Business Objectives (DP IB Economics)

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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

3-2-1-profit-maximisation-image_edexcel-al-economics

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 = begin mathsize 14px style left parenthesis straight P subscript 1 space minus space straight C subscript 1 right parenthesis space cross times space straight Q subscript 1 end style

Examiner Tip

Profit maximisation is all about the quantity of output.

To determine the level of profit:

  1. identify where MC = MR and then extend the dotted line upwards to the point where it hits the AR curve - this is your selling price

  2. Where this line crosses the average cost curve (AC) represents the cost per unit at this level of output

  3. The profit is the difference between the selling price and the average cost

 

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


Advantages


Disadvantages

  • Financial Stability and Growth
    Maximising profits allows businesses to accumulate capital, reinvest in growth opportunities, and withstand economic uncertainties
     

  • Shareholder Value Creation
    By focusing on profit maximisation, companies can enhance shareholder value, attract new investors and maintain their competitiveness in the market

  • Resource Allocation Efficiency
    Businesses are incentivised to allocate resources efficiently which can lead to improved productivity and cost control

  • Ethical and Social Concerns
    Focussing on profit maximisation can result in actions that disregard the well-being of employees, communities, and the environment (negative externalities)
     

  • Risk of Neglecting Non-Financial Metrics
    Important factors like employee satisfaction, customer loyalty, product quality, and environmental sustainability may be neglected if they are not directly tied to immediate profit generation

  • Short term profits versus long term value creation
    Extracting the highest level of short term profits will often detract from future value creation through research or innovation

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

3-2-1-revenue-maximisation_edexcel-al-economics

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 = left parenthesis straight P subscript 1 space minus space straight C subscript 1 right parenthesis space cross times space straight Q subscript 1

    • 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

S1IzTyxi_3-2-1-sales-maximisation_edexcel-al-economics

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)

Examiner Tip

Although sales and revenue maximisation are not in the syllabus per se, due to the fat they can form part of the growth objective, it would be useful to understand them. Revenue maximisation was also examined in the May 2023 session.

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


Advantages


Disadvantages

  • Increased market share and competitive advantage
     

  • Growth is often associated with improved financial performance and increased shareholder value
     

  • Pursuing growth stimulates innovation and attracts top talent

  • Growth also creates opportunities for employees to take on new roles and responsibilities, fostering a dynamic and engaging work environment

  • Growth comes with inherent risks and complexities. Expanding into new markets, integrating acquisitions, or scaling operations can strain resources, disrupt existing processes, and expose the company to new challenges

  • Rapid growth can strain organisational resources, systems, and structures e.g the ability to offer effective customer service

  • Pursuing growth opportunities can lead to a loss of focus if companies diversify into unrelated markets or industries, diluting their expertise and stretching their resources

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


Advantages


Disadvantages

  • Offers internal stakeholders (owners, management and employees) the opportunity to develop a healthy work-life balance - or to focus on other goals they consider to be important
     

  • It reduces decision-making costs and speeds up the decision making process as less extensive and time-consuming research is required as compared to seeking optimal solutions that maximise profit

  • There is the potential for mediocrity or suboptimal results. Companies may miss out on opportunities to achieve better results and improve their competitiveness

  • Satisficing may discourage the pursuit of innovative and creative solutions

  • By focusing on satisfactory outcomes, companies risk falling short of higher expectations, which can lead to customer dissatisfaction, employee disengagement, or investor skepticism

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 


Socially Responsible Activity


Example

Sustainable sourcing of raw materials and components

  • High street retailer H&M has a goal of using only recycled or sustainably sourced materials by 2030
     

  • It also publishes a list of the majority of their supplier’s information which is updated regularly, allowing stakeholders to verify and hold the company responsible for their suppliers’ conduct

Responsible marketing

  • Marks and Spencer ensures that it never actively directs any marketing communications to children under the age of 12 and does not directly advertise any products high in fat, sugar or salt to children under the age of eighteen

Protecting the environment

  • Cafe chain Prêt à Manger offers discounts to customers who bring their own coffee cup, reducing the number of single-use plastic containers it dispenses

Responsible customer service

  • John Lewis's famous 'Never Knowingly Undersold' slogan refers to the company's commitment to checking competitor prices regularly to ensure that the price its customers pay is the lowest available in the local area at that time

 

  • 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

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