5.2

• Total profit equation

  Total profit = total revenue - total cost
• what is profit maximisation

  when a firm chooses output where marginal cost = marginal revenue (MC=MR). highest possible profit
• why might a firm aim to profit maximise?

  • return for shareholders
  • finance for investment
  • survival in the long run
  • high bonuses for managers
  • market power
• what is revenue maximisation?

  when a firm produces at the output level where marginal revenue = 0. highest total revenue
• what is sales maximisation?

  maximising quantity sold while making at least normal profit (AR=AC)
• why might a firm pursue sales or revenue maximisation instead of profit ?

  • increase market share
  • achieve economies of scale
  • brand awareness
  • managerial bonuses based on revenue
  • limit pricing to deter new entrants
• what happens when MR > MC ?

  profits rise when output increases
• what happens when MR < MC ?

  profits rise when output reduces
• what is the profit maximising rule ?

  Marginal revenue = marginal cost or MR=MC
• divorce of ownership from control definition

  the owners and those who control the firm (managers) are different groups with different objectives
• what is the principal-agent problem ?

  when the agent (managers) make decisions for the principal (shareholders), but the agent is inclined to act in their own interests, rather than those of the principal
• examples of principal-agent problem

  shareholders and managers have different objectives which might conflict. managers might choose to make a personal gain, such as a bonus, rather than maximise the dividends of the shareholders
• how divorce of ownership from control may affect objectives, conduct and performance ?

  • agents may take excessive rise if they enjoy the benefits of doing so, but not the costs
  • managers take on excessive risk in the event they are rewarded with high bonuses. failure leads to lots of money being lost
  • illustrates moral hazard
• why can agents get away with not acting in best interest of principal ?

  • cost of sacking agent or punishing agent may be too high relative to any benefit the principal will enjoy
  • information asymmetry may result from the fact that agent know more that principal about business
  • disappointing profits don’t necessarily means its due to managerial incompetence or laziness
• possible business objectives other than profit maximisation?

  • growth maximisation and survival
  • revenue maximisation
  • Satisificing
  • corporate social responsibility
  • sales maximisation
• what is satisficing ?

  when firms aim for an acceptable level of profit rather than the maximum, due to conflicting objectives between owners and managers
• satisficing definition

  achieving a satisfactory outcome rather than the best possible outcome
• why might firms satisfied?

  • principal-agents problem: owners want profit; mangers want comfort
  • limited information
  • short-term goals or targets
  • avoiding risk or scrutiny
• what is utility maximisation for managers ?

  managers may try to maximise their own satisfaction (utility) - through perks, low stress or staff size - rather than focusing on profit
• why might firms pursue growth as an objective?

  • market power
  • reduce completion
  • economies of scale
  • managerial prestige
  • diversification (reduce risk)
• what is corporate social responsibility (CSR)?

  When firms act in ways that benefit society and the environment, beyond profit motives
• Why might firms adopt CSR/public interest goals?

  • positive brand image
  • Customer loyalty
  • Long-run sustainability
  • Employee satisfaction
  • Government support
• evaluate the idea that firms only aim to profit maximise

  + long term sustainability, shareholder returns

  X in reality:

  • principal-agent problem
  • short-run goals
  • ethical concerns
  • market share goals
  • regulatory pressure
• how do firms objective vary in different market structures?

  • perfect competition: profit maximisation less likely (normal profit only)
  • monopoly: more likely to profit maximise or purser CSR due to low completion
  • oligopoly: may revenue maximise or collude
  • monopolistic competition: sales/revenue goals common due to low entry barriers