Explicit and implicit costs and accounting and economic Profit
Private enterprise—the ownership of businesses by private individuals—is a hallmark of the US
economy. When people think of businesses, often giants like Wal-Mart, Microsoft, or General
Motors come to mind. But firms come in all sizes, as you can see in the table below.

The vast majority of US firms have fewer than 20 employees. As of 2010, the US Census Bureau
counted 5.7 million firms with employees in the US economy. Slightly less than half of all the
workers in private firms are at the 17,000 large firms, firms that employ more than 500 workers.
Another 35% of workers in the US economy are at firms with fewer than 100 workers.

These small-scale businesses include everything from dentists and lawyers to businesses that
mow lawns or clean houses. There are also millions of small, non-employer businesses where a
single owner or a few partners are not officially paid wages or a salary but simply receive
whatever they can earn—there is not a separate category in the table for these businesses.

Number of Firms, % of total Number of paid employees, % of total

employees firms employment

Total 5,734,538 112.0 million

0–9 4,543,315, 79.2% 12.3 million, 11.0%

10–19 617,089, 10.8% 8.3 million, 7.4%

20–99 475,125, 8.3% 18.6 million, 16.6%

100–499 81,773, 1.4% 15.9 million, 14.2%

500 or more 17,236, 0.30% 50.9 million, 49.8%

Range in size of US firms

Source: 2010 US Census, www.census.gov

Each of these businesses, regardless of size or complexity, tries to earn a profit.

\[\text{Profit}=\text{Total revenue} - \text{Total cost}\]

Total revenue is the income brought into a firm from selling its products. It is calculated by
multiplying the price of the product times the quantity of output sold:

\[\text{Total revenue}=\text{Price} \times \text{Quantity}\]

We can distinguish between two types of cost: explicit and implicit. Explicit costs are out-of-
pocket costs—payments that are actually made. Wages that a firm pays its employees or rent that
a firm pays for its office are explicit costs.

Implicit costs are more subtle but just as important. They represent the opportunity cost of using
resources already owned by the firm. Often for small businesses, they are resources contributed
by the owners—for example, working in the business while not getting a formal salary or using
the ground floor of a home as a retail store. Implicit costs also allow for depreciation of goods,
materials, and equipment that are necessary for a company to operate.

These two definitions of cost are important for distinguishing between two conceptions of
profit—accounting profit and economic profit. Accounting profit is a cash concept. It means total
revenue minus explicit costs—the difference between dollars brought in and dollars paid
out. Economic profit is total revenue minus total cost, which includes both explicit and implicit
costs.

The difference is important. Even though a business pays income taxes based on its accounting
profit, whether or not it is economically successful depends on its economic profit.

Calculating implicit costs

Let's take a look at an example in order to understand better how to calculate implicit costs.

Fred currently works for a corporate law firm. He is considering opening his own legal practice,
where he expects to earn $200,000 per year once he gets established. To run his own firm, he
would need an office and a law clerk. He has found the perfect office, which rents for $50,000
per year. A law clerk could be hired for $35,000 per year. If these figures are accurate, would
Fred’s legal practice be profitable?

Step 1. First we'll calculate the costs. We'll use what we know about explicit costs:
\[\begin{aligned}\text{Explicit costs} &= \text{Office rental} - \text{Law clerk's salary}\\
\\ \text{Explicit costs} &= \$50,000 + \$35,000\\
\\
\text{Explicit costs} &= \$85,000\end{aligned}\]

Step 2. Subtracting the explicit costs from the revenue gives you the accounting profit.

\[\begin{aligned} \text{Accounting profit} &= \text{Revenues} - \text{Explicit costs}\\

\\
\text{Accounting profit} &= \$200,000 - \$85,000\\
\\
\text{Accounting profit} &= \$115,000 \end{aligned}\]

But these calculations consider only the explicit costs. To open his own practice, Fred would
have to quit his current job, where he is earning an annual salary of $125,000. This would be an
implicit cost of opening his own firm.

Step 3. You need to subtract both the explicit and implicit costs to determine the true economic
profit:

\[\begin{aligned}\text{Economic profit} &= \text{Total revenues} - \text{Explicit costs} -

\text{Implicit costs}\\
\\
\text{Economic profit}& = \$200,000 - \$85,000 - \$125,000\\\\
\text{Economic profit} &= -\$10,000\end{aligned}\]

Fred would be losing $10,000 per year. That does not mean he would not want to open his own
business, but it does mean he would be earning $10,000 less than if he worked for the corporate
firm.

Implicit costs can include other things as well. Maybe Fred values his leisure time, and starting
his own firm would require him to put in more hours than at the corporate firm. In this case, the
lost leisure would also be an implicit cost that would subtract from economic profits.
 Summary

 Privately owned firms are motivated to earn profits. Profit is the difference between revenues
and costs.

 Private enterprise is the ownership of businesses by private individuals.

 Production is the process of combining inputs to produce outputs, ideally of a value greater
than the value of the inputs.

 Revenue is income from selling a firm’s product; defined as price times quantity sold.

 Accounting profit is the total revenues minus explicit costs, including depreciation.

 Economic profit is total revenues minus total costs—explicit plus implicit costs.

 Explicit costs are out-of-pocket costs for a firm—for example, payments for wages and
salaries, rent, or materials.

 Implicit costs are the opportunity cost of resources already owned by the firm and used in
business—for example, expanding a factory onto land already owned.

5. Discuss the strengths and weaknesses of the profit-maximizing model in comparison

with other models.
Meaning of Profit Maximization: – Profit maximization is the ability of a business or company
to earn maximum profit with low cost which is considered as the main goal of any business and
also considered as one of the objectives of financial management. Profit maximization is a short
term objective of the firm and is necessary for the survival and growth of the enterprise.
According to financial management, profit maximization is the approach or process that
increases the profit or earnings per share (EPS) of the business. More specifically, maximizing
profit to the maximum level is the focus of investment or financial decisions.
What are the advantages of Profit Maximization?
The advantages of Profit Maximization are as follows: –
 Economic Existence: – The foundation of profit maximization theory is profit and profit is
essential for the economic survival of any company or business.
 Performance Standard: – Profit determines the standard of performance of any business or
company. When a business is unable to earn profit, it fails to fulfill its main goal and creates a
risk to its existence.
 Economic and Social Welfare: – Profit maximization theory plays a role in economic and
social welfare indirectly. When a business makes a profit, it makes proper use and allocation
of resources that result in capital, fixed assets, labor and payments for the organization. Thus,
economic and social welfare is done.
 Prediction of Real-World Behavior: – Using leverage maximization allows you to predict
the behavior of companies in a real-world situation. Firms deal without too much difficulty
and with reasonable accuracy. This makes profit maximization useful for explaining and
predicting business behavior.
 Knowledge of Business Firms: – The profit motive is most influential in the dealings of
business firms. For small firms with strong competition, they must act as profit maximization
to increase their sales and reduce costs to avoid competition.
What are the disadvantages of Profit Maximization?
The disadvantages of Profit Maximization are as follows: –
 Ambiguity of Benefit Concept: – The concept of profit is uncertain as different people may
have a different idea about profit, such as profit may be EPS, gross profit, net profit, profit
before interest and tax, profit ratio etc. In particular, no fixed profit-maximizing rule or
method actually exists.
 Does Not Consider Time Value of Money: – The profit maximization principle simply
states that the higher the profit, the better the performance of the business. The theory
considers only profit without considering the time value of money. The concept of time value
of money states that a certain unit of money today will not be equal to the same unit of money
a year later.
 Does Not Consider the Risk: – Any business decision considering only the profit
maximization model ignores the risk factor involved which may be detrimental to the survival
of the business in the long run. Because if the business is unable to handle the high risk, its
existence will be in question.
 Ignoring The Quality: – Intangible benefits eg. Image, technological advancement, quality,
etc. are not considered in profit maximization approach which is considered as one of the
biggest drawbacks. These intangible assets have a remarkable role in creating value for the
business which cannot be ignored. Profit maximization theory is based on a traditional
approach, but modern business and financial concepts give more importance to profit than to
maximizing wealth.
How to achieve Profit Maximization?
There are two ways to achieve Profit Maximization: –
1. Increase in Sales-Revenue: –
o Increase sales volume by implementing better marketing strategies, improve quality, do a
thorough market study to assess which segments are bringing in more money to the
business and focus on driving more sales from those products or services. You can also
borrow the best marketing strategy from your competitors, or similar businesses.
o Motivating existing customers to purchase additional services or products.
o Diversification by selling a wide variety of products or services.
o Modifying the pricing of products or services to achieve an increase in sales-revenue. If
you are better at the quality of your product or service, you can charge a higher price for
 it. You may lose some customers temporarily but according to researchers, people prefer a
quality product or services even by paying a little more.
o Motivating employees can also increase sales-revenue as satisfied employees will perform
better and help in producing better products and services which will help the company to
make profit. Better performance appraisal techniques like announcement of employee of
the month, promotion, increment, etc. or picnics, going out for lunch, arranging cultural
events etc. can motivate the employees.
o Educating both existing and potential customers for your product or service by TV or
radio or newspaper advertisements, digital marketing or email-marketing or social-media
marketing, publishing and distributing leaflets, posters, banners, etc.

2. Cost-Cutting: –
o Analysis of the total expenditure of funds in different sectors.
o Negotiate with suppliers for cheaper prices, especially when buying in large quantities.
o The manufacturing process should be more efficient to reduce wastage. Techniques that
save time and expand production should be implemented.
o Looking for a new cost-effective energy supplier as huge amount of money is spent on the
energy sector.
o Outsourcing: – A business cannot do all the tasks by itself or a small business cannot hire
talented people on a full-time basis at high outsourcing can save a lot of money here. Full-
time employees will be engaged in revenue-generating projects and simple tasks can be
done through outsourcing or freelancers.
What is Wealth Maximization?
Meaning of Wealth Maximization: – Wealth maximization is the ability of a company to
increase the market value of its common stock over time. The market value of the firm is
based on many factors like their goodwill, sales, services, quality of products, etc. It is the
versatile goal of the company and highly recommended criterion for evaluating the performance
of a business organization. This will help the firm to increase their share in the market,
attain leadership, maintain consumer satisfaction and many other benefits are also there.
Wealth maximization is the concept of increasing the value of a business in order to increase the
value of the shares held by its stockholders. The concept requires a company’s management team
to continually search for the highest possible returns on funds invested in the business, while
mitigating any associated risk of loss. This calls for a detailed analysis of the cash flows
associated with each prospective investment, as well as constant attention to the strategic
direction of the organization.

The most direct evidence of wealth maximization is changes in the price of a company’s shares.
For example, if a company spends funds to develop valuable new intellectual property, the
investment community is likely to recognize the future positive cash flows associated with this
new property by bidding up the price of the company’s shares. Similar reactions may occur if a
business reports continuing increases in cash flow or profits.

Key Differences Between Profit Maximization and Wealth Maximization

The fundamental differences between profit maximization and wealth maximization is explained
in points below: –
1. The process through which the company is capable of increasing earning capacity known as
Profit Maximization. On the other hand, the ability of the company in increasing the value of
its stock in the market is known as wealth maximization.
2. Profit maximization is a short term objective of the firm while the long-term objective is
Wealth Maximization.
3. Profit Maximization ignores risk and uncertainty. Unlike Wealth Maximization, which
considers both.
4. Profit Maximization avoids time value of money, but Wealth Maximization recognises it.
5. Profit Maximization is necessary for the survival and growth of the enterprise. Conversely,
Wealth Maximization accelerates the growth rate of the enterprise and aims at attaining the
maximum market share of the economy.

Reference
 Managerial handout
 https://legalpaathshala.com/profit-maximization
 https://www.vedantu.com/commerce/positive-and-normative-economics
 https://en.wikipedia.org/wiki/Managerial_economics#:~:text=Managers%20stud
y%20managerial%20economics%20because,that%20apply%20to%20economic
%20behavior.&text=The%20first%20step%20in%20making,the%20problem%
20in%20its%20entirety.
 https://legalpaathshala.com/managerial-economics
 https://www.vedantu.com/commerce