The objectives of firms Flashcards
Why may firms choose to profit maximise
- So they can reinvest profits back into business e.g. through new tech
- Increase market share as they need to cut costs to increase profits which benefits consumers
- Reward for entrepreneurship i.e. reward for the risk that entrepreneurs take
- PLC’s want to pay more dividends to shareholders to make them happy as shareholders fund the business
How can firms profit maximise
- Produce at quantity where MC = MR
- If they produce past this quantity, MC>MR so the business is making a loss on each unit
- If they produce less than this quantity, MR>MC so each extra unit sold generates more revenue than cost (i.e. profit) so the business should keep increasing output to make more profit
Why may firms choose not to profit maximise
- They don’t know what their exact MC and MR are so don’t know the profit maximising level of output
- To avoid scrutiny from regulators
- They decide to profit satisfice
- Other objectives may be more appropriate
How does more profit means more scrutiny from regulators and why would this cause them not to profit maximise
- Regulators may have concerns over how that business is making so much profit e.g. shortcuts with costs, or health and safety, or too high prices
- They will investigate the business and may force them to e.g. reduce prices or become more environmentally etc
- This will decrease profit for firms so they would avoid profit maximisation to avoid scrutiny
What is profit satisficing
Sacrificing profit to satisfy key stakeholders who may be harmed if profits are too high
Where would a firm that is profit satisficing produce
Any quantity between profit max and sales max
What are examples of 6 key stakeholders being affected by profit maximisation
Shareholders: happy because more dividends
Managers: happy because higher salaries/bonuses
Consumers: unhappy if prices are too high
Workers: unhappy if wages are low due to cost cutting
Government: unhappy because of impact of consumers and workers
Environmental groups: unhappy if cost cutting is bad for environment e.g. pollution
Why is it a benefit for firms to profit satisfice
- Consumers are happier so reputation is better
- Workers are happier so they won’t strike
- Government is happier so less likely to investigate business
- Environmental groups are happier so won’t protest so better reputation
Reputation is very important in modern day world with social media
How can a firm revenue max
Produce where MR = 0
Why would a firm choose to revenue max
- Quantity produced is higher than profit max so experience more economies of scale
- Price is lower so firm can use predatory pricing tactics
- Principal agent problem
What is predatory pricing
When a firm sacrifices profit to undercut it’s rivals in price to drive out competitors in the market
What is the principal agent problem
There is a divorce between ownership and control as the principals own the business (shareholders) but the agents (managers) control the business
How does the principal agent problem mean a firm will revenue max
- The managers run the day in day out for the business (they control) and they want shareholders to give them greater perks in their job e.g. new office, bonuses, company car
- Both revenue max and profit max will provide them will leverage to go to shareholders and negotiate these perks
- However, revenue max may be easier to do for the managers than profit max
How can a firm sales max
AC = AR i.e. normal profit
This is the max quantity businesses can produce without making a loss
Why would a firm choose to sales max
- Economies of scale
- Limit pricing
- Principle agent problem
- Flood the market
What is limit pricing
- The limit price is where the firm produces at normal profit
- There is no incentive for new firms to enter the market as they can’t compete with the limit price
- This limits competition
Why might the principal ownership problem mean a firm will sales max
- Manager uses growth and number of sales as leverage to increase number of perks in their job as it may be easier than profit max or revenue max
Why would a firm want to flood the market with their product
- Selling a far greater quantity of output means consumers become more aware of the product
- Eventually, they will develop loyalty towards it even if you change to profit max later down the line
Where would a firm with survival as their objective produce
- Survival is a short term objective for a firm entering a hyper-competitive market
- The firm may choose to sales max or even make a loss to increase loyalty and reputation towards their product and then change to profit max later
Where would a public sector organisation produce
- Produce at allocatively efficient point to maximise societal welfare
So where demand = supply i.e. P = MC as P is AR which is demand curve and MC is supply curve
