Market operations of Market operations of firms:firms:

objectives of firmsobjectives of firms

Learning outcomes

Understand that firms have

a range of objectives

Explain and assess other objectives firms may

pursue

Understand the profit

maximising rule

Explain why firms may not

maximise profit

In pairs, discuss what objectives

firms might pursue.

Make a list of your top five objectives.

Keep on task:Keep on task:time is ticking away …time is ticking away …

In pairs, discuss what objectives firms In pairs, discuss what objectives firms might pursue.might pursue.Make a list of your top five objectives.Make a list of your top five objectives.

countdown.mp3

Profit maximisationProfit maximisationTraditional economic theory is based on the assumption that firms aim to maximise profits.

Profit is:

Total Revenue – Total Cost

So, to maximise profits firms must maximise the difference between total revenue and total cost.

Task 1Task 1Using the information below, draw a diagram of TR and TC against output (Q) and find out the profit maximising output.

Output Total Revenue Total Cost

0 0 6

1 8 10

2 16 12

3 24 16

4 32 24

5 40 36

6 48 52

0

10

20

30

40

50

60

0 1 2 3 4 5 6

Output

Rev

enu

e an

d C

ost

(£)

Total Revenue Total Cost

0

10

20

30

40

50

60

0 1 2 3 4 5 6

Output

Rev

enu

e an

d C

ost

(£)

Total Revenue Total Cost

Task 2Task 2Using the information below, calculate MR and MC, plot them on a diagram and find out the profit maximising output.

Output Total Revenue Total Cost

0 0 6

1 8 10

2 16 12

3 24 16

4 32 24

5 40 36

6 48 52

0

2

4

6

8

10

12

14

16

18

0.5 1.5 2.5 3.5 4.5 5.5

Output

MR

an

d M

C (

£)

MR MC

0

2

4

6

8

10

12

14

16

18

0.5 1.5 2.5 3.5 4.5 5.5

Output

MR

an

d M

C (

£)

MR MC

Profit maximising Profit maximising ruleruleThere is a very simple rule which has to be satisfied for profits to be maximised.

It is:

Marginal Revenue (MR) = Marginal Cost (MC)

If raising output adds more to revenue than it does to costs (MR > MC), then profits must rise.

If raising output adds more to costs than it does to revenue (MC > MR), profits must fall.

So, profits must be maximised (or losses minimised) when MR = MC

Do firms maximise profits?

Difficulties maximising profit

Firms may want to maximise profits but they are unable to

Difficulties maximising profit

Firms may want to maximise profits but they are unable to

Other aimsFirms pursue other aims either in addition

to maximising profit or instead of

Other aimsFirms pursue other aims either in addition

to maximising profit or instead of

Difficulties maximising profit

Knowledge of demand

Short run or long run?

Multi-product firms

Difficulties maximising Difficulties maximising profitprofitLack of information

Firms do not use economic concepts of profit (eg opportunity cost), so cannot maximise true profit

Firms do not know their demand curves, so cannot know their marginal revenue. Estimates of PED may help but are unreliable.

Firms do not know their demand curves because they do not know their competitors reactions (interdependence, oligopoly and game theory)

Difficulties maximising Difficulties maximising profitprofitShort run or long run?

Over what time period should the firm maximise profits? Over time revenue and costs change – in reality they are not static. Investment in capital equipment, for example, reduces profit in the short run but raises it the long run.

Multi-product firms

Multi-product firms will find it difficult to assign fixed costs (overheads) to each product. How much of Morrisons overheads can be allocated to a tin of Baked Beans – it doesn’t know the MC

Why alternative objectives?

Divorce of ownership from

controlAsymmetric information

Profit satisficing behaviour

Why alternative Why alternative objectives?objectives?Divorce of ownership from control

In modern day companies, PLCs are owned by shareholders, who elect directors, who in turn employ managers.

Those who own PLCs do not control them on a day-to-day basis.

Managers are likely to pursue their own objectives – maximise their own utility – through higher salaries, power and prestige, growth of the firm …

They will earn just enough profit to keep shareholders happy – profit satisficing

Why alternative Why alternative objectives?objectives?Asymmetric information

Asymmetric information occurs when one group has more information than another.

This is the principal-agent problem.

Shareholders are the principals, managers the agents of the shareholders.

Shareholders may not be in a position to judge whether performance (profit) could be better.

Managers (shareholders) pursue their own interests.

What alternative objectives?

Managerial utility

maximisationSales revenue maximisation

Growth maximisationachieved through mergers,

acquisitions, internal growth

Satisficing behaviour

In reality, firms are likely to have

multiple objectives Business

environment changes

Firms respond to changing environment

with changing objectives

profit acts as a constraint