Chapter 12: Objectives of business

Question 1

Define principal-agent problem

Answer 1

Arises from conflict between the objectives of the principles and their agents, who take decisions on their behalf

Question 2

Define x-inefficiency

Answer 2

Occurs when a firm is not operating at minimum cost, perhaps because of organisational slack

Question 3

Define bounded rationality

Answer 3

A situation in which firms’ ability to make rational decisions is limited by a lack of information or an inability to interpret the information that is available

Question 4

Define satisficing

Answer 4

Behaviour under which the managers of firms aim to produce satisfactory results for the firm rather than trying to maximise them

Question 5

Define corporate social responsibility

Answer 5

Actions that a firm takes in order to demonstrate its commitment to behaving in the public interest

Question 6

Define productive efficiency

Answer 6

When a firm operates at a minimum average cost choosing an appropriate combination of inputs and producing the maximum output possible from these inputs

Question 7

Define static efficiency

Answer 7

Efficiency at a particular point in time given the resources and technology available

Question 8

Draw a diagram illustrating the marginal condition/profit maximization

Answer 8

The diagram sheet

Question 9

Analyze a diagram illustrating profit maximization (3)

Answer 9

1. If the extra revenue from selling a unit (MR) is greater than the extra cost of producing it (MC) the firm can increase profits by selling that unit
2. If MR = MC the firm is profit maximization and selling one more or one less unit will reduce profit
3. If MR < MC the firm should cut back production as losses are being made on this unit

Question 10

Name 3 reasons why firms may maximise profits

Answer 10

1. To enable reinvestment into R & D which leads to dynamic efficiency
2. To reward entrepreneurship
3. To finance dividends for shareholders

Question 11

Name 4 issues with profit maximisation

Answer 11

1. In the real world firms don’t know where MR = MC and it will keep changing
2. It may attract greater scrutiny from the CMA
3. Other objectives may be more appropriate
4. Key stakeholders may be harmed

Question 12

What’s the condition for profit maximization

Answer 12

MR =.MC

Question 13

Name the condition for sales revenue maximization

Answer 13

MR = 0

Question 14

Why must you charge lower prices when revenue-maximizing?

Answer 14

The firm will produce more

Question 15

Name reasons why firms aim to maximise sales revenue (4)

Answer 15

1. Achieve more economies of scale - lower average costs enabling price reductions
2. To deter the entry of new firms by charging lower prices enabling abnormal profits in the long-run
3. Companies geared towards maximising revenue are more likely to make use of price discrimination to extract additional revenue and profit from consumers
4. Annual salaries and managerial perks tend to be linked to sales revenue rather than profit

Question 16

Name the condition of sales/ output maximisation

Answer 16

AR = AC

Question 17

Name 4 reasons why firms may choose to sales maximise

Answer 17

1. Achieve more economies of scale to reduce costs
2. Enables limit pricing to reduce competition
3. Principle agent problem - managers use sale volume figures to get perks
4. Flood the market with the product to establish brand increasing customer loyalty and increase the price in the future

Question 18

Draw a diagram illustrating the average condition

Answer 18

Diagram sheet

Question 19

Draw a diagram illustrating x-inefficiency

Answer 19

Diagram sheet

Question 20

Define survival

Answer 20

A short-run objective

Question 21

What’s the condition for allocative efficiency

Answer 21

P = MC