The Objectives of Firms (3.1.4.2)
Hello Economists! This short but crucial chapter asks a fundamental question:
What exactly do companies try to achieve?
Understanding a firm's goals is essential because these goals dictate its behaviour in the market—how it sets prices, how much it produces, and how it competes. In the section on Competitive and Concentrated Markets, knowing the firm's objective is key to predicting its strategy.
The Traditional Objective: Profit Maximisation
The traditional model in economics assumes that all firms have one primary objective: Profit Maximisation.
What is Profit?
In simple terms, profit is the difference between a firm's total revenue (TR) and its total costs (TC).
$$Profit = TR - TC$$
Why is Profit Maximisation so Important?
- Reward for Risk: Owners (shareholders) took a risk starting the business; profit is their reward.
- Survival in the Long Run: Without profits, firms cannot afford to reinvest, innovate, or survive economic downturns.
- Shareholder Demand: For large, publicly listed companies, managers are expected to maximise profits to keep the share price high and satisfy the owners.
Analogy: Think of profit maximisation as trying to get the highest possible grade (A*) in your Economics course. It’s the highest standard and the default goal for a firm to operate successfully.
Quick Review: Normal vs. Abnormal Profit
Remember the distinction from the Costs and Revenue section:
- Normal Profit: The minimum level of profit needed to keep the firm operating in the long run. It is counted as a cost (the opportunity cost of running the business).
- Abnormal (or Supernormal) Profit: Any profit earned above and beyond Normal Profit. This is the goal of profit maximisation.
Key Takeaway: Profit maximisation is the bedrock assumption of traditional economic theory, providing the motive for production and risk-taking.
A Variety of Other Possible Objectives
Don't worry if this seems tricky at first—real-world firms are complex! While profit is crucial, firms often pursue other goals, especially in the short run or depending on the market structure they are in (e.g., highly competitive vs. concentrated markets).
The syllabus requires you to be aware of three specific alternative objectives:
1. Survival
This is the most basic objective, often prioritised over profit, particularly when a firm is new, the market is highly competitive, or during an economic recession.
- Scenario: A small, independent bookstore opens next to a large chain store. In its first year, the owner's main goal isn't making supernormal profit, but simply covering costs and making sure the doors stay open.
- Behaviour: The firm might accept lower prices or offer heavy discounts just to generate enough cash flow to stay afloat.
Memory Aid: Survival is the objective for firms that are currently "Sailing Close to the Wind."
2. Growth
Firms often aim to increase their size, either by expanding their existing facilities (internal growth) or by buying other companies (external growth, like mergers).
Why aim for Growth?
- Economies of Scale: Getting bigger often allows the firm to reduce its average production costs.
- Market Power: Larger firms have more influence over prices and competition.
- Managerial Rewards: Managers often get higher salaries and more prestige running a larger company, even if it’s slightly less profitable overall (see "Divorce of Ownership from Control" below).
3. Increasing Market Share
Market Share refers to the percentage of total sales in a specific market that is held by one firm.
Why aim for Market Share?
- Long-Term Profit: Although maximising market share might require cutting prices (reducing short-term profit), it can lead to higher profits in the long run by dominating the market.
- Deterring Competition: A large market share acts as a strong barrier to entry for potential competitors.
Did you know? Companies like *Amazon* often prioritise increasing market share over short-term profitability. They often accept huge costs (like heavily subsidised shipping) to capture as many customers as possible, knowing that once they dominate, profits will eventually follow.
The Importance of Objectives: Affecting Firm Behaviour
The most important part of this topic is understanding that the objective chosen by a firm directly changes how it behaves.
| Objective Chosen | Resulting Behaviour | Impact on Market/Consumers | |:---|:---|:---| | Profit Maximisation | Focus on efficiency, cost minimisation, producing at the optimal output level. | Generally leads to productive efficiency, but potentially higher prices if the firm has monopoly power. | | Market Share/Growth | Aggressive pricing (lowering prices), high spending on advertising, focus on innovation and product quality. | Benefits consumers in the short run (lower prices, better products) but could lead to increased concentration (fewer large firms) later. | | Survival | Cost cutting, limiting investment, reducing output, price matching. | Can maintain competition, especially against larger rivals, but limits innovation. |
A Closer Look: Divorce of Ownership from Control
In many large, publicly owned companies, the people who *own* the company (the shareholders) are different from the people who *run* it day-to-day (the managers or directors). This is called the Divorce of Ownership from Control.
When this separation occurs, managers may not always pursue maximum profit for the distant owners. Instead, they might pursue objectives that benefit themselves:
- Maximising Sales Revenue: Larger sales figures make the company look more impressive, justifying higher managerial salaries and prestige.
- Satisficing: Managers might aim for a "satisfactory" level of profit—enough to keep the shareholders quiet—and then use the remaining resources to pursue other personal goals, such as shorter working hours or investing in prestige projects.
Important Note for Exams: You must appreciate that the firm's objective will affect its behaviour (price, output, quality). You do not need detailed knowledge or complex diagrams to explain sales revenue maximisation or satisficing. Just be aware that these alternatives exist and influence outcomes.
Key Takeaway
Firms operate with a variety of objectives beyond just profit, including survival, growth, and market share. These different objectives lead to different operational decisions and distinct competitive behaviours in the market.