Business Objectives - Theme 3

Question 1

Define profit maximisation.

Answer 1

Occurs at output level where supernormal profits are their greatest. This occurs where MR=MC. Where firm maximises profit or minimises losses.

Question 2

Give reasons for profit maximisation.

Answer 2

• Higher dividends for shareholders.
• More profit can be used to finance research and development.
• Higher profit makes the firm less vulnerable to takeover.
• Higher profit enables higher salaries for workers

Question 3

Define revenue maximisation.

Answer 3

Occurs when a firm seeks to make as much revenue as possible. They sell until MR=0

Question 4

Give reasons for revenue maximisation.

Answer 4

• Increased brand loyalty. If a firm is able to cut prices and gain more customers, it will gain bigger exposure and brand loyalty.
• Put competitors out of business. Pursuing sales maximisation may enable large firms to push rivals out of business. This enables the firm to have more market share and profit in the long-term. Consumers could benefit from lower prices in the short-term, but if firms do go out of business, then they will have lower choice and face prospect of less competition in the long-run.
• Economies of scale. Lower price and higher sales can help firms with high fixed costs gain economies of scale (lower average costs). This could lead to lower prices for consumers.

Question 5

Define sales maximisation.

Answer 5

Occurs when firm maximises sales of its output while achieving normal profits. Occurs when AC=AR.

Question 6

Reasons for sales maximisation.

Answer 6

• Increased market share increases monopoly power and may enable the firm to put up prices and make more profit in the long run.
• Managers prefer to work for bigger companies as it leads to greater prestige and higher salaries.
• Increasing market share may force rivals out of business. E.g. the growth of supermarkets have lead to the demise of many local shops. Some firms may actually engage in predatory pricing which involves making a loss to force a rival out of business.

Question 7

Define satisficing.

Answer 7

When a firm does just enough to make certain stakeholders are happy.

Question 8

Reasons for satisficing

Answer 8

• The management may have other objectives, or a decision been made to sacrifice some short-run profits may mean long run profit maximisation.
• The idea that businesses depart from pure profit maximisation is linked to the existence of a divorce of ownership from control and the principal agent problem.