Economics objectives of firms

Topics: Economics, Profit maximization, Profit Pages: 9 (929 words) Published: November 6, 2013
12-Sep-13

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.

Therefore, 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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By Jean-François Tuyau

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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Theory of Production

By Mr. Jean-François Tuyau

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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By Jean-François Tuyau

Theory of Production

Qty

By Mr. Jean-François Tuyau

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12-Sep-13

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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Theory of Production

By Mr. Jean-François Tuyau

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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By Jean-François Tuyau

Theory of Production

By Mr. Jean-François Tuyau

MR

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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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By Jean-François Tuyau

Theory of Production

By Mr. Jean-François Tuyau

4

12-Sep-13

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
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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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By Jean-François Tuyau

Theory of Production...
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