Theme 3.2 Flashcards
Why can a firm’s objective/motives vary?
A firm’s motives are often determined by who controls it. There are a range of people who could have control: owners or shareholders, directors and managers, the workers (through a trade union), the state (through regulation, taxes/subsidies and direct control), consumers (through their consumer sovereignty- businesses sell what consumers want to buy) and pressure groups.
Why would a firm want to profit maximise?
● Neo-classical economics assumes that the interests of owners or shareholders are the most important and therefore the goal of firms is to profit maximise in the short run, in order to maximise owners’ returns.
● By short-run profit maximising, firms can also generate funds for investment and to help them survive a slowdown during a recession.
How does profit maximisation occur?
In order to short run maximise, firms produce where MC=MR. If they produce less than this, then producing more will increase profit since MR would be higher than MC so they’re making more in revenue than it costs to produce the good and so producing more would increase profit. If they produce more than this, they would be making a loss on the goods produced above the profit maximising point and so they should decrease production.
What is revenue maximisation?
To revenue maximise, firms would produce where MR=0, since if marginal revenue is above 0 producing more would increase revenue. This means they produce Q2P2, whilst profit maximisation would produce at Q1P1..Prices would be lower than when they are profit maximising since they are producing more.
Why may firms want to revenue maximise?
-A high revenue will look good for managers trying to increase their salary
-High revenue is good for brand prestige.
-Fall in revenue could lead to a downwards spiral for the company, e.g making workers redundant and less willing to invest.
-Allows for some level of predatory pricing to prevent competition
-Using revenue maximisation rather than profit maximisation helps to avoid attention from regulators.
What is sales maximisation?
In order to sales maximise, the firm will want to get the highest level of sales possible without making a loss. They will want to ensure sufficient returns to keep the owners happy, so will aim for normal profits. As a result, they produce where AC=AR at P2Q2. Prices are lower and output is higher than they would be under profit maximisation.
Why may a firm sales maximise?
-Salaries of managers may be linked to the size of the company
-It can often be easier to judge the level of growth that is achieved rather than the level of profit, can positively influence prestige.
-Helps provide security with firm size
-Can increase market share, and low prices can push other firms out the market
-Can be used as short-term strategy to increase customer loyalty before then rising prices gradually and maintaining the customer base.
What is the issue with firms attempting to use both sales and revenue maximisation strategies?
The problem with both sales maximisation and revenue maximisation is that it necessitates a fall in price, which other firms may copy and so there may be no or little increase in revenue or sales: this is important in oligopoly. They also bring lower profits.
What is the principle-agent problem?
Due to the principal-agent problem, owners and directors will have different goals. Directors will want to maximise their own benefits but will need to make a certain amount of profit in order to keep their jobs, receive benefits and avoid criticism from shareholders/the press.
What is profit satisficing?
Make enough profits to satisfy stakeholders such as owners, but sacrifice making the maximum possible profits in order to reach targets to maximise the benefits for the managers.
How will managers profit satisfice?
● Therefore, managers are likely to follow the objective of profit satisficing: they will make enough profit to keep owners happy whilst following other objectives and not profit maximising. These other objectives are likely to be their own benefits, for example they may increase their own salaries which increases costs and therefore decreases profit.
● The amount of profit needed will change year on year and will depend on the level of profit made by other firms: if everyone else is making a loss, and the firm only manages normal profit then this will be good enough for shareholders but if other firms are making huge profits, shareholders too will expect huge profits.
