3.2.1 Business Objectives

Profit Maximisation

• Most firms have the rational business objective of profit maximisation
  • Profits benefit shareholders as they receive dividends & also increase the underlying share price
    • An increase in the underlying share price increases the wealth of the shareholder
      
      
• To achieve profit maximisation firms, follow the profit maximisation rule
  • When marginal cost (MC) = marginal revenue (MR) then no additional profit can be extracted by producing another unit of output
  • When MC < MR additional profit can still be extracted by producing an additional unit of output
  • When MC > MR the firm has gone beyond the profit maximisation level of output
    • It is making a marginal loss on each unit produced beyond the point where MC = MR
      
      
• In reality, firms may find it difficult to produce at the profit maximisation level of output
  • They may not know where this level is
  • In the short term they may not adjust their prices if the marginal cost changes
    • Marginal costs can change regularly and regular price changes would be disruptive to customers
  • In the long-term firms will seek to adjust prices to the profit maximisation level of output
  • Firms may be forced to change prices by the Competition Commission
    • The profit maximisation level of output often results in high prices for consumers
    • Changing prices changes the marginal revenue
      
      

The profit maximisation level of output occurs at Q₁ where MC = MR resulting in a market price of P₁

Diagram Analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping
• At the profit maximisation level of output (MC = MR)
  • The selling price is P₁
  • The average cost is C₁
  • The supernormal profit =
    
    

Revenue Maximisation

• Some firms have the business objective of revenue maximisation
  • This often occurs due to the principal agent problem
    
    • Sales managers often receive commission on sales as part of their wages and this incentivises them to maximise sales
    • Profit maximisation for shareholders becomes a secondary objective for the sales managers
  • Firms will also maximise revenue in order to increase output & benefit from economies of scale
  • In the short-term firms may use this strategy to eliminate the competition as the price is lower than when focussing on profit maximisation
    
    
• To achieve revenue maximisation firms produce up to the level of output where MR = 0
  • When MR > 0, producing another unit of output will increase total revenue
    
    

The revenue maximisation level of output occurs at Q₁ where MR = 0 resulting in a market price of P₁

Diagram Analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping
• At the revenue maximisation level of output (MR = 0)
  • The selling price is P₁
  • The average cost is C₁
  • The supernormal profit =
  • The supernormal profit is less than when the firm follows the profit maximisation rule
    

Sales Maximisation

• Some firms have the business objective of sales maximisation
  • This occurs at the level of output where AC = AR (normal profit/breakeven)
  • In the short-term firms may use this strategy to clear stock during a sale
    • They sell remaining stock without making a loss per unit
      

The sales maximisation level of output occurs at Q₁ where AC = AR resulting in a market price of P₁

Diagram Analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping
• At the sales maximisation level of output (AC = AR)
  • The selling price is P₁
  • The average cost is also at P₁
  • The firm is breaking even (normal profit)
    
    

Satisficing

• Some firms have the business objective of satisficing
• This often occurs as a result of the principal agent problem
  • Rationally, managers know shareholders want to profit maximise
  • Rationally, managers want to maximise sales or revenue so as to increase their wages
  • Managers (who control the business) settle for a level of output somewhere between profit and sales maximisation
    • This increases their wages and reduces potential conflict with shareholders