Last Minute Econ

Profit Max

• MC = MR

• Assumes interests of owners or shareholders are the most important

• Profit max allows them to maximise owners’ returns

• R&D, e.g. Apple and pharmaceutical industry

Pros of Profit Max

• Re-investment (R&D)

• Dividends/ greater share for shareholders

• Lower costs and lower prices for consumers

• Reward for entrepreneurship

Cons of Profit Max

• Firms don’t know their MC and MR

• Large profits encourage scrutiny by regulations

• Key stakeholders could be harmed

• Other objectives may be more appropriate

Revenue Maximisation

• MR = 0 (as if MR is above 0, producing more would increase revenue)

• Interest of managers, as salaries are dependent on revenue

• Growth in revenue increases business prestige and justifies managerial rewards

• Many firms aim to revenue maximise as long as they provide some profit for owners

• E.g. Amazon revenue maximise as they aim to dominate the market

Pros of Revenue Max

• Economies of scale

• Increased brand loyalty

• Predatory pricing - push competitors out of the business

Cons of Revenue Max

• Lower profitability

• Potential for losses

• Increases scrutiny

• Principle-Agent problem (divorce between ownership and control)

Sales Maximisation

• AC = AR (normal profits) - highest level of sale possible without making a loss

• Managers aim to maximise growth of company over any other objective

• Easier for people to judge level of growth than level of profit - increases prestige

• Size linked to security

• Increases market share - greater power over pricing

• Short-term strategy

• E.g. Netflix and Spotify sales maximise to increase size of their business

Pros of Sales Max

• Economies of scale

• Price control - limit pricing (stop new entrants)

• Flood the market

• Business growth (short term - better for new businesses)

• Prestige

Cons of Sales Max

• Greater scrutiny

• Principle Agent problem

• Risk of ion efficiency

• Market dependency

Profit Satisficing

• Due to principle-agent problem, owners and shareholders will have different goals

• Profit satisficing allows firms to make enough profit to keep owners happy whilst following other objectives (not profit maximising) - satisfies as many key stakeholders as possible

• Amount of profit needed will change each year depending on level of profit made by other firms

Managerial Utility Max

• Managers will make decisions to maximise their own satisfaction

• Dependent on their salary, number of staff they control, power over decision making and other benefits they receive

Marginal Cost Pricing/ Allocative Efficiency

• Some firms, particularly nationalised industries, aim to maximise social welfare

• MC = AR - producing where the value society places on the good is equal to the extra cost of producing that good

• Achieves allocative efficiency

Objectives of Business Growth

• Develop economies of scale

• Market power - gain more influence over market

• Develop market share - higher profitability

Problems with growth

• Diseconomies of scale

• Managerial inefficiency - divide between ownership and management, internal communication issues

• Overtrading - overspending in search of growth

Merger

• When two businesses join together to form one new company

Takeover

• One business purchases another

Vertical Integration

• Merger or takeover involving businesses at different stages of the supply chain

Horizontal Integration

• A merger or takeover involving businesses at the same stage of the supply chain

Backward Integration

• Company expands upstream in supply chain

Forward Integration

• Company expands downstream supply chain

Conglomerate Integration

• Merger or takeover a company in a different industry

• Also known as diversification

Organic Growth

• Growth that is through business’ own expansion - internal growth

Inorganic Growth

• Growth through merger or takeover - external growth

Benefits of Staying Small

• Reduced risk of overtrading

• Product differentiation and unique selling point - increased ability to respond to customer needs

• Better customer service - more personalised

Competitive Oligopoly

• Price or non-price competition

• Factors promoting competitive oligopoly:

  • Large no. of firms (less concentrated)

  • New market entry possible

  • One firm with significant cost advantages

  • Homogenous goods

  • Saturated markets

Collusive Oligopoly

• Overt or Tacit (price leadership)

• Factors promoting collusive:

  • Small number of firms (more concentrated oligopoly)

  • Similar costs

  • High entry barriers

  • Ineffective competition policy

  • Consumer loyalty

  • Consumer intertia

Relative Price Elasticity

PED>1

Relative Price Inelasticity

PED<1

Perfectly Elastic

• PED = infinity

Perfectly Inelastic

PED = 0

Unitary Elastic

PED = 1