5.2 The Objectives Of Firms Flashcards
What is the main objective of firms?
-Profit is an important objective of most firms.
-Models are based on the assumption that firms aim to maximise profits.
Define profit
-Profit is the difference between total revenue and total cost.
-It is the reward that entrepreneurs yield when they take risks.
When do firms break even?
-Firms break even when TR = TC.
When is a firm profit maximising?
-When they are operating at the price and output which derives the greatest profit.
-Profit maximisation occurs where marginal cost (MC) = marginal revenue (MR).
-In other words, each extra unit produced gives no extra loss or no extra revenue.
Draw a cost and revenue curve to illustrate
•where a firm breaks even (TR=TC)
•where profit maximisation occurs (MR=MC)
When do profits increase?
-When MR>MC
When do profits decrease?
-When MC>MR
Why might some firms choose to profit maximise?
- It provides greater wages and dividends for entrepreneurs.
- Retained profits are a cheap source of finance, which saves paying high interest rates on loans.
- In the short run, the interests of the owners or shareholders are most important, since they aim to maximise their gain from the company.
- Some firms might profit maximise in the long run since consumers do not like rapid price changes in the short run, so this will provide a stable price and
output.
Why are Public Limited Company’s keen to profit maximise?
- Because they could lose their shareholders if they do not receive a high dividend.
- They are more likely to have short run profit maximisation as an objective, because they need to keep their shareholders happy.
What are the reasons for and the consequences of a divorce of ownership from
control?
EXAMPLE-SAINSBURYS SHAREHOLDERS
- The principal-agent problem can be linked to the theory of asymmetric information.
- This is when the agent makes decisions for the principal, but the agent is inclined to act in their own interests, rather than those of the principal.
- For example, shareholders and managers have different objectives which might conflict.
- Managers might choose to make a personal gain, such as a bonus, rather than maximise the dividends of the shareholders.
- When an owner of a firm sells shares, they lose some of the control they had over the firm.
-This could result in conflicting objectives between different stakeholders in the firm.
-If the manager is particularly good, they might require higher wages to keep them in the firm.
-However, they also need to keep shareholders happy, since they are an important source of investment.
-It is not always possible to give both the manager a high salary and the shareholders large dividends, since funds are limited. - When a manager sells their shares, shareholders gain more control over the decisions of the firm.
-This could give rise to ‘shareholder activism’.
-This could be to put pressure on the management of the firm or to try and get higher dividends.
-For example, Sainsbury’s shareholders objected the decision to give the chairman a £2.3 billion bonus in 2004.
-What are some other possible objectives of a firm?
Acronym-Stop Going Increasingly Quiet My Son
- Survival
- Growth
- Increasing their market share
- Quality
- Maximising their sales revenue
- Sales maximisation
Objective-Survival
- Some firms, particularly new firms entering competitive markets, might aim
to simply survive in the market.
-This is a short term view. - During periods of economic decline such as the 2008 financial crisis, when consumer spending plummets, firms might have survival as their objective, until there is economic growth again.
- Firms might aim to sell as much as possible to keep their market position, even if it is at a loss in the short run.
Objective-Growth
- Some firms might aim to increase the size of their firm.
- This could be to take advantage of economies of scale, such as risk-bearing or technological.
- This would lower their average costs in the long run, and make them more profitable.
- Firms might grow by expanding their product range or by merging or taking over existing firms.
- Large firms are also more able to participate in research and development, which might make them more competitive and efficient in the long run.
Objective: Increasing their market share
EXAMPLE-AMAZON
- This helps increase the chance of surviving in the market, and it can be achieved by maximising sales.
- For example, Amazon aimed to increase their market share in the e-reader market, by trying to sell as many Kindles as possible.
- They did this at a loss in the short run, but they gained customer loyalty and now they are a leading e-reader producer.
Objective: Quality
- Firms might aim to increase their competitiveness by improving their quality.
- Firms might consider improving their customer service or the quality of the good they produce.
- This could be achieved through innovation.
- If firms can gain a reputation for high quality goods, they could potentially charge higher prices, since consumers might be willing to pay more for them.
