3.2.1 Business Objectives

Question 1

How do firms achieve profit maximisation?

Answer 1

• a firm should continue producing additional units until marginal costs = marginal revenue
• at this point no additional profit can be extracted by producing another unit of output

Question 2

What happens when MC<MR?

Answer 2

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

Question 3

What happens when MC>MR?

Answer 3

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

Question 4

Why is it difficult to produce at profit maximisation level?

Answer 4

• they may not know where this level is
• in the short term they may not adjust prices if the marginal costs changes = marginal costs change regularly + regular price changes would disrupt customers

Question 5

Profit maximisation diagram analysis

Answer 5

• the firm has market power as the MR + AR curve are downward sloping
• point of profit maximisation is (MC=MR)
• supernormal profit = (Ppm - ATC price) x QPm

Question 6

How is revenue maximisation achieved?

Answer 6

• firms produce up to the level of output where MR=0
• beyond this point MR is negative so TR falls

Question 7

What is the principal agent problem?

Answer 7

• revenue maximisation often occurs due to the principal agent problem
  = one group makes decisions on behalf of another group , placing their priorities above the principals
• e.g. sale managers receive commission on sales = incentive, profit max for shareholds becomes secondary objective

Question 8

Why do firms have revenue maximisation?

Answer 8

• want to maximise revenue to increase output + benefit from economies of scale
• in the short term firms may use this strategy to eliminate competition as the price is lower than when focusing on profit maxing

Question 9

Revenue maximisation diagram analysis

Answer 9

• TR is max when MR=0
• MR is positive up to this point = elastic PED —> fall in price = increase in revenue
• MR is negative beyond this point = inelastic PED —> TR falls
• supernormal profit smaller than profit maximisation diagram

Question 10

What is sales maximisation?

Answer 10

Maximising number of units without making a loss

Question 11

When does sale maximisation occur?

Answer 11

Where AC=AR (normal profit)

Question 12

Sale maximisation analysis?

Answer 12

• firm has market power as MR + AR curve are downward sloping
• sales maximisation point is AC=AR
• the firm is making normal profit

Question 13

What is profit satisficing?

Answer 13

• means to make enough profit to satisfy shareholders/owners
• this is opposed to traditional profit maxing

Question 14

What is a PLC?

Answer 14

Public limited company

Question 15

How does a PLC work?

Answer 15

• shares can be bought + sold on the stock market (shareholders are the owners)
• board of directors have some control over the company
• there is often a divorce of ownership + control = principal agent theory

Question 16

Problem with principal agent theory in PLCs?

Answer 16

• shareholders may suffer from asymmetric info = unlikely to know how the company is truly performing e.g. how much profit
• directors may aim to achieve a level of output which satisfies shareholders instead a level that is maximum
• managers may look to increase their staff + higher expense account (perks)