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) WITH EVAL

Answer 2

Marginal cost = marginal revenue (MC = MR)

DEF- 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)

• Retained profit- major source of finance of investment = improve profitability –major macroeconomic benefits. Increase S/R and L/R growth- jobs, improving intnl comp

§ Profit maximising obj can benefit consumers via lower prices. Profit motivation- keep costs low and rev high, no waste in production. Increase in Customer satisfaction.

EVALUATION:

• Knowledge of MR and MC may be imperfect making difficult for firms to be profit maximisers. Even if firms aren’t at MR=MC, profit maximisation still holds even if they adopt a diff strategy such as cost plus pricing

§ Making large supernormal profits might signal investigation by regulatory authorities. High profits may - excessive pricing beyond MC of collusive or monopoly behaviour- against interest of business- increases costs of production by having to sell stores etc.

§ Profit max- not best business strategy for businesses. Business may want to increase MS, flood market with products- develop brand loyalty or benefit from economies of scale all which need diff obj. in s/r

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 is a deliberate strategy of driving competitors out of the market by setting very low prices or selling below AVC. - 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)

+ Flood market with products and stores in developing brand and establishing presence of product.

+ highly competitive market, strategy allows businesses to gain brand loyalty and strong reputation. If successful provide an element of monopoly power allowing for long run profit maximisation.

+ 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)

Harms workers- low wages

Consumers- high prices

• 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

Question 9

Why do objectives change over time?

Answer 9

Example: Netflix

Objectives change over time due to growth and meet traditional objectives such as survival, profit maximisation. As they have grown they focus on other objectives such as innovation and competing against:

Changing trends
External environmental
Shareholders
Principal agency problem