Reasons for earning reasonable profits for a business firm are given below:
Every business firm wishes to earn maximum profit. But profit maximization goal has some serious limitations.
Due to these limitations this goal cannot be pursued actually. In practice, therefore, business firms aim at earning reasonable profits.
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Now the pertinent question is what are the reasons or compulsions for aiming at reasonable profits. Following are the reasons for earning reasonable profits.
1. Preventing entry of new firms:
Generally high profits attract the new firms into the industry! Fear of potential competitors is always there in the mind of weak monopolists and price leaders in oligopoly situations.
Therefore, firms follow such a price policy that guarantee them reasonable profit and keep the potential competitors away.
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2. Restraining trade unions demand:
Workers contribute in the production process. If firms aim at maximizing profit, the trade union will ask the management for a greater share in profits in the form of enhanced wages and bonus.
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Wage increase may lead to wage-price spiral which may defeat the profit maximizing objective of the firm.
3. Maintaining customers goodwill:
Prosperity of a business firm largely stands on the goodwill of the firm among customers. Customers’ goodwill depends to a great extent on the quality of the product, fair price and fair deal.
Fair price from the view point of good customers may not maximize profit. Reasonable profits in the short-run are the gateway to make profits in the long-run.
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Therefore, firms do sacrifice the goal of profit maximization in the short-run to earn more profits in future.
4. Projecting a favourable public image:
Modern business firms have certain social responsibilities. Modern firms owe a responsibility towards its employees to give them fair wages, make suitable arrangement for medical facilities and good working condition.
Firms aim at maintaining good relation with government and general public. Social responsibilities restrict the firms to maximize profits.
5. Other factors:
There are other factors which constraint on maximum profits. These include restricting the size of firm to increase organizational efficiency and control, belter industrial relations and maximizing managerial utility function.
Now the question arises what should be the standard of reasonable profits. The standard of reasonable profits may be in terms of aggregate money profits or a certain percentage of sales or rate of return on investment.
These standards may be fixed for the whole product-line or for each product separately. Out of these standards of profit, generally the rate of returns on investment is most favoured.