8.4 Objectives of Firms Flashcards
Objectives of Firms Diagram Analysis
What is Profit Maximization?
Profit maximization occurs where marginal revenue equals marginal cost, at Pp and Qp, and is assumed to be the objectives of private businesses in a market economy. It is the strategy that allows shareholders, who are the owners of the business, to receive higher dividends which is very important considering they are funding the enterprise. Retained profit is a major source of investment for firms which can further improve profitability for the business but also provide some major macroeconomic benefits as well.
Evaluation 1: What is the challenge with firms trying to be profit maximizers?
In reality, knowledge of marginal revenue and marginal cost may be imperfect making it difficult for firms to be profit maximizers as theory suggests. However, even if firms are not producing where marginal revenue equals marginal cost, the idea of profit maximization still holds even if they adopt a different strategy such as cost-plus pricing where a price differential on top of the cost of production is used instead.
Evaluation 2: Why might regulatory authorities investigate a firm making large supernormal profits?
Making large supernormal profits might signal investigation by regulatory authorities. This is because very high profits may be due to excessive pricing beyond marginal cost (consumer exploitation) or collusive or monopoly behavior, which signals for regulatory bodies to investigate the business. This is normally against the interest of business with the end result being forced price reductions, selling of stores to promote competition, improvements in working conditions, using greener machinery or greater reinvestment, which increases costs of production for businesses.
Evaluation 3: Why might profit maximization not be the best business strategy for businesses?
Perhaps profit maximization is not currently the best business strategy for businesses. This is because a business may want to increase its market share quickly, flood the market with products, develop brand loyalty or benefit from greater economies of scale all of which require different objectives to be pursued at least in the short run.
What is Profit Satisficing?
Profit satisficing is sacrificing profits to satisfy as many stakeholders as possible. Profit maximization will benefit key stakeholders such as managers and shareholders but could harm others like workers who suffer from low wages, consumers who may suffer from high prices, environmental groups and the government who may show concern over exploitative pricing. As a consequence, businesses may decide to purposefully reduce the level of supernormal profit being made whereby they can satisfy the needs and wants of as many of these stakeholders as possible to prevent costly future disputes.
What is Revenue Maximization?
Revenue maximization occurs where marginal revenue equals zero, Pr and Qr, with a lower price and higher quantity than profit maximization. This objective can be used for several reasons: (i) As predatory pricing to drive out existing profit maximising competition from the industry allowing a firm to gain more market share and potentially develop a monopoly presence in the market over time. (ii) Producing at a higher quantity than profit maximization allows a firm to experience greater economies of scale, reducing average costs to then reduce prices and gain market share ahead of rivals who do not benefit from the same economies of scale. (iii) The divorce between ownership and control may make revenue maximization an objective pursued by managers looking to maximize their benefits at work.
What is Sales Maximization?
Sales maximization occurs where average revenue equals average cost, Ps and Qs, with a lower price and higher quantity than both profit and revenue maximization. This objective ensures that normal profit is still made, maximizing sales without a loss being made and is used for several reasons: (i) To flood the market with products or stores in developing the brand and establishing the presence of the product. In a highly competitive market with several big players, this strategy can allow a business to gain brand loyalty and a strong reputation amongst consumers, developing a strong customer base. If successful, it can provide an element of monopoly power allowing for long-run profit maximization. (ii) Producing at the highest possible quantity without loss-making allows for a firm to experience greater economies of scale, reducing average costs to then reduce prices and gain market share ahead of rivals who do not benefit from the same economies of scale. This could be very important in industries where large incumbent firms already experience significant economies of scale and are therefore much more competitive on price. (iii) The divorce between ownership and control may make sales maximization an objective pursued by managers who are looking to maximize their benefits at work. Managers may be able to justify higher salaries, large offices, and other perks in the job using great sales quantity figures as justification of how successful they have been in growing the business.
What is Allocative Efficiency?
Allocative efficiency takes place where price (AR) is equal to marginal cost. At this production point, the sum of both consumer and producer surplus is being maximised where consumers are getting goods and services at the exact quantity they desire. The needs and wants of consumers are being met perfectly, with firms able to get ahead of rivals who are not as customer-oriented. This can allow for market share increases over time with a potential change to profit maximization if the market share gained has been substantial.
What is Survival?
For new firms in a highly competitive market place, survival by getting through the first couple of years of business activity may be the objective, establishing a presence in the market, developing a customer base, and brand loyalty for strong sales in the future. The objective can then change over time as long as significant losses have not been made upon immediate entry.
What is Corporate Social Responsibility?
Some firms believe in the idea of social responsibility to develop a different side to their brand. This can involve becoming more environmentally friendly in their production, looking after those at the bottom of their supply chains by issuing minimum prices, giving to charities, and providing excellent in-work benefits to their workers. This improves the image of the company leading to increased sales and marketing power in the future and simply can provide a utility boost to those who work in the company knowing they are doing something good without necessarily wanting something back.
