F&D P1: Objectives of Firms

What is the Profit Maximising Objective?

Firms aim to maximise profit (TR-TC) for survival, higher entrepreneur income, and ability to reinvest profits into R&D.

What is Supernormal Profit? (Positive Economic Profit)

TR > TC

What is Normal Profit? ('0' Economic Profit)

TR = TC

What is Subnormal Profit? (Negative Economic Profit / Loss)

TR < TC

What is Marginalist Principle? (Determining Profit Maximising Output)

Rational producers maximise profits at the output where marginal revenue equals marginal cost (MR=MC) and MC is rising.

What is Marginal Revenue (MR)?

The additional revenue that a firm makes from selling one more unit of output produced.

What is Marginal Cost (MC)?

The additional cost that a firm incurs from increasing output produced by one unit.

What happens if MR > MC?

Firm should increase output to gain higher profit, as additional revenue from last unit > additional cost. MC will rise due to Law of Diminishing Returns.

What happens if MC > MR?

Firm should cut back on output to increase profits, as additional revenue from last unit < additional cost.

Why are there Limitations of the Traditional Theory of Profit Maximisation? (Reasons for Limitations)

Firms may lack sufficient/accurate information on demand/cost conditions (unable to estimate MR/MC), making profit maximisation by chance. Cost of obtaining information can be high.

What is a dynamic environment? (Reason for Limitations)

Demand and cost conditions constantly change, making it difficult to find a static profit-maximising output/price.

What are Alternative Objectives of Firms?

Revenue maximisation, profit satisficing, market share dominance, or social objectives.

What is Revenue Maximisation?

Maximising total revenue (TR) (where MR=0). Often an objective for managers whose income/commission depends on TR.

What is Profit Satisficing?

Aiming for minimum acceptable levels of profit, rather than maximum. Occurs due to separation of ownership and management, where managers seek managerial utility.

What is Market Share Dominance?

Aiming for a large proportion of the firm's total sales (revenue) relative to the market. Used to attract talent and correlate with stock performance.

How do firms increase Market Share?

Reducing prices (subject to normal profits in LR) and/or engaging in strategies to shift demand curve outwards and make demand less price elastic.

What are Social Objectives of Firms?

Firms may consider impact on society/environment and use less harmful inputs/methods, even at expense of lower profits (e.g., social enterprises).