3.2 Flashcards
Profit maximisation
Firms set price and output based on MR=MC
This is an assumption of maximising profit in the short-run
PLCs may maximise profit as it is a way to increase their ability to pay shareholder dividends and increase share value
Profit maximisation also creates larger funds for investment and R&D - this in turn helps to improve the long run profitability
Why might firms not profit maximise?
Imperfect information
To operate at MR=MC requires very specific information which is not realistic in the real world
Whilst firms will generally prefer larger profits in the real world it may not be possible to achieve a price and output at exactly MR=MC
Long run profits may be improved by focussing on other short run goals such as capturing market share (e.g. sales maximisation)
Sales maximisation
Firm sets price and output based on AR=AC
AR=AC represents the largest level of output that a firm can produce without making a loss
Firms may sales maximise in order to increase market share
This could be a short-run objective with a view to maximising profit in the long run
Alternatively, sales maximisation could be used as part of a limit pricing strategy
An established firm with significant economies of scale could price at AR=AC in order to deter new entrants to the market
Why might firms not sales maximise?
It requires forgoing significant supernormal profits in the short run
PLCs that need profits in order to pay dividends may not be inclined to pursue this strategy
Revenue maximisation
Firm sets price and output based on MR=0
I.e. the firm produces up to a point where producing extra units stops adding to the revenue of the firm
Managers may receive performance related pay based on revenue targets
Larger revenue makes the company ‘bigger’ with greater justification for large executive pay
Supermarkets selling off perishable fruit and veg at the end of the day would be another example of attempting to maximise revenue in a practical way
Why might firms not revenue maximise?
Revenue based rewards structures require a very measurable success criteria
Works effectively in retail and sales cultures
Firms that are less retail and sales focussed might be less likely to implement a revenue based rewards structure due to having less quantitative measures of worker success
Profit satisficing
Managers of a firm ensure that they make enough profit for shareholders to be satisfied
Shareholders wish for a return on their shares – via dividends and increasing share value
Creating value for shareholders requires making some level of profit, with which to pay dividends
Once enough profit is achieved they may then pursue other managerial objectives – e.g. pursuing their own pay maximisation
PLCs can be subject to the principal-agent problem
The result is that directors of the company have personal goals which differ from the goals of shareholders
As long as directors earn enough profits to satisfy shareholders they can pursue their own goals
Why might firms not profit satisfise
Difficult for directors to know the level of profits that shareholders will deem to be enough
Directors may never feel secure enough in their position to ever aim for anything less than maximum profits
(Satisficing is not relevant to smaller companies where the owner runs the day-to-day operations)
Survival objective
Objective of the firm is to remain in business in the future
Behaviour is likely to be risk averse
It is feasible for a short-run objective of survival during recession to be replaced by profit maximisation when the economy improves
Some smaller businesses may have survival as their default objective
E.g a sole trader may simply wish to stay in business and earn a stable salary from their firm rather than taking the risks that might accompany profit maximisation
Why may firms not have survival objective
In the long run, some short run risk taking might be necessary to survive
Without innovating a firm may become less relevant to consumers over time, threatening there viability
Social objectives
Pursuing social and charitable goals rather than profit-based goals
Not-for-profit organisations
Charitable and public sector organisations may have social reasons for operating, based on objectives very different from profit maximisation
Price and output may be determined by need & circumstance
Why might firms not have social objective
Some firms outwardly appear to be aiming for social objectives but may simply be attempting to market their business as being socially responsible whilst actually pursuing profit maximisation
