The objectives of firms - Economics - HKDSE

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Study Notes: The Objectives of Firms

Hey everyone! Ever wondered what big companies like Apple or your local cha chaan teng are trying to achieve? Is it always about making as much money as possible? In this chapter, we'll dive into the main goals, or objectives, that firms have. Understanding this is super important because it helps us predict how businesses will act in the real world. Let's get started!

The Main Goal: Profit Maximization

For most firms, the number one goal is to make the most profit they can. This is called profit maximization. But to understand how they do that, we first need to be crystal clear on what profit actually is.

What is Profit? It's Simpler Than You Think!

Imagine you open a small shop selling phone cases. At the end of the day, how do you know if you've made money?

You need to look at two things:

1. Total Revenue (TR): This is the total amount of money you receive from selling your goods. If you sell 50 phone cases at $100 each, your TR is 50 x $100 = $5000.

2. Total Cost (TC): This is the total cost of everything you spent to make or sell your goods. This includes the cost of the phone cases, rent for your shop, electricity, your own salary, etc.

The profit is simply what's left over!

The formula is: $$Profit = Total Revenue (TR) - Total Cost (TC)$$

So, if your Total Revenue was $5000 and your Total Cost was $3000, your profit is $2000. Easy, right?

Quick Review: The Basics

Profit: The money a firm makes after paying all its costs. (TR - TC)
Total Revenue (TR): The total income from sales. (Price x Quantity Sold)
Total Cost (TC): The total expenses of production.

How to Maximize Profit? The Golden Rule!

Okay, so a firm wants to make the biggest profit possible. How does it decide exactly how much to produce? Should it make 100 phone cases? 1,000? 10,000?

To answer this, economists use a powerful idea called marginal analysis. Don't let the name scare you! 'Marginal' just means 'the extra one'. We compare the extra benefit of producing one more unit with the extra cost of producing it.

Let's introduce two super important key terms:

1. Marginal Cost (MC): The extra cost of producing one more unit of a good.
Analogy: If it costs you $100 to make 10 cakes, and $108 to make 11 cakes, the marginal cost of the 11th cake is $8.

2. Marginal Revenue (MR): The extra revenue from selling one more unit of a good.
Analogy: If you sell 10 cakes for a total of $200, and 11 cakes for a total of $220, the marginal revenue of the 11th cake is $20.

Here's the logic:

If MR > MC (the extra revenue is MORE than the extra cost), it's worth producing that extra unit. You'll add to your total profit!
If MR < MC (the extra revenue is LESS than the extra cost), you should NOT produce that extra unit. It will reduce your total profit!

So, where is the sweet spot? The profit-maximizing quantity is where the firm produces right up until the point that the extra revenue equals the extra cost.

The Golden Rule of Profit Maximization is to produce at the quantity where:
Marginal Revenue (MR) = Marginal Cost (MC)

A Special Note for Price-Taking Firms

In our syllabus, we focus on price-taking firms. These are firms that are too small to influence the market price (like a single farmer selling vegetables in a huge wet market). For them, the price is just given by the market.

This makes things easier! If the market price for a phone case is $100, they can sell as many as they want at $100. So, the extra revenue (MR) from selling one more case is always just the price ($100).

For a price taker: Price (P) = Marginal Revenue (MR)

So, their profit maximization rule becomes even simpler: Produce where Price (P) = Marginal Cost (MC)

Let's See it in Action (with a Schedule!)

This is exactly how it will look in an exam. You'll be given a schedule (a table) and asked to find the profit-maximizing output. Don't worry, it's just a step-by-step process.

Example: A firm produces T-shirts and sells them in a competitive market at a price of $70 each. Its costs are shown below.

Step 1: Understand the given table.

Output (Q): 0, 1, 2, 3, 4, 5, 6
Total Cost (TC): $50, $80, $120, $150, $200, $270, $350

Step 2: Calculate Marginal Cost (MC). Remember, MC is the CHANGE in TC when you produce one more unit.

MC of 1st unit = $80 - $50 = $30
MC of 2nd unit = $120 - $80 = $40
MC of 3rd unit = $150 - $120 = $30
MC of 4th unit = $200 - $150 = $50
MC of 5th unit = $270 - $200 = $70
MC of 6th unit = $350 - $270 = $80

Step 3: Identify the Price (P), which is also the Marginal Revenue (MR) for a price taker.

The question tells us the price is $70. So, P = MR = $70.

Step 4: Apply the rule! Find the output where P = MC.

Let's look at our MC values: $30, $40, $30, $50, $70, $80.
We see that the MC is exactly $70 at an output of 5 units.

So, the profit-maximizing output is 5 T-shirts.

Step 5 (Optional but good for checking): Let's calculate the profit at this level.

Total Revenue (TR) = Price x Quantity = $70 x 5 = $350
Total Cost (TC) at 5 units (from the table) = $270
Profit = TR - TC = $350 - $270 = $80

You can check the profit for other quantities (e.g., 4 units or 6 units) and you'll find that $80 is the highest possible profit!

Common Mistakes to Avoid

Some students just calculate the profit for every single output level to find the highest one. While this might get you the right answer, it doesn't show the examiner you understand the economic principle! Always state the P = MC rule first, and then find the output that satisfies it.

Why is the Marginal Cost Schedule the Supply Schedule?

This sounds complicated, but it follows directly from our golden rule. A firm's supply schedule shows how much it is willing to produce and sell at different prices.

Let's think about our T-shirt firm:

If the market price was $50, where would it produce? It would produce where P = MC, which is at 4 units (MC = $50).
If the market price was $70, where would it produce? It would produce where P = MC, which is at 5 units (MC = $70).
If the market price was $80, where would it produce? It would produce where P = MC, which is at 6 units (MC = $80).

Do you see the pattern? The Marginal Cost schedule is literally telling us the quantity the firm will supply at any given price. Therefore, for a price-taking firm, its Marginal Cost schedule IS its supply schedule!

Key Takeaway for Profit Maximization

The main goal for most firms is to maximize profit (TR - TC). The golden rule to achieve this is to produce at the quantity where the extra revenue from the last unit equals its extra cost. For a price-taker, this means producing where Price = Marginal Cost (P = MC).

It's Not Always About Profit! Other Objectives

While making money is crucial, sometimes firms, especially large ones, have other goals in mind. These can be important for long-term success or because of the nature of the company.

Objective 1: Maximizing Market Share

What it is: Trying to get the biggest percentage of total sales in the industry. It's about being the biggest player, not necessarily the most profitable one right now.

Why do it? A large market share can lead to brand recognition (everyone knows your name!), economies of scale (lower costs), and can make it harder for new competitors to enter the market.

Real-world example: When food delivery apps like Deliveroo and Foodpanda first started in Hong Kong, they gave out massive discounts and free delivery offers. They were losing money on each order, but their goal was to attract the most customers and restaurants to their platform to become the market leader.

Objective 2: Provision of Non-profit Making Services

What it is: Some firms, particularly public corporations owned by the government, provide essential services to the public even if those services lose money.

Why do it? The goal is social welfare, not profit. It ensures that all citizens have access to necessary services.

Real-world example: The MTR might operate certain bus routes to remote villages in the New Territories that are not profitable. The passenger numbers are too low to cover the costs, but it's a vital transport link for the residents there.

Objective 3: Corporate Social Responsibility (CSR)

What it is: This is about a company being a "good citizen". It means operating in an ethical way that respects people, the community, and the environment.

Why do it? Good CSR improves a company's public image, which can attract more customers and talented employees. It's about building a sustainable business for the long term.

Real-world example: A fast-food chain like McDonald's switching to using cage-free eggs or paper straws to reduce plastic waste. A bank like HSBC sponsoring community arts festivals or encouraging staff to volunteer.

Did you know?

Often, these "other objectives" are just smart ways to maximize profit in the long run! A company with a good reputation for CSR might attract more loyal customers, who are willing to pay a little more for their products. This can lead to higher profits over many years.

Key Takeaway for Other Objectives

Firms may also aim to maximize market share for long-term dominance, provide non-profit services for social welfare, or practice Corporate Social Responsibility (CSR) to build a positive brand image.