Geoff Tricky Microeconomics

Question 1

Reasons why firms choose to profit satisfice instead of to profit maximise

Answer 1

Divorce of ownership and control: managers want to promote themselves by selling more, managerial objectives and owner objectives don’t align & minimise conflict between these parties
Profit satisficing can prevent new firms being attracted on the basis of supernormal profits (limit pricing) despite low barries to entry / exit
Attract investors to gain equity

Geoff says:
Bounded rationality: firms don’t have complete data to calculate the true profit maximising price. Under bounded rationality, they settle for profit satisficing which reduces risk
Separation of ownership and control: in large corporations, shareholders own the firm, but managers run it. They might have slightly different goals to equity holders in a business

Question 2

Possible effects of profit satisficing on the economic efficiency / consumer welfare

Answer 2

Improve allocative efficiency as the price is closer to MC
Loss of dynamic efficiency as SNP reduced

Geoff says:
Allocative efficiency: satisficing involves setting a lower price, price is closer to marginal cost leading to an improvement in allocative efficiency. Consumer surplus increases
Dynamic efficiency: supernormal profits are lower which reduces the funds available to finance R&D. This might limit gains in dynamic efficiency

Question 3

What are the key aims of price collusion in an oligopoly?

Answer 3

Maximise joint profits: agreeing to fix prices at a level above competitive equilibrium, so firms act like a monopoly, reducing output and increasing prices to maximise collective profits
Reduce price competition: collusions helps to avoid destructive price wars that reduce SNPs for members
Create barriers to entry: incumbent firms can deter new entrants by maintaining high prices while threatening lower prices if a new entrant appears (limit pricing)