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Economics objectives of firms

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    Objectives of firms

    1. Profit Maximisation
    In neo-classical economics it is assumed that the interest of owners or shareholders are the most important.
    Just as consumers attempt to maximise utility, shareholders main motivation is to maximise their gain firm the company.

    Th

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    By Jean-François Tuyau

    MR
    qπ qo qTR qe qs

    AR

    AC

    qTR

    qe
    qo
    qs

    erefore, one of the main objectives of firms is to maximise profit.
    Profit is the reward for the risk-bearing function of the
    entrepreneur.
    The firm is in equilibrium, and is maximising profit, when it is producing the level of output for which MC=MR and the MC
    curve cuts the MR curve from below.
    MC = MR
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    Theory of Production

    By Mr. Jean-François Tuyau

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    12-Sep-13

    1. Profit Maximisation
    Long Run Profit Maximisation.
    In some cases, firms may sacrifice profits in the short term to increase profits in the long run. For example, by investing heavily in new capacity, firms may make a loss in the short
    run, but enable higher profits in the future.

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    2. Minimise Cost
    Another objective of the firm can be to minimise cost.
    The firm is said to be minimising cost of production when:
    i.
    It produces at the optimum level of output
    It is therefore achieving productive efficiency
    • It uses a mimimum amount of resources
    to produce a given level of output, or
    • It produces the maximum output possible
    with a given amount of resources

    Cost
    AC

    qopt
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    Theory of Production

    Qty

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    2. Minimise Cost
    ii.

    When it uses the least-cost combination of factor of
    production: The Marginal Physical Product
    MPPF3
    MPPF1
    MPPF2
    =
    =
    PriceF3
    PriceF1
    PriceF2

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    3. Maximise Sales Revenue
    Sales Revenue can be maximised
    when the firm produces the level of
    output for which Marginal Revenue is
    equal to zero.

    TR

    MR=0 ; TR is at max
    AR

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    Theory of Production

    By Mr. Jean-François Tuyau

    MR

    3

    12-Sep-13

    4. Sales (output) Maximisation
    Maximising Sales (output) rather than sales revenue might
    be an alternative objective.
    Sales level is maximised when TC=TR
    TC
    TR

    0
    7

    Q
    Theory of Production

    By Mr. Jean-François Tuyau

    4. Sales (output) Maximisation
    Firms often seek to increase their market share – even if it means less profit. This could occur for various reasons:
    a) Increased market share increases monopoly power and may
    enable the firm to put up prices and make more profit in the long run.
    b) Managers prefer to work for bigger companies as it leads to greater prestige and higher salaries.
    c) Increasing market share may force rivals out of business. E.g. supermarkets have lead to the demise of many local shops.
    Some firms may actually engage in predatory pricing which
    involves making a loss to force a rival out of business.
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    Theory of Production

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    5. Sales Maximisation and Normal Profit
    Another objective is the maximisation of sales while
    achieving at least normal profit (at Q on the diagram
    below).
    This is achieve when AC=AR.
    Cost/Revenue
    At this level, the firm is breaking-even
    AC

    AR
    0
    9

    Theory of Production

    Qnormal π Output
    By Mr. Jean-François Tuyau

    6. Allocative Efficiency
    A firm is said to be allocatively efficient when the amount of money the consumer is spending on one unit of good (Price);
    and the amount of money the producer is spending on one
    unit of good (Marginal Cost) are equal.
    P = MC
    When Allocative Efficiency is achieved, there is no consumer exploitation.
    Note that the Price (P) consumers spend on one unit of goods is also the Average Revenue (AR) the firm receives from the
    sales of that unit. Therefore, P=MR is where the MC Curve
    cuts the AR curve.
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    7. Profit Satisficing
    This is when the manager of a firm will make sufficient
    profit to satisfy the demands of their shareholders.
    However, once a satisfactory level of profit have been
    made, the managers are free to maximise their own
    rewards from the company.
    This objective is also common to small firm (sole traders)
    where the owner’s aim is not to work ‘flat out’ very long hours to earn maximum profit, but more to earn enough
    profit to ‘live comfortably’ (to also have leisure time) 11

    Theory of Production

    By Mr. Jean-François Tuyau

    8. Social/Environmental concerns
    A firms may incur extra expense to choose products
    which don’t harm the environment or products not
    tested on animals.
    Alternatively, firms may be concerned about local
    community / charitable concerns.
    Many companies who have adopted such strategies have
    been quite successful.
    But a cynic may argue they see it as another opportunity
    to increase profits rather than a genuine sacrificing of
    profits in order to promote other objectives.
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    Theory of Production

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    9. Co-operatives
    Co-operatives may have completely different objectives
    to a typical PLC. A co-operative is run to maximise the
    welfare of all stakeholders – especially workers.
    Any profit the co-operative makes will be shared amongst
    all members.

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    Graphical illustration of the Objectives
    Profit Maximisation → qπ → MC=MR

    Cost/Revenue
    MC

    Po
    PTR
    Pe
    Ps

    Cost Minimisation → qo → AC min

    Sales Revenue Max → qTR → MR=0
    Allocative Efficiency → qe → P(AR)=MC

    AC

    Sales level Maximisation → qs → AC=AR
    and Normal Profit

    MR
    MC

    0
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    MR
    qπ qo qTR qe qs

    AR

    AC

    qTR

    qe
    qo
    qs

    Output
    Theory of Production

    By Mr. Jean-François Tuyau

    7

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