1) Objectives of firms (1) Flashcards
firm definition
an organisation that brings together factors of production in order to produce output
normal profit definition
the return needed for a firm to stay in the market in the long run
supernormal (abnormal or economic) profits definition
profits above normal profits
profit definition
total revenue minus total cost; TR-TC
profit maximisation definition
MC=MR
- increasing Revenue through an extra sale - lower prices
sales revenue maximisation definition
MR=0
sales volume maximisation definition
AC=AR
Notes: traditional theory of the firm assumes that firms are aiming to maximise
profit
notes
where/when does profit maximisation occur?
Profit maximisation occurs where MC=MR; more output is produced and sold until the extra cost incurred by one more unit of production exactly equals the revenue gained from that unit of production
notes
how does profit maximisation work?
Because we assume unit costs to fall, then rise, with output, and revenue per unit assumed to fall with output, there will be an optimum point at which to cease extra production and maximise profit
Profit maximisation is often a … run objective
long
notes
Profit maximisation is often a long run objective
Other objectives could be …run objectives
notes
what may a firm do in the short run to maximise profit in the long run
A firm may sacrifice profit in the short run to maximise profit in the long run
notes
• A firm may sacrifice profit in the short run to maximise profit in the long run by: (list 3 points)
- Maximise sales revenue by producing where MR = 0.
o Maximise sales volume by producing where AR = AC.
o Maximising growth by increasing market share and the size of the firm.
notes
• A firm may sacrifice profit in the short run to maximise profit in the long run by: maximising sales revenue, explain
1) Maximise sales revenue by producing where MR = 0. Production is increased to a point where additional sales would reduce overall revenue because to make an extra sale the price of all such goods would have to be reduced.
notes
• A firm may sacrifice profit in the short run to maximise profit in the long run by: maximising sales volume, explain
Maximise sales volume by producing where AR = AC. This is the highest level of sales that a firm can sustain in the long run; a higher level of sales would see AR<AC and the firm would make a loss.
notes
• A firm may sacrifice profit in the short run to maximise profit in the long run by: maximising growth, explain
Maximising growth by increasing market share and the size of the firm. Cutting prices below cost will lead to a loss in the short run, but may lead to even higher long run profits. This is due to increased brand recognition or an ability to cut costs due to increased scale of operation (economies of scale).
notes
why may a firm try to maximise sales or revenue in the short run
1) to increase its market share or to gain market power so that it can make monopoly profits in the long run
2) higher sales make it easier to borrow money
3) achieving these short run objectives could help to maximise profits in the long run
analysis
what is the conventional theory of a firm?
Conventional theory of the firm assumes that businesses set a price that maximises their total profits, and have enough information, market power and motivation to. By default, we assume that firms will profit maximise, and stay in the market if they are making supernormal profit.
Evaluation
what are profit maximisation’s realistic assumptions? state points
1) information
2) single-product businesses (A business may only make a single product)
Evaluation
how is information a realistic assumption of Profit maximisation?
Businesses know their costs and revenue based on market experience, so are best placed to calculate where MC=MR
Evaluation
what are profit maximisation’s unrealistic assumptions? state points
1) Imperfect information
2) Multi-product businesses
3) Ignores time
Evaluation
how is imperfect information an unrealistic assumption of Profit maximisation?
- It’s hard for a business to pinpoint their precise profit maximising output, as they cannot accurately calculate marginal revenue and marginal cost
• Day-to-day pricing decisions are taken on the basis of “estimated demand”
Evaluation
how are multi-product businesses an unrealistic assumption of Profit maximisation?
Most businesses are multi-product firms operating in a range of markets across countries and continents - the sheer volume of information that they have to handle is vast. And they must keep track of the ever-changing preferences of consumers.
Evaluation
how is ignoring time an unrealistic assumption of Profit maximisation?
To maximise profits in the long run may, in the short run, require not producing at MC=MR to capture market share and raise prices to increase profits later
Evaluation
what are the 3 advantages/disadvantages of objectives of firms?
1) Sales revenue maximisation
2) Sales volume maximisation
3) Growth maximisation
evaluation
how is sales revenue maximisation an advantage?
- Faster growth than profit maximisation
• Larger firms gain easier access to finance
evaluation
how is sales volume maximisation an advantage?
Faster growth than sales revenue maximisation
evaluation
how is growth maximisation an advantage?
Faster growth than sales volume maximisation
evaluation
how is sales revenue maximisation a disadvantage?
Lower profits than profit maximisation
evaluation
how is sales volume maximisation a disadvantage?
lower profits than sales revenue maximisation - zero profit
evaluation
how is growth maximisation a disadvantage?
lower ptofitd than sales volume maximisation - profits will be negative (making a loss)
