1) The document discusses different corporate objectives including profit maximization, share price maximization, revenue maximization, sales maximization, and social entrepreneurship. 2) It explains the concept of profit maximization using marginal cost and marginal revenue, where a firm will produce up to the point where marginal cost equals marginal revenue. 3) The document also discusses alternatives to pure profit maximization including satisficing behavior, where firms aim to generate sufficient profits to satisfy shareholders rather than always seeking to maximize profits.

1. Unit 3
Kno-how! on motives for firms

2. 3.1 Objectives & 3.6 Profit
 Students should be able to:
 Distinguish between different corporate
objectives and exemplify these
diagrammatically
 Understand the distinction between
normal and supernormal profit
 Explain and illustrate the concept of profit
maximisation using MC and marginal
revenue

3. 3.1 Objectives & 3.6 Profit
 Background Reading:
 Nutter A2 micro book (2nd ed) p. 27- 32
 Student Unit Guide (Old ed / New ed)
p.24-27 / p.15-19

4. Motives of Firms

5. Profit maximisation

6. Profit Maximisation
 Profit maximisation – assumed to be the standard
motive of firms in the private sector
 Profit maximisation occurs where
 Marginal Cost (MC) = Marginal Revenue (MR)
 The firm will continue to increase output up to the
point where the cost of producing one extra unit of
output (MC) = the revenue received from selling that
last unit of output (MR)

7. Profit maximisation diagram
Cost/Revenue
Output
MR
MR – the addition
to total revenue as
a result of
producing one
more unit of
output – the price
received from
selling that extra
unit.
MC
MC – The cost
of producing
ONE extra unit
of production
100
Assume output is at
100 units. The MC of
producing the 100th
unit is 20.
The MR received from
selling that 100th unit
is 150. The firm can
add the difference of
the cost and the
revenue received from
that 100th unit to
profit (130).20
150
Total
added
to profit
If the firm decides to
produce one more unit –
the 101st – the addition
to total cost is now 18,
the addition to total
revenue is 140 – the firm
will add 128 to profit – it
is worth expanding
output.
101
18
140
Added to
total
profit
30
120
Added
to total
profit
The process continues
for each successive
unit produced.
Provided the MC is
less than the MR it
will be worth
expanding output as
the difference
between the two is
ADDED to total profit.
102
40
145
104103
Reduces
total
profit by
this
amount
If the firm were to
produce the 104th unit,
this last unit would cost
more to produce than it
earns in revenue (-105)
this would reduce total
profit and so would not
be worth producing.
The profit maximising
output is where MR =
MC.

8. Profit maximisation
Output
Price &
Cost
AR
MC
AC
MR
P1
AC
Q1

9. Profit maximisation
 The traditional maximising goal
 assumes that owners control the management
of the business
 requires sufficient and accurate knowledge of
cost and revenue conditions in the market so
that MR and MC can be found
 This neo-classical assumption of all firms
behaving in a manner that seeks to maximise
profits is now questioned

10. Alternatives to profit
maximisation

11. 1. Share price maximisation
 Share price maximisation:
 Pursuing policies aimed at increasing the share
price

12. 2. Revenue maximisation
 Total Revenue =
 Average Revenue =
 Marginal Revenue =
 Revenue maximisation occurs where MR becomes 0
and therefore TR is maximised as in the following
diagram at MR = 0.

13. Revenue maximisation
Output
Price &
Cost
AR
MC
AC
MR
P2
AC
Q2

14. 3. Sales maximisation
 Sales maximisation is achieved when AC = AR
which is beyond the output which maximises profits
but where the firm earns ...
 ... normal profits, where AR = ATC as this ‘break-
even’ point is where all costs are being covered
including the opportunity cost of the entrepreneur
which is their potential pay as an employee doing a
similar job.
 Any output beyond this incurs a subnormal profit
and therefore ...

15. Normal profits
Output
Price &
Cost
AR
MC
AC
MR
P3=AC
Q3

16. Costs
Output (Q)
Different output levels - test
ATC
AR
(Demand)
MR
MC
A B C D

17. Costs
Output (Q)
Different output levels - answers
ATC
AR
(Demand)
MR
MC
A B C D
A= profit max
B=productive efficiency
C=rev max
D=sales max (all. eff)

18. 4. Social entrepreneurship
 A social enterprise is a business that has primarily
social objectives whose surpluses are reinvested
for that purpose in the business or the community,
rather than being driven by the need to seek profit
to satisfy investors.
 A social enterprise is looking to achieve social and
environmental aims over the long term.
 They may be profit seeking – but it is what they do
with their profits that makes the difference

19. Examples of social enterprises
 Café Direct
 Fair Trade
 Traidcraft
 Divine Chocolate
 Eden Project
 Housing Associations
 Fifteen Foundation
 Fair Finance
 First Fruit
 Greenwich Leisure
 Brentford FC or Exeter FC
 Big Issue

20. Minimum (normal) profit
constraint
 Why is minimum profit necessary?
 Desire to receive an acceptable distribution of
company profits from interim and final dividends
 Dilution of profits may have a negative effect on the
company’s share price on the stock market
 In this way the stock market acts as a check on the
behaviour and performance of each quoted company
 Opportunity cost
 Sales maximisation, revenue maximisation or social
entrepreneurship takes profits below their maximum
level. Thus social entrepreneurs are less likely therefore
to be plc’s.

21. Stakeholders & aims
 Stakeholders are groups who have an interest in the
activity and performance outcomes of a business, eg
 Shareholders
 Managers
 Employees
 Suppliers
 Customers
 Government and local communities.
 Eg in public limited companies, ownership and
control are separate: owners seek maximum profits;
managers may seek sales maximisation as these
increase their bonuses.
 Modern firms have to attempt to match competing
stakeholder needs

22. Stakeholder objectives
Firms may have to balance out their stakeholder
responsibilities because different stakeholders tend to
have different objectives and therefore may come into
conflict:
 ‘Fat cat pay’ & management rewards – bonuses
v social and environmental audits
v employee welfare & high wages
v meeting consumer needs esp low prices
v paying suppliers on time
v satisfying shareholders (owners) (‘The City’), who want
(maximum?) profits (> large dividends or share price
growth), about its policies, plans and actions.

23. Divorce between ownership &
control
 The majority of shareholders in a plc cannot
exercise day-to-day control over the decisions of
managers
 Managers employed by a business may have
different motivations than owners, they may want to
maximise their own utility from being in charge of a
business
 This may lead to decisions that are not consistent
with profit maximisation / or maximising shareholder
value over time

24. Ownership and control
Principals:
Shareholders
Control Mechanisms:
Pressures from the stock market
Regular meetings with shareholders (AGM)
Performance related pay (to provide
incentives)
Agents:
Board of Directors
Senior Management
OWNERSHIP
CONTROL

25. Managerial Discretion Models
 The divorce of ownership from control has lead
behavioural economists examine the decisions that are
taken within complex business organisations.
 Managers may have discretionary powers in deciding on
price and output and marketing in different segments
of markets
 Much depends on the degree of autonomy (freedom)
that the head office of a business gives to its managers
employed in individual sales outlets
 Divorce of ownership from control leads to the
principal agent problem with maximising behaviour
may be replaced by satisficing.

26. The principal agent problem
 The principal (shareholder), hires an agent (manager)
to perform tasks on his behalf but cannot ensure that
the agent performs them in exactly the way the
principal would like.
 The efforts of the agent are expensive and time-
consuming to monitor
 Incentives of the agent may differ from those of the
principal leading to a conflict of objectives
 It is linked to the problem of asymmetric information
 Unequal information share between two parties
 It does not arise if a legal contract can be drawn up to
specify all the duties of the agent

27. Coping with the principle agent
problem
Have the right incentives!
1. Share-ownership schemes
2. Performance-related pay
(a) Incentive pay schemes e.g. profit sharing
(b) Wages and salaries related directly to productivity /
profitability
3. Long-term employment contracts for senior management
– to give them a higher degree of loyalty to the business
4. Generous non-financial rewards but based on /
contingent on assessments of performance
5. Regular performance reviews

28. Ownership, control & influence
Principals:
Shareholders
Control Mechanisms:
Pressures from the stock market
Regular meetings with shareholders (AGM)
Performance related pay
Agents:
Board of Directors
Senior Management
OWNERSHIP
CONTROL
INFLUENCE
Other influences on business behaviour:
Consumers – e.g. ethical retailing
Industry regulators
Government (taxation, trade policy etc)

29. Most people and businesses SATISFICE!

30. 5. Herbert Simon & (profit)
satisficing
 Profit satisficing:
 Generating sufficient profits to satisfy
shareholders but maximising the rewards to the
managers / board and avoiding attention from
rivals or regulatory authorities, ie setting
minimum acceptable levels of achievement
 Satisficing = Satisfy + Suffice.
 No business can process all the factors affecting
the marketing / pricing of a product, in the hope of
maximising profit.

31. Herbert Simon & (profit)
satisficing
 An example of “bounded rationality” because
the complexity of decision-making may lead
to managers following “rules of thumb”
rather than seek optimal decisions all of the
time.
 Agents (e.g. managers) face information costs
in the present and uncertainty about the
future
 This limits their decision-making ability and
may force them to make decisions by seeking
the first satisfactory solution rather than
optimizing