Business Objectives (DP IB Economics)

Profit Maximisation

• Most firms have the rational business objective of profit maximisation

  • Profits benefit shareholders as they receive dividends & also increase the underlying share price

    • An increase in the underlying share price increases the wealth of the shareholder
      

• To achieve profit maximisation firms, follow the profit maximisation rule

  • When marginal cost (MC) = marginal revenue (MR) then no additional profit can be extracted by producing another unit of output

  • When MC < MR additional profit can still be extracted by producing an additional unit of output

  • When MC > MR the firm has gone beyond the profit maximisation level of output

    • It is making a marginal loss on each unit produced beyond the point where MC = MR
      
      

• In reality, firms may find it difficult to produce at the profit maximisation level of output

  • They may not know where this level is

  • In the short term they may not adjust their prices if the marginal cost changes

    • Marginal costs can change regularly and regular price changes would be disruptive to customers

  • In the long-term firms will seek to adjust prices to the profit maximisation level of output 

  • Firms may be forced to change prices by the competition regulators in their country (especially natural monopolies)

    • The profit maximisation level of output often results in high prices for consumers

    • Changing prices changes the marginal revenue
      
      

The profit maximisation level of output occurs at Q₁ where MC = MR resulting in a market price of P₁

Diagram Analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping

• At the profit maximisation level of output (MC = MR)

  • The selling price is P₁

  • The average cost is C₁

  • The supernormal profit =
    

Evaluating Profit Maximisation as a Business Objective

• Apart from the very significant advantages that are offered by pursuing profit maximisation, there are some distinct disadvantages too
    

The Advantages & Disadvantages of Pursuing Profit Maximisation

Growth

• Some firms have the business objective of growth

• Firms with a growth objective often focus on increasing their sales revenue or market share

• Firms will also maximise revenue in order to increase output & benefit from economies of scale

  • A growing firm is less likely to fail
     

1. Revenue Maximisation as a Sign of Growth

• Firms aim to maximise revenue in order to increase output & benefit from economies of scale

  • In the short-term firms may use this strategy to eliminate the competition as the price is lower than when focussing on profit maximisation
     

• To achieve revenue maximisation firms produce up to the level of output where MR = 0

  • When MR > 0, producing another unit of output will increase total revenue
    

The revenue maximisation level of output occurs at Q1 where MR = 0 resulting in a market price of P1

Diagram Analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping

• At the revenue maximisation level of output (MR = 0)

  • The selling price is P₁

  • The average cost is C₁

  • The supernormal profit =

  • The supernormal profit is less than when the firm follows the profit maximisation rule

2. Market Share as a sign of Growth

• Some firms have the business objective of sales maximisation which further lowers prices and has the potential to increases market share

  • Sales maximisation occurs at the level of output where AC = AR (normal profit/breakeven)

  • In the short-term firms may use this strategy to clear stock during a sale or increase market share

    • Firms sell remaining stock without making a loss per unit
      

The sales maximisation level of output occurs at Q₁ where AC = AR resulting in a market price of P₁

Diagram Analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping

• At the sales maximisation level of output (AC = AR)

  • The selling price is P₁

  • The average cost is also at P₁

  • The firm is breaking even (normal profit)

Evaluating Growth as a Corporate Objective

• Companies need to carefully assess the trade-offs and consider a balanced approach to growth, taking into account risk management, organisational capabilities, and long-term sustainability of any growth actions
   

The Advantages & Disadvantages of Pursuing Growth

Satisficing

• Satisficing refers to the pursuit of satisfactory or acceptable outcomes rather than profit maximisation

  • It is a decision-making approach where businesses aim to meet a minimum threshold or standard of performance rather than striving for the absolute best outcome
     

• Small firms may satisfice around the desires of the business owner (sole trader) to have more well-being in their life
   

• Many large firms often end up satisficing as a result of the principal agent problem

  • Rationally, managers know shareholders want to profit maximise

  • However, managers want to maximise sales or revenue so as to increase their wages

  • Managers (who control the business) settle for a level of output somewhere between profit and sales maximisation

    • This increases their wages and reduces potential conflict with shareholders
       

Evaluating Satisficing as a Corporate Objective

• Balancing the advantages and disadvantages of satisficing is essential, and companies may adopt a combination of satisficing and profit or growth strategies to achieve the best possible outcomes
   

The Advantages & Disadvantages of Pursuing Satisficing

Corporate Social Responsibility (CSR)

• Corporate social responsibility involved conducting business activity in an ethical way and balancing the interests of shareholders with those of the wider community
  

Examples of Corporate Socially Responsible Activities 

• It is now common practice for large companies to publish annual Corporate Responsibility Reports which provide an audit of the steps being taken to meet their commitments to a range of stakeholders alongside annual financial reports

• Extra costs are involved in operating in a socially responsible way and these costs must be passed on to consumers
    

The Advantages of CSR Objectives

• CSR can enhance the business image and reputation

• CSR is attractive to many stakeholders

• CSR can be very profitable as it adds value for many stakeholders

• CSR may improve employee motivation and productivity

• CSR can help to recruit strong candidates for jobs advertised

• CSR may help to solve social problems e.g. resource depletion
   

The Disadvantages of CSR Objectives

• CSR goals can involve significant financial and resource commitments which can divert funds and attention away from other business priorities

• CSR goals means facing increased expectations from stakeholders, including customers, employees, investors, and the general public

• Defining and measuring the impact of CSR initiatives can be challenging as it may be difficult to establish clear metrics and demonstrate tangible results

• Adopting CSR goals without genuine commitment and meaningful action can lead to accusations of greenwashing or socialwashing