profit and revenue Flashcards
conditions for profits to rise/fall
If MR > MC, then total profit rises. If MC is greater than MR, total profit falls
if average revenue > average total costs (AR > ATC)
The firm is making supernormal profits
if average total costs > average revenue > average variable costs (AVCltARltATC)
The firm is making an operating profit, and is covering its variable costs, but not all its total costs. Therefore, in the short run it is best to keep producing because it has already paid for its fixed costs and it is making a contribution to fixed costs.
if average revenue = average variable costs (AR=AVC)
The firm is just covering its variable costs. This is known as the shutdown point as anything less is an operating loss.
if average variable costs > average revenue (ARlessthanAVC)
The firm is making an operating loss and will shut down.
Apart from profit maximisation, firms may pursue other objectives: (1)
- Profit Satisficing
• In many firms there is separation of ownership and control.
• This is a problem because although the owners may want to maximise profits, the managers have much less incentive to maximise profits because they do not get the same rewards as owners (share dividends)
• In this situation of separate ownership and control, managers may create a minimum level of profit to keep the shareholders happy, but then maximise other objectives such as enjoying work.
Apart from profit maximisation, firms may pursue other objectives: (2)
Sales Maximisation.
Firms often seek to increase their market share, even if it means less profit. This could occur for various reasons:
• Increased market share increases their monopoly power and may enable them to put up prices and make more profit in the long run.
• Managers prefer to work for bigger companies, as it tends to lead to greater prestige and higher salaries.
• Increasing market share may force rivals out of business.
Apart from profit maximisation, firms may pursue other objectives: (3)
- Social / Environmental concerns.
A firm may incur extra expenses to choose products which don’t harm the environment or choose products not tested on animals. This has actually proved quite a good marketing strategy, e.g. for firms like the Body Shop with their ‘Go Green’ campaign.
Theory of the firm
firms exist and make decisions in order to maximize profits, Modern takes on the theory of the firm take such facts as low equity ownership by many decision-makers into account - other objectives
Divorce of ownership of control
The owners of a private sector company normally elect a board of directors to control the business’s resources for them. However, when the owner sells shares, or takes out a loan or bond to raise finance, they may sacrifice some of their control. Other shareholders can exercise their voting rights, and providers of loans often have some control (security) over the assets of the business. This may lead to conflict between them as different stakeholders can have varying objectives.
