Objectives of Firms Flashcards
What can firms do with their profit?
- pay dividends to shareholders
- save for the future
- invest towards future growth e.g. R+D
What is the main objective for firms?
profit maximisation (although this ISN’T for ALL firms)
When will firms profit maximise?
Marginal revenue = Marginal cost (MR = MC)
What happens when MC > MR? Why?
There is a negative impact on revenue because of diminishing returns.
To gain LR profit some firms may…
gain revenue+ market share in SR, even if profit must be sacrificed.
Why has Amazon gained little profit in the last 10yrs?
They aimed to maximise market share in SR.
What can bounded rationality limit in firms?
Ability to make choices that lead to profit maximisation.
As a result, profit maximisation is not always possible.
If some firms don’t profit maximise what might they do instead?
Satisfice
Who was the Theory of Satisficing preposed by?
Herbert Simon
Theory of Satisficing
owners setting minimum acceptable levels of achievement.
E.G. min goal for sales, revenue and profit
Corporate social responsibility
Firms trying to make SNP in a sustainable way. This can be beneficial for society.
E.G. a firm might aim to produce its goods whilst keeping carbon emissions low.
Maximising market share
AKA sales maximisation.
Produce where average revenue is equal to average cost (AR = AC).
Why might an oligopoly aim for sales maximisation?
Would allow them to achieve economies of scale and greater price-setting power in the long-run.
Revenue maximisation.
Produce where marginal revenue is equal to zero (MR = 0).
Why may a firm revenue maximise not profit maximise?
- Increases the size of the firm, this could be beneficial to managers due to the prestige.
- perks they may receive from managing a large firm.
Divorce of ownership from control
Shareholders own the company, managers run the company.
Principle- agent problem
Asymmetric information problem.
Interests of the manager may not be in the interest of the shareholder.
Why does the principle-agent problem occur?
It comes about because shareholders often can’t observe easily and accurately the key day-to-day decisions of management.
How can shareholders regain control over managers of a company?
- Holding them accountable for the firms performance, adding pressure for them to perform their interests.
- Managers could have their pay linked to the share price over a number of years.
This realigns the goals of managers and shareholders.
negatives of profit maximisation
- higher prices for final consumers- reduces income/purchasing power- lower consumer surplus.
- high profits may incentivise others to join market- more competitive- may reduce returns to shareholders.
- overly focused on profits- lose sight of social + enviro aspect of businesses.
Why do firms sales maximise?
- economies of scale- lower AC
- limit pricing- limiting competition (illegal)
- principle-agent problem- divorce between ownership + control- sales growth as leverage to shareholders.
- to flood the market- consumers become loyal.
Why do firms revenue maximise?
- economies of scale- lower AC
- predatory pricing- sacrifice its profit to drive out competition (illegal)
- principle agent problem- divorce between ownership + control- revenue as leverage to shareholders.