the objectives of firms

• what is the main objective of rational firms?

  profit maximisation
• why 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
• when does profit maximisation occur?

  • When marginal cost (MC) = marginal revenue (MR) then no additional profit can be extracted by producing another unit of output
• why may firms find it difficult to determine profit maximisation level of output?

  • They may not know where this 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
• what will firms do to achieve profit maximisation level of output in the long run?

  adjust prices
• who may firms be forced to change their prices by?

  • 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
• what does this graph show about monopoly firms?

  • This firm has market power as the MR and average revenue (AR) curve are downward sloping
  • At the profit maximisation level of output (MC = MR)
  • The selling price is P1
  • The average cost is C1
  • The supernormal profit = (P1-C1) x Q1

  
• what are the advantages of profit?

  • Financial Stability and GrowthMaximising profits allows businesses to accumulate capital, reinvest in growth opportunities, and withstand economic uncertainties 
  • Shareholder Value CreationBy focusing on profit maximisation, companies can enhance shareholder value, attract new investors and maintain their competitiveness in the market
  • Resource Allocation EfficiencyBusinesses are incentivised to allocate resources efficiently, which can lead to improved productivity and cost control
• what are the disadvantages of profit?

  • Ethical and Social Concerns
  • profit maximisation can result in disregarding the well-being of employees, communities, and the environment (negative externalities) 
  • Risk of Neglecting Non-Financial Metricsemployee satisfaction, customer loyalty, product quality, and environmental sustainability may be neglected if they are not directly tied to immediate profit generation
  • Short term profits versus long term value creationExtracting the highest level of short term profits will often detract from future value creation through research or innovation
• what are alternative business objectives?

  Growth, Survival, Social Welfare, Satisficing
• why do firms have the business objective of growth?

  • A firm growth can be calculated by using the number of employees, market share, size of profits & market capitalisation
  • Firms with a growth objective often focus on increasing their sales revenue or market share
  • Firms will also maximise revenue in order to increase output & benefit from economies of scale
  • A growing firm is less likely to fail
• what do firms have a business objective of survival?

  • In the short term, many new firms focus solely on business survival
  • Generally, as much as 25% of new firms fail in their first year of business
  • Once a firm is established, it may then begin to focus on profit maximisation as its new objective
• why do firms have social welfare as a business objective?

  • More firms than ever are launching with a social welfare objective
  • These typically include a focus on climate action & addressing poverty or inequality
  • They still require profit to survive, but will accept less than if they were profit maximising as long as they are meeting their social objective
• why do firms have satisficing as a business objective?

  • Firms can opt to make a satisfactory level of profit  and not seek to maximise profits
  • They may aim to make enough money to keep the owner/shareholders happy
  • E.g a small family owned business may make enough profits to support the family but not pursue more profits. Satisficing can allow firms time to pursue other objectives, such as leisure or a better work-life balance
• what is divorce of ownership from control?

  • Divorce of ownership from control occurs when there is a clear split between the ownership of firm and those who run the business on a day-to-day basis 
  • It usually occurs in larger firms where there is a distinction between ownership and management 
• what is the principal agent problem?

  • The separation of ownership from control is linked to the 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
• how do public limited companies have divorce of ownership of control?

  • A board of directors or executives are responsible for decision-making in public traded companies 
  • A shareholder owns part of business but usually lacks influence over business decisions
  • Conflicts of interest may arise if shareholders prioritise profit maximisation while the board of directors prioritise other goals, such as maximising sales growth
• how do family businesses have divorce of ownership of control?

  • Not all family members are involved in daily management
  • Control rests with a small group of family members or non-family executives who manage operations
  • Conflicts of interest may arise if some family members aim to pursue objectives such as long term stability and family values while other members aim to pursue profit maximisation