3.2 Business Objectives

Question 1

Different business objectives

(with formulas)

Answer 1

• Profit maximisation (MC = MR)
• Revenue maximisation (MR = 0)
• Sales maximisation (AC = AR)
• Satisficing

Question 2

Profit maximisation (reasons for it being a business objective or not)

Answer 2

Marginal cost = marginal revenue (MC = MR)

+ main reason to increase dividends paid out to shareholders (rewards)

+ high profits make firms stock more appealing, pushes up stock price, benefits shareholders

+ to reinvest some of profit into business, to expand & grow organically (new capital, new tech, R&D, innovation)

• firm may not know point where MC=MR is, so may set prices above or below profit maximisation point
• to minimise risk of investigation from competing & market authorities as firm operating at profit maximisation doesn’t act in consumers interest (lack of choice at P1 & Q1) may be seen as consumer exploitation, may be forced to lower prices
• key stakeholders harmed (consumers can have excess charges (exploitation) so bad reputation, workers can suffer from wage cost cuts so trade unions strike, environmental groups if pollution, resource degradation, waste so protest)

Eg. Apple & pharmaceutical companies profit maximise as need money to reinvest (in R&D or tech)

Question 3

Profit maximisation

(graph & formula)

Answer 3

Profit maximisation point (MC = MR)

Firms produces at P1Q1 where MC = MR meets AR/D curve

Cost of producing at this point shown where MC = MR meets AC (average cost) curve

Supernormal profit firm makes shown by box between production costs and price level

Firms charge high prices (P1) and produce small quantity (Q1)

Question 4

Revenue maximisation (reasons for it being a business objective or not)

Answer 4

Where MR = 0

Firm may not always make profit

+ predatory pricing - drives out competition as offer low prices than competitors (other firms can’t offer as low prices or wont break even, firms average costs determine whether they can match revenue maximisation price, directly affected by extent they experience economies of scale)

+ greater quantity/output so experience economies of scale (high quality of output Q1), as firm grows it experiences benefits (paying less interest back on loans, lower average costs, potentially lower prices for consumers)

+ managers control business so revenue maximise for greater bonuses, benefitting from principle agent problem

• fall in price which other competitive firms may copy so there may be no or small increase in revenue (common in oligopoly)

Eg. Amazon follow objective of revenue maximisation (£120bn in 2015) but profit relatively stable, aim to dominate market

Question 5

Revenue maximisation

(graph & formula)

Answer 5

Firms produce where MR = 0 (revenue maximisation point)

So firms produce at Q1P1 where MR=0 meets AR=D curve for revenue maximisation (higher output, lower prices)

Question 6

Sales maximisation (reasons for it being a business objective)

Answer 6

Firms focus on highest level of sales possible without making a loss (break even point/sales maximisation point AC = AR)

+ experience economies of scale through increasing size of firm (helps firm lower average costs so more competitive in market)

+ limit pricing (price at break even) takes away incentive for new firms to enter market so limits competition

+ producing very high quantity/output so flood the markets (attract loads of consumers & develop loyalty, but later firm can change objective towards profit maximisation once high demand)

+ allows manager to maximise utility (manager salary linked to size of firm)

• fall in price which other competitive firms may copy so there may be no or small increase in sales (common in oligopoly)

Eg. Netflix & Spotify objective of sales maximisation, as attempting to increase size of business, but now increasing prices to earn profit

Question 7

Sales maximisation

(graph & formula)

Answer 7

Firm produces at P1Q1 where AC=AR/D (where AC curve meets AR=D curve)

Low price level (P1) as firm not trying to make profit
So greater quantity demand (Q1)

Question 8

Satisficing (reasons for it being a business objective)

Answer 8

= sacrificing profit to satisfy as many key stakeholders as possible (shareholders, managers, consumers, workers, government, environmental groups)

• stakeholders have conflicting interests, firm chooses price point which is profit satisfying
• Minimum level of profit that satisfies each stakeholder is achieved (stems from principal-agent problem)

Eg. Owners want to profit maximise so increase in dividends & firms share priced
Eg. Managers want to sale maximise so increase in their salary