3.2 Business Objectives

Question 1

what is the rational business objective most firms have?

Answer 1

profit maximisation

Question 2

How do profits benefit shareholders

Answer 2

benefit shareholders as they receive dividends and increase the underlying share price
- an increase in the underlying share price increases the wealth of the shareholder

Question 3

How can a firm achieve profit maximisation

Answer 3

by following the profit maximisation rule

Question 4

What is the profit maximisation rule?

Answer 4

• when marginal costs = marginal revenue
• no additional profit can be extracted by producing another unit of output

Question 5

why is profit not maximised when MC< MR

Answer 5

additional profits can still be extracted by producing an additional unit of output

Question 6

why is profit not maximised when MC> MR

Answer 6

• the firm has gone beyond the level of profit maximisation
• it is making a marginal loss on each unit produced beyond the point MC=MR

Question 7

Why, in reality, may firms find it difficult to produce at the profit maximisation level of output? 4

Answer 7

• may not know where this level is
• in short term they may not adjust prices if the marginal cost changes
• in the long term firms will seek to adjust prices to the profit maximisation level of output
• firms may change prices by the competition commission

Question 8

why might revenue maximisation occur?

Answer 8

the principal agent problem

Question 9

what is the principal agent problem

Answer 9

when the agent makes decisions on behalf of the principal, often placing the agents priorities above the principals

Question 10

why do sales managers priorities revenue maximisation over profit maximisation?

Answer 10

• sales managers often receive commission on sales as part of wages, this provides an incentive for them to maximise sales
• profit maximisation for shareholders becomes a secondary objective for the sales managers

Question 11

Why would firms maximise revenue? 3

Answer 11

• increase ouput
• benefit from economies of scale
• in the short term, to eliminate the competition as the price is lower than when focussing on profit maximisation

Question 12

how does a firm achieve revenue maximissation

Answer 12

firms produce up to a level of output where MR=0
- when MR >0 producing another unit of output will increase total revenue

Question 13

When does sales maximisation occur?

Answer 13

the level of output where AC=AR
- normal profit/breakeven

Question 14

why would firms have the objective of sales maximisation

Answer 14

in the short term this strategy may be used to clear stock during a sale
- they sell remaining stock without making a loss per unit

Question 15

What is satisificing?

Answer 15

aiming for a satisfactory level of profit instead of profit maximisation

Question 16

Why would Satisfying occur?

Answer 16

• rationally, managers know shareholder want to profit maximise
• rationally, managers want to maximise sales or revenue to increase their wages
• managers settle for a level of output somewhere between profit and sales maximisation, increasing their wages and reducing potential conflict with shareholders