The Objectives of Firms (AQA A Level Economics)

• Most firms have the rational business objective of profit maximisation
  • Profits benefit shareholders as they receive dividends and also increase the underlying share price
    • An increase in the underlying share price increases the wealth of the shareholder
      
      
• To achieve profit maximisation, firms should 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

Diagram: The Profit Maximising Level of Output

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

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 Focusing 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

• The firm can have objectives other than profit maximisation. These are the reason for their existence or the desired focus of their owners

1. Growth

• Some firms have the business objective of growth
  
• A firm growth can be calculated by using the number of employees, market share, size of profits & market capitalisation
  
• 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

2. Survival
 

• In the short term, many new firms focus solely on business survival
  
• Generally, as much as 25% of new firms fail in their first year of business
• Once a firm is established, it may then begin to focus on profit maximisation as its new objective

3. Social Welfare
 

• More firms than ever are launching with a social welfare objective
  • These typically include a focus on climate action & addressing poverty or inequality
    
• They still require profit to survive, but will accept less than if they were profit maximising as long as they are meeting their social objective

4. Satisficing

• Firms can opt to make a satisfactory level of profit  and not seek to maximise profits
• They may aim to make enough money to keep the owner/shareholders happy
  • E.g a small family owned business may make enough profits to support the family but not pursue more profits. Satisficing can allow firms time to pursue other objectives, such as leisure or a better work-life balance

• Divorce of ownership from control occurs when there is a clear split between the ownership of firm and those who run the business on a day-to-day basis 
  
  • It usually occurs in larger firms where there is a distinction between ownership and management 

• The separation of ownership from control is linked to the principal-agent problem

  • Firm owners, such as shareholders (principals), appoint managers (agents) to make decisions and represent their interests. Managers may have differing goals and motivations, leading to conflicts of interest
     

Examples of Divorce of Ownership of Control 

Example	Explanation
Public limited companies	A board of directors or executives are responsible for decision-making in public traded companies  A shareholder owns part of business but usually lacks influence over business decisions Conflicts of interest may arise if shareholders prioritise profit maximisation while the board of directors prioritise other goals, such as maximising sales growth
Family businesses	Not all family members are involved in daily management Control rests with a small group of family members or non-family executives who manage operations Conflicts of interest may arise if some family members aim to pursue objectives such as long term stability and family values while other members aim to pursue profit maximisation