Business Objectives Flashcards
What objective are firms assumed to be
Firms are assumed to be profit maximisers, but sometimes they may opt to satisfy different objectives such as revenue maximisation or sales maximisation.
When does profit maximisation occur
Profit maximisation occurs at the output level where supernormal profits are at their greatest (or losses are at their lowest). This occurs where marginal cost is equal to marginal revenue (MC =MR), but while this is a necessary condition, it is not sufficient. Marginal cost must also be rising.
Define profit maximisation
Occurs where MC = MR. it is where the firm maximises profits or minimise losses.
How is profit represented on a diagram
When MC is below MR - the area beneath the MR is profit.
When MC = MR what happens
No more profit can be made either by increasing or decreasing output. The marginal profit is zero.
How can we evaluate profit maximisation
When evaluating profit maximisation, consider whether the local coffee shop knows the marginal costs of a cup of coffee. Furthermore, what would it do if it knew that level of output? Would it stop selling because the next item would result in a fall in total profit? Some firms, then, look to other objectives.
When does revenue maximisation occur
It occurs when a firm seeks to make as much revenue as possible. Firms are willing to sell products until the last unit sold adds nothing to total revenue, knowing that the next unit sold will reduce revenue: that is, they sell until the marginal revenue is zero.
Define revenue maximisation
When a firm maximises total revenue. This occurs where marginal revenue = 0
When the MR curve touches the x axis (equals 0) what happens to the TR curve
It is n shape and at this point is the turning point.
On any questions on revenue maximisation draw a diagram showing the parabola-shaped TR curve with its peak lining up with where the MR crosses the horizontal axis. Mark on MR=0. It shows that as the firm expands output, the marginal revenue declines. While marginal revenue is positive, it continues to add to total revenue; it is only when it passes zero and becomes negative that total revenue starts to decline.
What’s sales maximisation
Sales maximisation occurs when a firm attempts to sell as much as it can without making a loss. That is, it sells as much as it can subject to the constraint of making normal profits. This occurs where average cost equals average revenue .
Where AC = AR this is…
Sales maximisation.
Tell me how not to confuse sales maximisation with something else
Do not confuse sales maximisation, AR = AC, with sales revenue maximisation, MR =0 (which Is referred to in this guide as revenue maximisation).
Remember that sales maximisation is the highest level of sales given that the firm must makes normal profit. It is also called output maximisation.
Why may firms embark on revenue or sales maximisation
In an effort to gain market share or drive a rival out of the industry. Prices are lower than under perfect competition and output is higher.
Define allocative efficiency
Producing at a point where the price of a good is equal to the marginal cost of production
Why may government seek to ensure that firms operate at the allocatively efficient point (other motive for firms)
This is where price equals marginal cost. In other words, the price paid for a good is equal to the cost of the factors of production used to manufacture the last unit.
What is allocative efficiency on a diagram
Where P = MC
AR = P so MC crosses the AR curve
Tell me about the other motive for firms: satisficing
This is an important behavioural theory that you need to know for this theme. It means making just enough profit to keep stakeholders happy, allowing for other motives then to be pursued. Stakeholders are people who have a vested interest in the firm. They include shareholders, employees, managers, customers, suppliers, government and the trade unions.
Tell me about the other motive for firms: long run profit maximisation with short term increased market dominance as a primary motive
This may lead to higher profits over time
Define satisficing
A combination of two words ‘satisfying’ (keeping people happy) and ‘sufficing’ (just enough). So it means doing just enough to make certain stakeholders happy.
What are the two types of strategy to gain market share or increase profitability
Pricing strategies
Non-price competition
What are the two types of pricing strategies
Predatory pricing
Limit pricing
What is predatory pricing
Pricing below costs to drive out other firms. In the short run the firm makes a loss, but as the other firms leave, the prices are raised to higher levels than would have been possible without competition. This is an anti-competitive practice and can lead to fines being imposed by the competition authorities.
What is limit pricing
Pricing at a level low enough to discourage entry of new firms: that is, ensuring that the price of the good is below that which a new firm entering the industry would be able to sustain. This exploits the economies of scale that an incumbent firm has and is not necessarily illegal in the UK.
How can pricing strategies affect consumers in the short and long run
In the short run, both limit and predatory pricing will seem to benefit the consumer by giving them low prices. However, when the firm has managed to drive rival firms out of the industry and gained monopoly power, it will be able to raise prices, reducing the consumer surplus and reducing consumer choice.
What are some other pricing strategies firms might use, apart from profit maximising
Cost-plus pricing (making a fixed percentage mark up on average costs)
Price discrimination
Discount pricing such as buy one get one free.
These often have a good practical rationale and can lead to greater consumer loyalty, thereby increasing long run profits.
Why may non-price competition strategies be used
As an alternative to limit pricing and predatory pricing, firms may embark on non price competition in order to increase sales or profit. This is particularly evident where price competition might lead to price wars.
Tell me what non price competition strategies a firm might use
Any action by a firm that does not involve changing price comes under this category.
Including marketing strategies such as advertising (also including placing the product in the hands of celebrities),
increased investment in branding (including measures to increase brand loyalty, such as loyalty cards)
Packaging (for instance, including free gifts or prizes)
After care/customer service/warranties
Product development
Quality and innovation
Mergers/acquisitions to remove competition
Here you can also include ‘buy one get one free’ as it is a commonly used marketing technique to attempt to increase consumer loyalty.
What is the aim of non pricing strategies
The aim of non pricing strategies is to shift the average revenue (demand) curve to the right or to prevent it from falling as other firms try to increase their market share. The cost of the advertising must be below the increase in supernormal profit if it is to be of any benefit.
Exam tip what is the aim of non pricing strategies
Is to increase demand for the good being sold and to reduce the price elasticity of demand by reducing the availability of substitutes, without changing price.
Do non pricing strategies work
It may be the case that other firms will also increase their advertising or copy the innovations being introduced, and spending large sums of money on an advertising campaign is no guarantee of success. When evaluating, it is always worth asking whether the firm has enough money to back up any planned non price competition strategy, how long it will take to work, and indeed whether or not it will work at all, especially in the face of the actions of rival firms.
Firms are assumed to be what?
Profit maximisers
Where does profit maximisation occur
Where MC = MR and marginal cost is rising.
Firms will pursue what other objectives
Revenue or sales maximisation
Where does revenue maximisation occur
Where MR = 0
Where does sales maximisation occur
Where a firm can sell as much as it can without making a loss - this is where AC = AR.
Managers may seek to ______ rather than profit maximise
Satisfice
Some firms will pursue other ______ or ________
Pricing or non pricing strategies
