Objectives of Firms Flashcards
Profit
Profit: Difference between TR & TC, the reward that entrepreneurs yield when they take risks
- Profit is objective of most firms, but can have other objectives which affect how they behave
- Firms break even when TR = TC
- In other words, each extra unit produced gives no extra loss or no extra revenue
- Profits increase when MR > MC, Profits decrease when MC > MR
Profit Maximisation
Profit Maximisation: When operating at the price & output which derives greatest profit, MC = MR
- Provides greater wages & dividends for entrepreneurs
- Retained profits are cheap source of finance, saves paying high interest rates on loans
- SR, interests of owners/shareholders are most
important, since they aim to maximise their gain from company - LR, consumers do not like rapid price changes in SR, provide a stable price & output
Private Limited Companies (PLCs): Keen to profit maximise, because they could lose shareholders if they do not receive high dividend
- More likely to have SR profit maximisation as objective, because they need to keep shareholders happy
Divorce of Ownership From
Control
Principal-Agent Problem: When the agent makes decisions for the principal, but the agent acts in their own interests, rather than the principal
- E.g shareholders & managers, Managers choose personal gain, rather than maximise the
dividends of the shareholders.
- When owner sells shares, they lose some control of the firm, could result in conflicting objectives between different stakeholders in
the firm - If manager is good, they might require higher wages to keep them. However, they also need to keep shareholders happy
- Not always possible to give both manager a high salary & shareholders large dividends, since funds are limited.
- When manager sells shares, shareholders gain more control over the decisions of the firm
- Could give rise to ‘shareholder activism’, put pressure on the management of the firm or to try & get higher dividends
- E.g Sainsbury’s shareholders objected the decision to give the chairman a £2.3 bil. bonus in 2004
Other Objectives of Firms
-
Survival: Some new firms entering competitive markets aim to survive in the market
- Short term view, During periods of economic decline (e.g 2008 GFC), firms aim to survive , until there is economic growth again
- Firms might aim to sell as much as possible to keep market position, even if it is at a loss in SR -
Growth: Aim to increase size of firm, could be to take advantage of EoS (e.g Risk-bearing, technological)
- Lowers AC in LR, making them more profitable
- Might grow by expanding product range or merging/acquisitions
- Large firms able to participate in R&D, making them more competitive & efficient in LR -
Increasing Market Share: Helps increase chance of surviving, can be achieved by maximising sales
- E.g Amazon increases market share in e-reader market, by selling as many Kindles
as possible at a loss in SR, but gained customer loyalty & now are leading the market -
Quality: Aim to increase competitiveness by improving quality, might consider improving customer service or the quality of goods
- Can be achieved through innovation
- If firms gain reputation for high quality goods, can charge higher prices - Maximising Sales Revenue: Revenue maximisation occurs when MR = 0, each extra unit sold generates no extra revenue
-
Sales Maximisation: When firm aims to sell as much G&S as possible without making a loss
- Non-profit organisations might work at this output & price
- Where AC = AR
Other Objectives: Society, Environmental, Ethical, Worker welfare
The Satisficing Principle
The Satisficing Principle: Firm is profit satisficing when earning just enough profits to keep shareholders happy
- Shareholders want profits since they earn dividends from them
- Managers might not aim for high profits, because their personal reward from them is small compared to shareholders
- Therefore, managers might choose to earn enough profits to keep shareholders happy, whist still meeting their other objectives.
- Occurs where there is a divorce of ownership & control
