3.1, 3.2,3.3 Business Objectives, Costs And Economies Of Scale, And Revenue And Profit

Question 1

What are business objectives ?

Answer 1

The reasons behind the decisions a firm takes

Question 2

What are the maximisation objectives ?

Answer 2

Profit 
Sales 
Revenue 
Sales volume 
Growth 
Utility

Question 3

What is profit maximisation ?

Answer 3

Main assumption for firms to achieve the highest level of profits possible: where MR=MC

When a business aims to have the most difference between total costs and total revenues = highest proft

Question 4

What are the positives of profit maximisation?

Answer 4

To re-invest 
Lower costs and lower prices 
Bonuses 
Dividends 
Reward for entrepreneurship

Question 5

What are the negatives of profit maximisation?

Answer 5

Do businesses know where MC=MR
Greater scrutiny
Key stakeholders may be harmed
Other objectives may be more appropriate

Question 6

What is Sales revenue maximisation ?

Answer 6

Producing where MR=0, keep producing more output as long as it adds to revenue

make as much revenue from sales as possible - likely to be a objective for a business launching a new product or trying to build up customer loyalty

Question 7

Why use sales revenue maximisation ?

Answer 7

Economies of scale
Predatory pricing
Principle agent problem

Question 8

What is the principle agent problem ?

Answer 8

This arises from conflict / disagreement between the objectives of the principals (managers) and their agents (owners), who take decisions on their behalf

Question 9

What is sales volume maximisation ?

Answer 9

Producing at a point where TR=TC, to maximise the volume of sales

Question 10

Why use sales volume maximisation ?

Answer 10

Economies of scale
Limit pricing
Principle agent problem
Flood the market

Question 11

What is growth maximisation ?

Answer 11

Aim to grow as large as possible, often to achieve a higher market share

Question 12

What is utility maximisation ?

Answer 12

Firms/managers aim to produce where they gain the maximum satisfaction

Question 13

What is profit satisficing

Answer 13

Managing a firm to make a level of profits to satisfy the main stakeholders

Question 14

What is social welfare ?

Answer 14

Non-profit-making firms that aim to improve social welfare, the well being of a community or country - e.g. charities

Question 15

What is corporate Social responsibility

Answer 15

Actions that a firm takes in order to demonstrate its commitment to behaving in the public interest

Question 16

What is fixed costs ?

Name 2 FC’s ?

Answer 16

Costs that do not vary with the level of output

Rent and Marketing costs

Calculated by Total FC divide by Output

Question 17

What are variable costs ?

Name 2 VC’s

Answer 17

Costs that vary with the level of output

2 VC’s - wages and transport

Calculated by Total VC divide by Output

Question 18

What are total costs ?

Answer 18

The sum of all costs that are incurred in producing a given level of output ( including opportunity cost)

Total VC + FC = TC

Question 19

What are average costs ?

Answer 19

Total cost divided by the quantity produced, sometimes known as unit cost

Question 20

What are marginal costs?

Answer 20

The cost of producing an additional unit of output

Question 21

What is the short run ?

Answer 21

The period in which at least one factor of production is fixed in supply

Question 22

What is the long run ?

Answer 22

The period over which the firm is able to vary the inputs of all its factors of production

Question 23

What is the law of diminishing returns ?

Answer 23

Theory that in the short run when at least one factor of production is fixed, the average return from a factor of production decreases

A law stating that if a firm increases its inputs of one factor of production while holding inputs of the other factor(s) fixed, eventually the firm will get diminishing marginal returns from the variable factor

Question 24

What are economies of scale ?

Answer 24

These occur for a firm when an increase in the scale of production leads to production at lower long-run average cost

Question 25

What are internal economies of scale?

Answer 25

Reduction in average costs that can occur from the growth of a BUSINESS

Purchasing - negotiate a lower cost of purchasing raw materials - “bulk buying”
Technical - buy better technology that can reduce average cost
Marketing - if producing a lot they can afford mass marketing
Management - larger businesses can afford to employ specialist managers - Legal, HR, Procurement - who are efficient whereas smaller business can’t afford this
Financial - a larger business can negotiate a lower cost

Question 26

What are external economies of scale?

Answer 26

Reductions in average costs that can occur from the growth of a INDUSTRY

Concentration - as an industry increases in size the businesses within that industry may benefit from being close to one another - e.g. a new restaurant may locate near other restaurants as it saves money on marketing

Infrastructure - as the industry in a particular area increases there is likely to better transport (roads) and comms (internet links) which benefit all businesses in the area and reduce costs

Technology and skill -as an industry increases in size more people are likely to train to work in that industry and other businesses are likely to develop better technology for that industry - both will decrease the average costs of the business

Question 27

What are diseconomies of scale ?

Why might a business encounter them ?

Answer 27

Increases in average costs that can occur from the growth of a business
(The benefits of growing are overtaken by limitations called diseconomies of scale )

Communication - as a business increases output communication may become more difficult - need to ensure everyone receives the same message

Coordination - as a business increases output organizing a complicated production process may be more difficult and incur costs to overcome this

Motivation - as a business increases output not every manager is likely to be able to motivate all employees which is likely to increase avg costs of production

Question 28

What is the minimum efficient scale ?

Answer 28

The level of output at which long run average cost stops falling as output increases

Question 29

What is total revenue ?

Answer 29

The revenue received by a firm from its sales of a good or service — it is the quantity sold, multiplied by the price

Question 30

What is average revenue ?

Answer 30

The average revenue received by the firm per unit of output — it is total revenue divided by the quantity sold

Question 31

What is marginal revenue ?

Answer 31

The additional revenue received by the firm if it sells an additional unit of output -“the price of the last unit sold”

Question 32

What is profit ?

Answer 32

The difference between the total revenue received by a firm and the total costs that it incurs in production:
Profit = total revenue − total cost

Question 33

What is loss?

Answer 33

When total revenue is smaller than total costs

Question 34

What is accounting profit ?

Answer 34

Profit made by a business after it has taken away total costs but excluding opportunity cost

Question 35

What is normal profit ?

Answer 35

The level of profit required to cover total costs and the opportunity cost

“In other words its the minimum profit needed for a firm to stay in a market in the long run

Question 36

What is supernormal profit ?

Answer 36

The profit above normal profits — also known as abnormal or economic profit

Question 37

What is CSR ?

Answer 37

CSR requires a firm to be responsible to the major stakeholders of the business

e.g. a responsibility to make a profit for the owners, a responsibility to do what is right for society and a responsibility to the environment

Question 38

What factors determine the business objectives ?

Answer 38

What stage the business is at ? ….new business unlikely to set profit maximisation as its objective
Owners / Founders wishes - some businesses deliberately set up to be non profit making or to help society
Timescale - many businesses have profit maximisation as long term objective but change objectives depending on circumstances - e.g. business might aim to drive competitors out of the market so focus on sales volume maximisation
State of the macro economy - e.g. if recession focus on survival

Question 39

The extent to which businesses benefit from or are limited by economies and diseconomies of scale depend on a number of factors ?

What are they ?

Answer 39

Demand for the product or service - economies and diseconomies of scale are based on increases in output however the market may no demand this output

The nature of production - a car manufacturer benefits from technical economies of scale but this is less likely for a hairdresser

Technological advancement - e.g. now small business can now access low cost mass marketing on line whereas previously Marketing was only affordable to large companies

The importance of price - economies of scale allow a business to charge a lower price

The nature of the product or service - some products and services tend to benefit from economies of scale more than others - e.g. taxi drivers operate on their own as there are few economies of scale to be gained through growth

Question 40

What’s the difference between accounting profit and normal profit

Answer 40

Accounting profit excludes opportunity cost

Question 41

What is utility maximisation ?

Answer 41

When the managers of a business aim to increase their own happiness a much as possible