Business Objectives

Question 1

firm

Answer 1

an organisation that brings together factors of production in order to produce output

Question 2

normal profit

Answer 2

the return needed for a firm to stay in the market in the long run

Question 3

supernormal (abnormal or economic) profits

Answer 3

profits above normal profits

Question 4

profit

Answer 4

TR-TC

Question 5

profit maximisation

Answer 5

MC=MR

Question 6

sales revenue maximisation

Answer 6

MR=0

Question 7

sales volume maximisation

Answer 7

AC=AR

Question 8

Examples of private sector firms

Answer 8

Tesco
Uber
Santander
Samsung

Question 9

Examples of public sector firms

Answer 9

Network rail
Royal Bank of Scotland

Question 10

profit maximisation occurs where

Answer 10

where MC=MR; more output is produced and sold until the extra cost incurred by one more unit of production exactly equals the revenue gained from that unit of production

long run objective

Question 11

How may a firm sacrifice profit in the short run to maximise profit in the long run

Answer 11

1. Maximise sales revenue by producing where MR = 0. Production is increased to a point where additional sales would reduce overall revenue because to make an extra sale the price of all such goods would have to be reduced.
2. Maximise sales volume by producing where AC=AR. This is the highest level of sales that a firm can sustain in the long run; a higher level of sales would see AR<AC and the firm would make a loss.
3. Maximising growth by increasing market share and the size of the firm. Cutting prices below cost will lead to a loss in the short run, but may lead to even higher long run profits. This is due to increased brand recognition or an ability to cut costs due to increased scale of operation (economies of scale).

Question 12

Why may a firm try to maximise sales or revenue in the short run

Answer 12

1. to increase its market share or to gain market power so that it can make monopoly profits in the long run.
2. higher sales may make it easier to borrow money.
3. Achieving these short run objectives could help to maximise profits in the long run

Question 13

conventional theory of the firm anaylsis

Answer 13

assumes that businesses set a price that maximises their total profits, and have enough information, market power and motivation to. By default, we assume that firms will profit maximise, and stay in the market if they are making supernormal profit

Question 14

Evaluation, profit maximisations realistic assumptions

Answer 14

1. Information

Businesses know their costs and revenue based on market experience, so are best placed to calculate where MC=MR

2. Single-product businesses

A business may only make a single product, such as…

Question 15

Evaluation, profit maximisations unrealistic assumptions

Answer 15

1. Imperfect information

It’s hard for a business to pinpoint their precise profit maximising output, as they cannot accurately calculate marginal revenue and marginal cost

2. Multi-product businesses

Most businesses are multi-product firms operating in a range of markets across countries and continents – the sheer volume of information that they have to handle is vast. And they must keep track of the ever-changing preferences of consumers.

3. Ignores time

To maximise profits in the long run may, in the short run, require not producing at MC=MR to capture market share and raise prices to increase profits later

Question 16

Advantages of profit maximisation

Answer 16

1. Sales revenue maximisation

Faster growth than profit maximisation
Larger firms gain easier access to finance

2. Sales volume maximisation

Faster growth than sales revenue maximisation

3. Growth maximisation

Faster growth than sales volume maximisation

Question 17

Disadvantages of profit maximisation

Answer 17

1. Sales revenue maximisation

Lower profits than profit maximisation

2. Sales volume maximisation

Lower profits than sales revenue maximisation – zero profit

3. Growth maximisation

Lower profits than sales volume maximisation – profits will be negative (making a loss)

Question 18

principal-agent problem

Answer 18

arises from conflict between the objectives of the principals and their agents, who take decisions on their behalf

Question 19

principals

Answer 19

business owners

Question 20

agents

Answer 20

managers running a business on shareholders’ behalf

Question 21

utility maximisation

Answer 21

managers maximising their utility

may enjoy status of running a large team, having a large office, having a prestigious company car

Question 22

social welfare

Answer 22

a firm existing to benefit wider society

to increase this may donate a large % of profit

Question 23

corporate social responsibility (CSR)

Answer 23

a firm acting to benefit wider society, the community or their employees

may involve the business doing, or sponsoring charity work or encouraging employees to volunteer

Question 24

profit satisficing

Answer 24

managers doing just enough to satisfy shareholders by producing satisfactory profits

lazy managers may want to have an easier time at work, accepting lower profits that are still acceptable to shareholders

Question 25

Examples private sector firms

Answer 25

Apple
Amazon
Google

Question 26

Examples public sector firms

Answer 26

Network Rail
Royal Bank of Scotland

Question 27

Principle agent problem in terms of shareholders, managers and directors

Answer 27

The principals of a firm are the owners; usually shareholders
Shareholders exert control over managers with meetings (AGM)
Performance related pay to provide incentives
The agents control the business and are usually comprised of a board of Directors and senior management
Managers and directors run the business on behalf of the owners, making the day-to-day decisions.
The principle-agent problem arises because information asymmetry between managers and owners, means that managers may not be viewed by shareholders as maximising profits.
If the objectives of managers are different to shareholders, managers may not even be trying to achieve the same objective

Question 28

Analysis How can owners minimise the principal-agent problem

Answer 28

Owners can minimise the principal-agent problem by aligning the incentives of managers with owners with performance related pay. This way the managers are incentivised to maximise the profits of the firm because the size of their remuneration is directly linked to the financial performance of the firm.

Question 29

Analysis, firms that are owned by shareholders rather than government

Answer 29

A firm will choose an objective, or group of objectives, that reflect the objectives of the owners. Firms that are owned by shareholders will usually want to maximise profits, whereas firms owned by the government will usually want to increase social welfare. Some firms, such as those owned by charitable trusts, may have more leeway to aim for a range of different objectives.

Question 30

Advantages of principal-agent problem

Answer 30

1. Utility maximisation

The ‘trappings of power’ may be necessary to recruit the most productive and effective employees

2. Social welfare

In private firms, social welfare may be popular with customers, increasing sales
Most public sector firms have social welfare as their objective

3. CSR

CSR may lead to happier, and so more productive, employees
Cheaper to achieve than social welfare

4. Profit satisficing

May prevent unscrupulous, though legal, behaviour that can lead to new legislation being imposed

Question 31

Disadvantages of principal-agent problem

Answer 31

1. Utility maximisation

The ‘trappings of power’ may be expensive and unnecessary

2. Social responsibility

High opportunity cost of not earning more profit

3. CSR

The opportunity cost of CSR is diverted attention and effort away from more profitable endeavours

4. Profit satisficing
   Leads to lower profits than are possible.

Question 32

Judgement of principal-agent theory

Answer 32

The objective or group of objectives that a firm chooses will depend on the owners, and the extent to which the principal-agent problem exists. The larger the principal-agent problem, the greater the degree to which the objectives of the owners and managers may diverge.

The extent to which the non-maximising objective of social welfare benefits the firm over profit maximisation depends upon the preferences of the target market. Assuming the target market is large enough, the more strongly the target market feel about the causes supported by the social welfare objective, the greater the potential benefit of increased sales.