4.1.5.2 Objectives of firms (Paper 1 & 3)

Question 1

Profit max

Answer 1

Where MC = MR

Question 2

Why may firms profit max?

Answer 2

1) Re-investment
2) Dividends for shareholder
3) Lower costs and lower prices for consumers
4) Reward for entrepreneurship

Question 3

Drawbacks of profit of max?

Answer 3

1) Knowledge of MC = MR
2) Greater scrutiny - more likely to draw attention from independent regulators
3) Key stakeholders damaged
4) Other objectives more appropriate

Question 4

Define divorce of ownership and control

Answer 4

The separation that exists between owners of the firm (shareholders) and directors in large PLCs

Question 5

Implications of divorce of ownership and control

Answer 5

• Profit max not always achieved
• Large corporations may be predominantly owned by shareholders - who are separate from the day-to-day running of the business (having bought shares as a form of investment) - board of directors may not hold any shares
• May lead to conflicting objectives - with directors pursuing their own - profit max may not be top priority

Question 6

What may the objectives of directors of firms, who run the business on a day-to-day basis, include?

Answer 6

• Growth maximisation
• Sales revenue maximisation
• Satisficing

Question 7

Profit satisficing

Answer 7

Sacrificing profit to satisfy as many key stakeholders as possible.

Question 8

Key stakeholders impacted by profit max

Answer 8

• Shareholders - happy w/ profit max
• Managers - happy w/ profit max
• Consumers - could suffer if excess prices are charged
• Workers/TUs - could suffer if wages a are low due to cost cutting
• Govt - may disapprove of low wages and excess prices
• Environmental groups - not happy if costs are cut - pollution, resource degradation

Question 9

Revenue max

Answer 9

MR = 0

Question 10

Why may firms revenue max?

Answer 10

1) EoS - revenue max Q > profit max Q
- Greater growth - greater EoS - lower AC - potentially lower prices for consumers
2) Predatory pricing
- Revenue max price lower than profit max price
- Firm uncut rival - sacrificing profit to drive competitors out the market
3) Principle Agent Problem?
- Divorce between ownership from control
- Managers - those who control - might decide to rev. max for leverage for share holders for greater perks in their jobs

Question 11

Sales (growth) maximisation

Answer 11

• Occurs at breakeven - where AC = AR

Question 12

Why may firms decide to sales max?

Answer 12

1) EoS
2) Limit pricing
- Price at normal profit - takes away incentive for new firms to enter market - limiting competition
3) Principle Agent Problem - Divorce between ownership from control - managers using growth and sales as leverage
4) Flood the market - many consumers aware of product - develop loyalty - gain market share - then move away from sales max to profit max

Question 13

Firms that have used sales max?

Answer 13

• Netflix, Amazon, Spotfiy, Costa Coffee

- High market shares

Question 14

Benefits and drawbacks of higher market share?

Answer 14

• Firms have benefit of monopoly power - i.e. price setting

- However - may attract attention from govt - may gear that such firms abuse their power

Question 15

Survival

Answer 15

• Short-run objective for a business a hyper-competitive market
• To survive in the short run - i.e. cover AVC

Question 16

Public Sector Organisations

Answer 16

• Maximise society welfare (allocative efficiency, where P = MC)
• Low prices, high quantity

Question 17

Corporate social responsibility

Answer 17

• Charity, producing sustainable, paying workers, even suppliers, well
• Acting ethically - e.g. body shop don’t test products in laboratories