4.1.5.2 The objectives of firms Flashcards
What is the traditional assumption about firm objectives?
Traditional theory assumes firms aim to maximize profits.
What is the profit-maximizing rule?
Profit maximization occurs where marginal cost (MC) equals marginal revenue (MR): MC = MR.
When do profits increase?
Profits increase when MR > MC (each additional unit adds more to revenue than to costs).
When do profits decrease?
Profits decrease when MC > MR (each additional unit adds more to costs than to revenue).
Why do firms choose to profit maximize?
Reasons include:
- Higher wages/dividends
- Retained profits as cheap finance
- Shareholder expectations
- Price stability in long run
What is the principal-agent problem?
When managers (agents) make decisions that benefit themselves rather than shareholders (principals), due to conflicting objectives.
What is shareholder activism?
When shareholders pressure management to align decisions with shareholder interests (e.g., higher dividends rather than manager bonuses).
What are alternative firm objectives besides profit maximization?
- Survival
- Growth
- Market share
- Quality
- Sales revenue maximization
- Sales maximization
- Social/environmental goals
When might firms prioritize survival?
During economic downturns or when entering competitive markets, to maintain market position even at short-term losses.
Why might firms aim for growth?
To achieve economies of scale, lower costs, increase R&D capability, and improve long-term profitability.
What is revenue maximization?
Producing where MR = 0 (selling maximum possible units without considering costs).
What is sales maximization?
Producing where AC = AR (selling maximum possible units without making a loss).
What is an example of sales maximization?
Amazon selling Kindles at a loss initially to gain market share and customer loyalty.
What is the satisficing principle?
Earning just enough profit to keep shareholders happy while pursuing other objectives.
When does satisficing typically occur?
When there’s a divorce of ownership and control (managers prioritize personal/other goals over maximum profits).
How might quality be a firm objective?
Improving product/service quality to build reputation, justify higher prices, and increase competitiveness.
Why might PLCs prioritize short-run profit maximization?
To satisfy shareholders with dividends and maintain share prices.
What are managerial objectives that may conflict with profit maximization?
- Personal gains (bonuses, perks)
- Easier work conditions
- Firm growth for prestige
How can divorce of ownership from control affect firm decisions?
Managers may pursue:
- Sales growth over profits
- Personal benefits
- Easier targets
Rather than shareholder value.
What diagram position shows revenue maximization?
Where MR = 0 (top of the total revenue curve).
What diagram position shows sales maximization?
Where AC = AR (break-even point).
How might ethical objectives affect firm behavior?
Prioritizing social/environmental goals over pure profit (e.g., fair trade, sustainability).
What is break-even for a firm?
When total revenue equals total costs (TR = TC).
Why is profit important for firms?
As:
- Reward for risk-taking
- Source of investment funds
- Indicator of success
- Means to satisfy stakeholders
