3.2.1 Business Objectives

Question 1

What are business objectives businesses may have?

Answer 1

Question 2

What is profit maximisation?

Answer 2

Profits are maximised at an output level where marginal cost = marginal revenue (MR=MC)

Question 3

What is the point of revenue maximisation?

Answer 3

Revenues are maximised at an output where marginal revenue = zero

Question 4

What is sales maximisation?

Answer 4

Supplying the largest output possible consistent with earning at least normal profits where AR=AC

Question 5

What is satisficing behaviour?

Answer 5

Satisficing involves the shareholders setting minimum acceptable levels
of achievement of either revenue or operating profits

Question 6

Explain the reasons for different objectives

Answer 6

Managerial objectives:
* Revenue or sales growth is often preferred instead of profit maximisation
* Achieve a satisfactory profit / return for shareholders to reward them for risk-taking

Information gaps:
* Lack of accurate information on marginal cost & revenues in their markets

Small businesses have different aims
* Many small firms are “life-style businesses” for owners
* Start-ups often target rapid growth rather than profit

Question 7

Explain the profit situation in this table

Answer 7

• The firm moves into positive profit at an output level of 57 units.
• Thereafter profit is increasing because the marginal revenue from selling units is greater than the marginal
  cost of producing them. I.e. the marginal profit is positive.
• But once marginal cost is greater than marginal revenue, total profits start to fall.

Question 8

Explain marginal profit on a diagram and how it relates to profit maximisation, on a diagram.

Answer 8

• If MR > MC, the firm could increase profit by raising output – this occurs at output levels less than Q1
• If MR < MC, the marginal profit is negative. It would be better to decrease output. On the diagram,
  this occurs at all output levels above Q1

Question 9

Draw a diagram showing price, output and profits when profits are maximised?

Answer 9

Question 10

What are the benefits of aiming to maximise profits?

Answer 10

1. Employees may gain if some part of their pay is linked to the profitability of the business
2. Higher profits may lead to increased capital investment spending which will benefit other businesses in
   industries such as engineering and construction
3. Businesses may choose to ‘plough back’ profits into R&D, leading to dynamic efficiency and improved
   products/processes
4. Provides a safety net for businesses in tough times or recession

Question 11

What are the drawbacks of aiming to maximise profits?

Answer 11

1. Higher prices for final consumers which reduces their real incomes / purchasing power and means a lower
   level of consumer surplus
2. High profits might act as an incentive for new firms to enter the market – depending on how contestable it is
   – which in the longer term might reduce the returns to shareholders as competition intensifies
3. Companies that become overly focused on maximising profits might lose sight of the social / ethical and environmental aspect of businesses to the detriment of local communities.
4. If profits are increased by pushing costs lower then this could impact on quality

Question 12

When is loss minimised?

Answer 12

Losses are minimised at the same output as profit maximisation – the same condition applies i.e. firms making a loss should produce at an output where marginal revenue = marginal cost.

Question 13

Explain why revenue maximisation is an objective

Answer 13

• Research from the economist William Baumol found that salaries & rewards for mangers were closely linked to sales revenue rather than profits
• A business might also aim to maximise sales revenue rather than profits because it wishes to deter the
  profitable entry of new firms / rivals into an industry and therefore maintain more market power
• If a firm decides to aim to maximise sales revenue rather than profits, one consequence of this can be a
  reduction in the price of the firm’s shares since operating profit is likely to be lower

Question 14

Show where total revenue is maximised

Answer 14

Total revenue is maximised at a price and output where marginal revenue = zero.
MR is zero at the ‘halfway’ point along the AR curve; this is also the point where PED is unitary (i.e. equal to -1).

Question 15

What is sales maximising output?

Answer 15

• The sales maximising output is when a business maximises output without making a loss
• Sales maximisation is at an output where AR=AC
• At this output, normal profits are made – i.e. just enough profit to keep a firm in a market in the long run

Question 16

Where does sales maximisation occur in this graph?

Answer 16

In this example, sales maximisation occurs at an output of 5 where AC and AR both equal £30

Question 17

How is sales maximisation shown in a diagram?

Answer 17

Question 18

Explain satisficing

Answer 18

• Maximisers behave in a traditional economic way and always try to make the best possible choice from all
  available alternatives (the implicit assumption being made here is of rational choice)
• Satisficers examine only a limited set of alternatives, and choose the best option between them
• Satisficing is generally concerned with ‘keeping a range of stakeholders happy’ and ensuring that the business
  is earning ‘enough’ profit to do so
• Many businesses who adopt satisficing use simple rules of thumb rather than complex pricing policies. Instead of trying to find the optimum profit-maximising price and output, they rely on simpler “cost plus approaches” e.g. they charge the unit cost of supply + 10%
• Satisficers might be the managers of a business who are more concerned with increasing sales revenue and/or their market share instead of seeking pure profit maximisation.

Question 19

Show the price, output and profit with satisficing behaviour

Answer 19

There is no unique profit satisficing output. It can occur at any output between profit maximisation and sales
maximisation. The firm is sacrificing some total profit but perhaps gains in other objectives such as revenue
and/or an increase in market share