objectives of a firm

TOPIC: OBJECTIVES OF A FIRM
SUBMITTED BY: SUBMITTEDTO:
NAME VIBHA JAIN
CLASS MCOM I (SEM 1)
ROLL NO. 4656
MRS. PREETI CHOPRA
[P.G. DEPT. OF COMMERCE]

 A firm is an association of individuals who have organized
themselves for the purpose of turning inputs into output.
 The firm organizes the factors of production to produce goods and
services to fulfill the needs of the consumers.
 Another important characteristic of firms are that they are legal
undertakings because no illegal undertaking, association and
organizations fall under the category of firms.
 The firm undertakes economic activities.

 Profit maximization is the course of action a business takes to make
the highest return from the goods or services they offer.
 Profit maximization is the basic objective of all the firms and is
necessary for the long run survival of the firm.
 Usually, in economics, we assume firms are concerned with
maximizing profit.
 Higher profit means:
i. Higher dividends for shareholders.
ii. More profit can be used to finance research and development.
iii. Higher profit makes the firm less vulnerable to takeover.
iv. Higher profit enables higher salaries for workers

 Profit Maximization is possible at the point where MC=MR.
 This situation of MR=MC keeps shareholders happy, provides
reinvestment opportunities, and create greater efficiency for the
firm.
BUT
 the point where marginal costs (MC) are equal to marginal
revenue (MR) is difficult to calculate as MC includes physical
costs and the opportunity cost- which is hard to quantify.
 Additionally, firms have greater risk of investigations by regulatory
authorities if huge profits are being made.
 .The ideal situation for both parties is for the business to
maintain quality at a reasonable cost while still making a
healthy profit.

 Sales maximization is achieved when:
AC = AR or TC = TR
 In other words, a business is selling as much as they can without
making a loss.
• At the sales maximization output, there are normal profits only and
no supernormal profits/loss.
• They want to achieve a rapid growth of market share (subject to the
constraint that they need to achieve a minimum rate of profit (normal
profit) to justify staying in the market in the long run).
• Sales maximization typically involves businesses charging lower
prices for their products contrasted with profit maximization.
• This can be good news for consumer welfare in the short run as the
level of consumer surplus increases.

Output per
week
Total
revenue
(£millions)
Average
revenue
(£millions)
Total cost
(£millions)
Average
cost
(£millions)
Marginal
cost
(£millions)
0 0 - 10 - -
1 40 40 25 25 15
2 60 30 34 17 9
3 78 26 52 17.3 18
4 96 24 96 24 44
5 105 21 150 30 54
A numerical example of sales maximisation while achieving
normal profits
•Average cost = average revenue at an output of 4 units per week
•At output level 5, a loss is made because average revenue is less than
average cost (i.e TR<TC)

C. REVENUE
MAXIMISATION
 Maximizing sales revenue is an
alternative to profit maximization and
occurs when the marginal revenue,
MR, from selling an extra unit is zero.
 Revenue maximization – example
 In the example below a small firm
produces tennis rackets, and sells them
in boxes of 10 to retail stores. The table
shows weekly sales. Total revenue (TR)
will be maximised at a price of £50 per
racket, with sales of 60 rackets, giving a
total revenue of £3,000. At revenue
maximisation, marginal revenue will
equal zero.
P(£) Qd TR
MR
[∆TR/∆
Qd]
100 10 1000
90 20 1800 80
80 30 2400 60
70 40 2800 40
60 50 3000 20
50 60 3000 0
40 70 2800 -20

 In a purely competitive firm (assuming many sellers and buyers in the
industry), managerial analysis holds that a company should set its price where
marginal revenue equals marginal costs.
 Marginal revenue is the amount of money earned on the last product sold.
 Similarly, marginal cost is amount of money spent on the last product made.
 While marginal revenue often stays static, marginal cost tends to increase.
This is due to wear and tear on machinery, reduced productivity of the
employees and other inputs. This is the law of diminishing returns.
 For example, if a t-shirt manufacturer sells each t-shirt for $10, this amount is
also the marginal revenue. As marginal costs increase, the t-shirt
manufacturer should sell t-shirts as long as the marginal costs are less than or
equal to $10.

Diagram showing different objectives of firms
Q1 = Profit maximisation (MR=MC)
Q2 = Revenue Maximisation (MR=0)
Q3 = Marginal cost pricing (P=MC) – allocative efficiency
Q4 = Sales maximisation – maximum sales while still making normal profit (AR=ATC)

 Firms often seek to increase their market share – even if it means
less profit.
 This could occur for various reasons:
i. Increased market share increases monopoly power and may enable
the firm to put up prices and make more profit in the long run.
ii. Managers prefer to work for bigger companies as it leads to greater
prestige and higher salaries.
iii. Increasing market share may force rivals out of business.
E.g. the growth of 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.

 In many firms, there is a separation of ownership and control. Those
who own the company (shareholders) often do not get involved in the
day to day running of the company.
 This is a problem because although the owners may want to
maximise profits, the managers have much less incentive to maximise
profits because they do not get the same rewards, (share dividends).
 Therefore managers may create a minimum level of profit to keep the
shareholders happy, but then maximise other objectives, such as
enjoying work, getting on with other workers. (e.g. not sacking them)
This is the problem of separation between owners and managers.
 This ‘principal-agent‘ problem can be overcome, to some extent, by
giving managers share options and performance related pay although
in some industries it is difficult to measure performance.

 This is similar to sales maximization and may involve mergers and
takeovers.
 With this objective, the firm may be willing to make lower levels of
profit in order to increase in size and gain more market share.
 More market share increases their monopoly power and ability to
be a price setter.
H. 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

 A firm may incur extra expense to choose products which don’t
harm the environment or products not tested on animals.
Alternatively, firms may be concerned about local community /
charitable concerns.
 Every firm is obliged to fulfill its corporate social responsibility and
work towards the betterment of the society.
 Some firms may adopt social/environmental concerns into part of
its branding. This can ultimately help profitability as the brand
becomes more attractive to consumers.
 Some firms may adopt social/environmental concerns on principal
alone – even if it does little to improve sales/brand image.

 O. E. Williamson propounded the hypothesis of maximization of managerial
utility function.
 He argues that managers have the freedom to pursue objectives other than
profit maximization.
 Managers seek to maximize their own utility function subject to a minimum
level of profit.
 According to Williamson, manager’s utility function can be expressed as: U =
f(S, M, ID)
where,
 S = additional expenditure on staff
 M = managerial emoluments
 ID = discretionary investments
 According to the hypothesis, managers attempt to maximize their utility
function subject to a satisfactory profit.
 A minimum profit is necessary to satisfy the shareholders or else the
manager’s job security will be at stake.

 Other alternative objectives of business firms as suggested by economists
are the prevention of entry of new firms and risk avoidance.
 It is argued that the motive behind entry-prevention may be any or all of
the followings:
a) profit maximization in the long-run;
b) securing a constant market share; and,
c) avoidance of risk caused by unpredictable behaviour of new firms.
 The advocates of profit maximization as business objective argue,
however, that only profit-maximizing firms can survive in the long-run.
 Firms can achieve all other subsidiary objectives and goals easily only if
they can maximize their profits.
 Another argument is that prevention of entry may be the major objective
in the pricing policy of the firm, particularly in the case of limit pricing.
 But the motive behind entry prevention is to secure a constant share in
the market, which is compatible with profit maximization.

1. To achieve the Organizational Goal.
2. To maximize the Output
3. To maximize the Customer and Stakeholders Satisfaction
4. To maximize Shareholder’s Return on Investment
5. To survive for a long time.
6. To earn a prestige or a goodwill for a firm.
7. Creating and retaining customers.
8. Optimum utilization of scarce resources.
9. To cater to the needs of the employees.
10. To promote social justice.
11. To generate employment opportunities.
12. To provide good quality goods and services.

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