3.2 Business Objectives

Question 1

profit maximisation

Answer 1

• most firms have the rational business objective of profit maximising as it’s the reward that entrepreneurs yield when they risk take
• it occurs either when;
• total costs and total revenue are at their greatest difference apart
• marginal costs = marginal revenue (MC=MR); when each extra unit provided generates no extra loss or revenue
• profits decrease when MC > MR

Question 2

reasons why firms choose to profit maximise

Answer 2

• provides greater wages and dividends for shareholders, keeping them happy
• retained profits are a cheap source of finance, which saves paying high interest rates on loans, i.e. they can be reinvested
• neo-classical economists; in the short-run, interests of shareholders are most important as they aim to maximise their gain from the company
• keynesian economists; when firms use cost plus pricing (average cost+profit margin), they’ll adjust prices in response to changes in market conditions, but consumers don’t like rapid price changes and they see price reductions as the firm’s desparation, so firms may choose to profit maximise in the long-run by continuing to charge the profit maximising price, even if they make a loss in the short-term

Question 3

reasons why some firms choose not to profit maximise

Answer 3

• key stakeholders harmed, e.g. consumers may be charged higher costs
• huge profits causes a risk of investigations into the company, e.g. scrutiny from CMA
• other objectives may be more important
• synoptic point; firm may be less likely to profit maximise during a recession

Question 4

revenue maximisation

Answer 4

• occurs when marginal revenue = 0 (MR=0); when each extra unit sold generates no extra revenue
• revenue maximising firm produces more output than a profit maximising firm but charges less in order to sell the extra output
• firms are making as much money as they can, but ignore the fact that on some units, costs are greater than the revenue they recieve

Question 5

reasons why firms choose to revenue maximise

Answer 5

• principal-agent problem; sales managers often recieve commission on sales as part of their wages, incentivising them to maximise sales, with profit maximising for shareholders becoming a secondary objective for them
• predatory pricing; in the short-term, firms will reduce prices to maximise output thus revenue, which eliminates the competition as the price is lower than when focusing on profit maximisation
• maximising revenue increases outputs so firms can benefit from economies of scale
• more realistic in contestable markets, because if firms choose to profit maximise, new firms will have an incentive to engage in ‘hit and run’ competition and take market share

Question 6

sales maximisation

Answer 6

• when firms aim to sell as much of their goods and services as possible without making a loss
• occurs where average costs = average revenue (AC=AR), i.e. breakeven point / normal profits being made
• e.g. amazon’s kindle launch; they sold as many kindles as possible to gain market share, so they can earn more profits in the long-run - it helps deter competitors

Question 7

reasons why some firms choose to sales maximise

Answer 7

• principal-agent problem; sales managers often recieve commission on sales as part of their wages, incentivising them to maximise sales, with profit maximising for shareholders becoming a secondary objective for them
• good in some circumstances where costs aren’t relevant and stock must be cleared, so they can sell remaining stock without making a loss per unit, e.g. for a florist having to dispose of stock which would’ve wilted by the next day

Question 8

profit satisficing

Answer 8

• earning a satisfactory level of profits (rather than the maximum) which is enough to keep shareholders happy
• occurs anywhere between profit and sales maximisation
• occurs where there’s a divorce of ownership and control, due to the principal-agent problem as managers know shareholders want to profit maximise, but they want to maximise revenue or sales themselves to increase their wages, so they settle for a level of output between profit and sales maximisation, as it increases their wages and reduces potential conflict with shareholders
• if they ignored profits completely, shareholders can revolt and vote out the managers

Question 9

business objectives on a diagram

Answer 9

• diagram 1