5.2.1

Business Objectives

Test yourself

Firms Aim to Maximise Profits

According to traditional theory, maximising profit is the main objective of firms in an industry.

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Firms may not always maximise ONLY profit

  • The traditional theory of the firm uses models that rely on the assumption that firms will aim to maximise profit.
  • But it is not always possible to maximise profit and so we do not always observe this.
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Profit maximisation

  • Firms maximise profit when the marginal revenue (MR) is equal to the marginal cost (MC).
  • Any extra units produced from here will have a negative impact on profit.
  • This is because of diminishing returns. So marginal cost will be higher than marginal revenue past this point of MC=MR.
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Profit in the long run

  • To make profit, firms may have to achieve a number of other objectives first.
    • E.g to gain long run profit it might be more important to gain revenue and market share in the short term, even if profit must be sacrificed.
    • Amazon has made very little profit in the last 10 years and seems to have aimed to maximise market share in the short run.
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What to do with profit?

  • There is an opportunity cost to not using profit and so firms have several options regarding how to use these funds, including:
    • Pay dividends to shareholders.
    • Save the money for future use.
    • Invest towards future growth, e.g. in R&D.

Firm Objectives other than Profit Maximisation

Firms can have a number of objectives that aren't just profit maximisation:

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Corporate social responsibility

  • This involves firms acting in a sustainable way whilst trying to make supernormal profit.
    • E.g a firm might aim to produce its goods whilst keeping carbon emissions low.
  • This can be beneficial for society.
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Revenue maximisation

  • Firms may try to maximise revenue.
  • To do this, a firm must produce where marginal revenue is equal to zero.
  • Revenue maximisation increases the size of the firm, this could be beneficial to managers due to the prestige, and the perks they may receive from managing a large firm.
    • Amazon seems to be a company that has aimed to maximise revenue, at least in the short run.
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Not for profits

  • These are firms that don't aim to maximise supernormal profits.
  • But rather, to operate in ways that are beneficial to society.
    • E.g a student union.
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Satisificing

  • Bounded rationality can limit our ability to make choices that lead to profit maximisation.
  • As a result, profit maximisation is not always possible.
  • Some firms will satisfice instead. The theory of satisficing was proposed by Herbert Simon.
  • This involves reaching a minimum requirement in a number of areas.
    • E.g setting a minimum goal for profit, sales and revenue.
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Market share

  • Firms may try to maximise market share (without making a loss), also known as sales maximisation.
  • To do this, a firm would produce where average revenue is equal to average cost.
  • A company such as Tesco may focus on this; it would allow them to achieve economies of scale and greater price-setting power in the long-run.
  • This could be beneficial to managers due to the prestige, and the perks they may receive from managing a large firm.

Jump to other topics

1Introduction to Markets

2Market Failure

3The UK Macroeconomy

4The UK Economy - Policies

5Business Behaviour

6Market Structures

7A Global Perspective

8Finance & Inequality

9Examples of Global Policy

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