a) Different business objectives and reasons for them:
b) Diagrams and formulae to illustrate the different business objectives:
Firm’s profit – difference between its total revenue (TR) and total costs (TC)
A firm’s profit maximises when they are operating at the price and output which derives the greatest profit
Profit maximisation occurs where marginal cost (MC) = marginal revenue (MR) – each extra unit produced gives no extra loss or no extra revenue
Profits increase when MR > MC – Profits decrease when MC > MR
When TC> TR there is a loss made – when TC < TR there is a profit made
Where TC = TR – sales maximisation (AC = AR), normal profit
Some firms choose to profit maximise because:
• Provides greater wages and dividends for entrepreneurs • Retained profits are a cheap source of finance – saves paying high interest rates on loans • Short run – interests of owners or shareholders are most important, since they aim to maximise their gain from the company • Some firms might profit maximise in the long run since consumers don’t like rapid price changes in the short run, so this will provide a stable price and output
Occurs when MR = 0 – each extra unit sold generates no extra revenue
Firms aim to sell as much of their goods and services as possible without making a loss
Not-for-profit organisations might work at this output and price
On a diagram this is where average costs (AC) = average revenue (AR)
E.g. Amazon’s Kindle launch – they sold as many Kindles as possible to gain market share, so they can earn more profits in the long run – helps keep out and deter competitors
This diagram summarises each objective:
A firm is profit satisficing when it is earning just enough profits to keep its 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.
So managers might choose to earn enough profits to keep shareholders happy, whilst still meeting their other objectives.
Occurs where there is a divorce of ownership and control – Principal-Agent problem