What

Objectives do
Firms Have?
.

1
 Sectors of the Economy

Private Sector

Public Sector

2
Different Objectives of Firms

Main Objectives of Firms:

1. Profit Maximisation
2. Revenue Maximisation
3. Sales Maximisation
4. Profit Satisficing
3
 Other competing potential objectives are:

Growth
Economies of scale
Competitive advantage
Market leadership
Higher profits
Normal Profit
Survival
4
 Profit Maximisation
profit maximisation is the short run or
long run process by which a firm
determines the price and output level that
returns the greatest profit.

At profit maximisation, marginal

revenue is equal to marginal cost.
MR=MC

5
 Revenue Maximisation
This is the point where the
highest level of revenue (average
revenue X quantity) is achieved.

At
revenue maximisation, the
marginal revenue is equal to zero.
MR = 0
6
 Sales Maximisation
Sales maximisation is when firms sell
as much as possible without making a
loss.
Not-for-profit organisations may choose to
operate at this level of output.

This is where the average revenue is

equal to the average cost.
AR = AC (Normal profit)
7
 Profit Satisficing
This is NOT to aim for profit maximisation
but to make some level of profit enough to
satisfy the shareholders and at the same
time keep the other stakeholders happy.

Satisficing behaviour involves setting

minimum acceptable levels of achievement
in terms of revenue and profit e.g. a target
rate of growth of sales, or an acceptable
rate of return on capital.
8
 Task
1. Do firms always profit maximising?
2. Why do some firms engage in satisficing?

9
Why Do Firms
Grow?

10
 The Birth of Firms
Different ways firms can be formed:
Demerger
Recession
Economic climate
Level of entrepreneurial talent
Technological Development
Government assistance/policy

11
 Benefits of Growth to Firms
Economies of Scale
Increased Market Share
Gain more Profits
Gain Monopoly Power/Market Power
To increase pay and status of managers
Job security for the managers

12
Internal and External Growth
Internal Growth involves the firm
increasing its output and labour force,
opening new offices and factories.

External Growth involves firms

merging and taking over another firm.

13
How do firms grow? / types of Mergers
1. Horizontal Integration

2. Vertical Integration

3. Conglomerate Integration /
Diversification

14
 Horizontal Integration
This is where two firms in the same
industry and at the same stage of
production process merge.

Examples
Tesco merging with ASDA
BMW merging with Ford
Barnet College merging with
Southgate College
15
 Vertical Integration
This is where two firms in the same
industry and at different stage of
production process merge.

Examples
Tesco merging with Nestle
BMW merging with Alan Day Car
Retail

16
 Vertical Integration
There are two types of vertical integration:
Forward Vertical Integration This is
where two firms in the same industry and
at different stage of production process
merge and moving closer to the market

Backward Vertical Integration This is

where two firms in the same industry and
at different stage of production process
merge and moving closer to the production.
17
Conglomerate Integration / Diversification
This is where two unrelated firms
merge.

The reason is to diversify and spread

the risk.

Example:
BT merging with Mercedes Benz

18
 Why Do Some Firms Remain Small
Niche Market/ local monopoly
Lack of Economies of scale
Lack of finance for expansion
Lack of demand
Heavy government regulation

19
Why Do Some Firms Want to Grow
Economies of Scale
Increased Market Share
Gain more Profits
Gain Monopoly Power/Market Power
To increase pay and status of managers
Job security for the managers

20
 The Reasons for Demergers
A demerger is when a firm is divided into
two or more parts.
Reasons
Increasing the focus of the firm
Avoiding diseconomies of scale
Increase the share price of the new firm

21
How Can We
Calculate the
Revenue of a
Firm?
22
 Types of Revenues
Total Revenue is Price x Quantity

Average Revenue is the total revenue

divided by the quantity. (TR/Q)

Marginal revenue is the revenue from

selling one extra unit of output from the
total revenue. ( TR/ Q)

23
Revenues in perfectly competitive markets
Output Price Total Revenue Average Revenue Marginal Rev
sold (AR) (TR) (AR) (MR)

1 10

2 10

3 10

4 10

5 10

6 10

7 10

8 10

Use the graph paper provided to sketch the AR, MR and TR curves24
Diagram of AR and MR Curves

25
Revenues in imperfectly competitive markets
Output Price Total Revenue Average Revenue Marginal Rev
sold (AR) (TR) (AR) (MR)

1 10

2 9

3 8

4 7

5 6

6 5

7 4

8 3

Use the graph paper provided to sketch the AR, MR and TR curves26
Diagram of AR and MR Curves

27
Relationship between TR, AR, MR and PED

28
How Can We
Calculate the
Costs of a
Firm?
29
 Types of Costs
Total cost is fixed cost plus variable
cost. (FC + VC)

Average cost is the total cost

divided by the quantity. (TC/Q)

Marginal cost is the cost of

producing one extra unit of output
from the total cost. ( TC/ Q)
30
 .

Total Fixed Cost (FC): A fixed cost or indirect or

overhead cost is a cost which does not vary
directly with output.

Average Fixed Costs: Total FC divided by output

or quantity

Total Variable Cost (VC): A variable cost or direct

or Prime cost is a cost which varies directly with
output or quantity

Average Variable Costs: Total VC divided by

output or quantity 31
Total, Average and Marginal Costs
Output Total Cost() AC() Marginal cost ()

0 55 - -

1 70

2 82

3 87

4 92

5 120

6 180

Use the graph paper provided to sketch the AC and MC curves

32
33
34
 Short Run vrs Long Run
In the short run, at least one factor of
production is fixed.

Whereas in the long run all factors of

production is variable.

In the very long run, the state of the

technology can change.

35
Short Run vrs Long Run Costs
Costs that are fixed, example rent, have no
impact on a firm's short-run decisions, since
only variable costs and revenues affect
short-run profits.

The short run costs increase or decrease

based on variable cost as well as the rate of
production.

Long run costs have no fixed factors of

production
36
Diagram: Cost in the short run

37
Diagram: Cost in the Long run

38
Short run and long run curves

39
 Diminishing Marginal Returns
Diminishing Returns occurs in the short run when
one factor is fixed (e.g. Capital)

If the variable factor of production is increased,

there comes a point where it will become less
productive and therefore there will eventually be a
decreasing marginal and then average product.

Total Product (TP) - This is the total output

produced by workers.
Marginal Product (MP) - This is the output
produced by an extra worker. 40
 The Law of Diminishing Returns
It states that As more workers are added
to a given stock of fixed factor of
production, first the marginal product of
labour and the average product increase
and then eventually decline.

41
42
Diagram of Diminishing Returns

43
Economies and
Diseconomies
of Scale

44
 Economies of Scale
Economies of scale occur when the Long
Run Average Costs (LRAC) fall as output
increases.

External economies of scale are the

cost-saving advantages that accrue to the
industry as a whole, as a result of the firms
being close to each other and an increase
in the number of firms in the industry.

45
 Economies of scope
Economies of scope are conceptually
similar to economies of scale.
Economies of scope refers to lowering
the long run average cost for a firm in
producing two or more products.
Whereas economies of scale for a firm
primarily refers to reductions in the long
run average cost associated with
increasing the scale of production for a
single product type.
46
Diagram: Economies of Scale

47
 Types/Examples of EoS
Internal Economies of Scale
Technical Economies of Scale
Purchasing Economies of Scale (Bulk Buying)
Marketing Economies of Scale
Financial Economies of Scale
Labour Economies of Scale
Risk Bearing Economies of Scale
Selling Economies of Scale (large lorry)

48
 Types/Examples of EoS
External Economies of Scale
Auxiliary Industry
Supply of Skilled labour
Special Transport Facilities

49
 Diseconomies of Scale
Diseconomies of scale occur when the
Long Run Average Costs (LRAC) rise as
output increases.

External diseconomies of scale are the

disadvantages that arise due to over
concentration and over-production as a
result of an increase in the number of firms
in an industry.

50
Diagram: Diseconomies of Scale

51
 Types/Examples of Dis -EoS
Internal Diseconomies of Scale
Bureaucratic Red Tape
Administrative cost
Poor Labour relationship - low motivation
Poor Communication
Co-ordination problem
X inefficiency

52
 Types/Examples of Dis -EoS
External Diseconomies of Scale
The concentration of similar firms in an
area -Increased competition for resources
Lack of supply for skilled labour
Problems of waste disposal - Pollution
Congestion

53