3.2.1 Business Objectives

Question 1

Firms motives are determined by who controls it:

Answer 1

Stakeholders
> Owners or shareholders.
> Directors and managers (divorce of ownership from control).
> Workers (through a trade union).
> The state (legislation on things like taxation, the environment, health and safety, etc, forces companies to behave in a way that they may not have done in an unregulated market).
> Consumers (consumer sovereignity - business sell what consumers want to buy).
> Pressure groups

Question 2

Profit maximisation:

Answer 2

Reasons for it:
> Neo-classical economists assume that the interests of owners or shareholders are the most important, and therefore the goal in the short run is to profit maximise, to maximise the owners’ gain from the company.
> By short-run profit maximising, firms can also generate funds for investment and to help survive a slowdown during a recession. Retained profit is a cheap form of finance and will save the firm paying high interest rates on loans.
> Provides greater wages and dividends for shareholders.
> Neo-Keynesian economists believe firms maximise long-run profit instead. Consumers do not like rapid price changes in the short run, so this will provide a stable price and output.

Question 3

Profit maximisation diagram:

Answer 3

(diagram sheet 3)
> In order to maximise profit in the short-run, firms produce where MC=MR.
> If they currently produce less, producing more will increase profit because MR would be higher than MC, so they’re making more revenue than it costs to produce the good.
> If they produce over it they would be making a loss on the goods produced above the profit maximising point.
> The diagram shows they will produce at P1Q1. The output is determined by where MC=MR, and the price at this output is determined by the AR curve.

Question 4

Revenue Maximisation:

Answer 4

> Occurs when total revenue is highest.
It is assumed that the objective of managers is to maximise total revenues of the firm, hoping that it will help increase their salary.
Even if salary isn’t directly connected to sales revenue, a growth in revenue will almost always be positive for a firm. It increases their prestige, and can be used as justification to shareholders for managerial rewards.
Therefore many firms will aim to maximise revenue as long as they provide some profit for owners.

Question 5

Revenue maximisation diagram:

Answer 5

(diagram sheet 3)
> To revenue maximise, firms would produce where MR = 0, since if marginal revenue is above 0, producing more would increase revenue.
> This means they produce Q2P2. Selling an extra unit above Q2 would result in negative marginal revenue, and therefore a fall in total revenue.
> Prices would be lower than when they are profit maximising, since they are producing more (it is further down the AR curve).

Question 6

Sales maximisation:

Answer 6

> When they maximise sales volume.
Managers salaries may be linked to the size of the company, so they could try to maximise growth. They can justify rewards by showing the level of growth.
Maximising sales will make the firm larger, so the firm will feel more secure becuase bigger firms are less likely to have financial trouble.
Growth increases market share, and may push other firms out of business. The firm can have more market power.

Question 7

Sales maximisation diagram:

Answer 7

(diagram sheet 3)
> In order to sales maximise, the firm will want to get the highest possible level of sales without making a loss.
> They will aim for normal profits to keep the owners happy.
> Therefore they produce where AC=AR at Q3P3.
> The problem with sales maximisation and revenue maximisation is that it results in a fall in price. Other firms may copy this so there may be no increase in revenue or sales. They also bring lower profits.

Question 8

Satisficing

Answer 8

> Often occurs with divorce of ownership from control.
Due to the principal agent problem, owners and directors will have different goals. Directors will want to maximise their own benefits but will need to make a certain amount of profit to keep their jobs and receive benefits.
Therefore managers may follow the objective of profit satisficing, where they make enough profit to keep owners happy while following other objectives.
These other objectives are likely to be their own benefits.
The amount of acceptable profit will change year on year, and often depends on how the other firms are performing.