3.2 - Business Objectives

Question 1

What is profit maximisation?

Answer 1

• Where MC=MR
• When MC < MR additional profit can still be extracted by producing an additional unit of output
• When MC > MR the firm has gone beyond the profit maximisation level of output - making a marginal loss on each unit produced beyond where MC = MR

Question 2

Why do firms want to profit maximise?

Answer 2

• Profit maximisation implies efficient allocation of resources
• Keep shareholders happy - maximise shareholder value + increase dividend payments - increased confidence in business also raises share prices (higher demand)
• Lower costs and lower prices for consumers
• Reward for entrepreurship
• Reinvest profits towards future growth e.g. in R&D

Question 3

Why do some firms choose not to profit maximise?

Answer 3

• Greater scrutiny from CMA
• Corporate social responsibility - involves firms acting in a sustainable way while trying to make supernormal profit
• Key stakeholders harmed
• Lack knowledge of where MC and MR are
• Other objectives more appropriate

Question 4

What is the difference between normal and supernormal profit?

Answer 4

• Normal: breakeven
• Supernormal: occurs where TR>TC

Question 5

What is revenue maximisation?

Answer 5

• Where MR=0
• When a firm is making as much revenue as possible whilst still maintaining a low level of profit

Question 6

Why do firms choose to maximise revenue?

Answer 6

• Principal agent problem- sales managers receive commission on sales as part of their wages (want to sales max) + profit max for shareholders becomes a secondary objective for the sales managers - happens in larger firms
• Economies of scale - able to produce more output & take advantage of EOS
• Predatory pricing by undercutting rivals to reduce competition (firms are driven out of market - higher market share)
• Increases the size of the firm - beneficial to managers due to prestige of larger firm

Question 7

What is sales maximisation?

Answer 7

• Where AR=AC (breakeven)
• Firms want to get the highest level of sales without making a loss

Question 8

Why do firms choose to maximise sales?

Answer 8

• Economies of scale
• Limit pricing
• Flood the market -> dominate market -> once they have control over prices, raise them
• Principal agent problem - divorce between ownership and control

Question 9

What is satisficing?

Answer 9

• Where a firm sacrifices profit in order to satisfy an alternative stakeholder
• Due to principal-agent problem