the objectives of firms Flashcards
what do most firms have the rational business objective of ?
profit maximisation
how do profits benefit shareholders?
Profits benefit shareholders as they receive dividends and also increase the underlying share price
An increase in the underlying share price increases the wealth of the shareholder
what should firms do to achieve profit maximisation?
firms should 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
why would firms find it difficult to produce at the profit maximisation level of output ?
may not know where the 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 regulators in their country (especially natural monopolies)
The profit maximisation level of output often results in high prices for consumers
Changing prices changes the marginal revenue
what are the advantages of pursuing profit maximisation?
financial stability and growth - allow businesses to accumulate capital , reinvest in growth opportunities
shareholder value and creation- can enhance shareholder value , attract new investors and maintain their competitiveness
resource allocation efficiency - lead to improved productivity
what are the disadvantages of pursuing profit maximisation ?
Ethical and social concerns - focusing on profit maximisation can result in actions that disregard the well - being of employees , communities and the environment (negative externalities)
Risk of neglecting non financial metrics -employees satisfaction , customer loyalty , product quality , and environmental sustainability may be neglected
short term profits vs long term value creation - extracting the highest level of short term profits will often detract from future value creation through research or innovation.
what are alternative business objectives
Growth - often focusing on increasing their sales revenue or Markeyt share , may also maximise revenue to increase output and benefit from economies of scale
survival - in the short term many new firms only focus solely on business survival (approx 25% firms fail in their first year)
social welfare - focus on climate action and addressing poverty or inequality.
satisficing - firms can opt to make satisfactory level of profit and not profit maximise
when does a divorce of ownership from control occur?
occurs when there is a clear split between ownership of firm and those who run the business on a day to day basis
what is the separation of ownership from control linked to
principal - agent problem
Firm owners, such as shareholders (principals), appoint managers (agents) to make decisions and represent their interests. Managers may have differing goals and motivations, leading to conflicts of interest
