business-objectives

Profit and Revenue Maximisation

Profit Maximisation

• Most firms have the rational business objective of profit maximisation

  • Profits benefit shareholders as they receive dividends and also increase the underlying share price

    • An increase in the underlying share price increases the wealth of the shareholder

• To achieve profit maximisation firms, follow the profit maximisation rule

  • When marginal cost (MC) = marginal revenue (MR) then no additional profit can be extracted by producing another unit of output

  • When MC < MR additional profit can still be extracted by producing an additional unit of output

  • When MC > MR the firm has gone beyond the profit maximisation level of output

    • It is making a marginal loss on each unit produced beyond the point of output where MC = MR

• In reality, firms may find it difficult to produce at the profit maximisation level of output

  • They may not know where this level is because it is difficult to calculate

  • In the short term they may not adjust their prices if the marginal cost changes

    • Marginal costs can change regularly and regular price changes would be disruptive to customers

  • In the long-term firms will seek to adjust prices to the profit maximisation level of output

  • Firms may be forced to change prices by the Competition Commission

    • The profit maximisation level of output often results in high prices for consumers

    • Changing prices changes the marginal revenue

Diagram analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping

• At the profit maximisation level of output (MC = MR)

  • The selling price is P₁

  • The average cost is C₁

  • The supernormal profit =

Revenue Maximisation

• Some firms have the business objective of revenue maximisation

  • This often occurs due to the principal agent problem

    • Sales managers often receive commission on sales as part of their wages and this incentivises them to maximise sales

    • Profit maximisation for shareholders becomes a secondary objective for the sales managers

  • Firms will also maximise revenue in order to increase output & benefit from economies of scale

  • In the short-term firms may use this strategy to eliminate the competition as the price is lower than when focusing on profit maximisation

• To achieve revenue maximisation firms produce up to the level of output where MR = 0

  • When MR > 0, producing another unit of output will increase total revenue

Diagram analysis

• This firm has market power as the MR and average revenue (AR) curve are downward sloping

• At the revenue maximisation level of output (MR = 0)

  • The selling price is P₁

  • The average cost is C₁

  • The supernormal profit = <img alt=”left parenthesis straight P subscript 1 space minus space straight C subscript 1 right parenthesis space cross times space straight Q subscript 1″ data-mathml='<math style=”font-family:Arial” ><semantics><mstyle mathsize=”14px”><mo>(</mo><msub><mi mathvariant=”normal”>P</mi><mn>1</mn></msub><mo> </mo><mo>-</mo><mo> </mo><msub><mi mathvariant=”normal”>C</mi><mn>1</mn></msub><mo>)</mo><mo> </mo><mo>×</mo><mo> </mo><msub><mi mathvariant=”normal”>Q</mi><mn>1</mn></msub></mstyle><annotation encoding=”application/vnd.wiris.mtweb-params+json”>{“language”:”en”,”fontFamily”:”Times New Roman”,”fontSize”:”18″}</annotation></semantics></math>’ height=”22″ role=”math” src=”data:image/svg+xml;charset=utf8,%3Csvg%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F2000%2Fsvg%22%20xmlns%3Awrs%3D%22http%3A%2F%2Fwww.wiris.com%2Fxml%2Fmathml-extension%22%20height%3D%2222%22%20width%3D%22103%22%20wrs%3Abaseline%3D%2214%22%3E%3C!–MathML%3A%20%3Cmath%20xmlns%3D%22http%3A%2F%2Fwww.w3.org%2F1998%2FMath%2FMathML%22%20style%3D%22font-family%3AArial%22%3E%3Cmstyle%20mathsize%3D%2214px%22%3E%3Cmo%3E(%3C%2Fmo%3E%3Cmsub%3E%3Cmi%20mathvariant%3D%22normal%22%3EP%3C%2Fmi%3E%3Cmn%3E1%3C%2Fmn%3E%3C%2Fmsub%3E%3Cmo%3E%26%23xA0%3B%3C%2Fmo%3E%3Cmo%3E-%3C%2Fmo%3E%3Cmo%3E%26%23xA0%3B%3C%2Fmo%3E%3Cmsub%3E%3Cmi%20mathvariant%3D%22normal%22%3EC%3C%2Fmi%3E%3Cmn%3E1%3C%2Fmn%3E%3C%2Fmsub%3E%3Cmo%3E)%3C%2Fmo%3E%3Cmo%3E%26%23xA0%3B%3C%2Fmo%3E%3Cmo%3E%26%23xD7%3B%3C%2Fmo%3E%3Cmo%3E%26%23xA0%3B%3C%2Fmo%3E%3Cmsub%3E%3Cmi%20mathvariant%3D%22normal%22%3EQ%3C%2Fmi%3E%3Cmn%3E1%3C%2Fmn%3E%3C%2Fmsub%3E%3C%2Fmstyle%3E%3C%2Fmath%3E–%3E%3Cdefs%3E%3Cstyle%20type%3D%22text%2Fcss%22%3E%40font-face%7Bfont-family%3A’math1298aafb3379f56b0a3af85c9c2’%3Bsrc%3Aurl(data%3Afont%2Ftruetype%3Bcharset%3Dutf-8%3Bbase64%2CAAEAAAAMAIAAAwBAT1MvMi7iBBMAAADMAAAATmNtYXDEvmKUAAABHAAAADxjdnQgDVUNBwAAAVgAAAA6Z2x5ZoPi2VsAAAGUAAAA4WhlYWQQC2qxAAACeAAAADZoaGVhCGsXSAAAArAAAAAkaG10eE2rRkcAAALUAAAADGxvY2EAHTwYAAAC4AAAABBtYXhwBT0FPgAAAvAAAAAgbmFtZaBxlY4AAAMQAAABn3Bvc3QB9wD6AAAEsAAAACBwcmVwa1uragAABNAAAAAUAAADSwGQAAUAAAQABAAAAAAABAAEAAAAAAAAAQEAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAACAgICAAAAAg1UADev96AAAD6ACWAAAAAAACAAEAAQAAABQAAwABAAAAFAAEACgAAAAGAAQAAQACANciEv%2F%2FAAAA1yIS%2F%2F%2F%2FKt3wAAEAAAAAAAAAAAFUAywAgAEAAFYAKgJYAh4BDgEsAiwAWgGAAoAAoADUAIAAAAAAAAAAKwBVAIAAqwDVAQABKwAHAAAAAgBVAAADAAOrAAMABwAAMxEhESUhESFVAqv9qwIA%2FgADq%2FxVVQMAAAIAgABVAtUCgAADAAcARhiwARQAsQAAExCxAAnksQABExCwBDyxBgj0sAI8MAGxCAETELEAA%2FawBzyxAQX1sAY8sgUHABD0sAI8sQkD5rEEBfWwAzwTMwEjETMBI4BVAgBVVf4AVQKA%2FdUCK%2F3VAAEAgAFVAtUBqwADADAYAbAEELEAA%2FawAzyxAgf1sAE8sQUD5gCxAAATELEABuWxAAETELABPLEDBfWwAjwTIRUhgAJV%2FasBq1YAAAAAAQAAAAEAANV4zkFfDzz1AAMEAP%2F%2F%2F%2F%2FWOhNz%2F%2F%2F%2F%2F9Y6E3MAAP8gBIADqwAAAAoAAgABAAAAAAABAAAD6P9qAAAXcAAA%2F7YEgAABAAAAAAAAAAAAAAAAAAAAAwNSAFUDVgCAA1YAgAAAAAAAAAAoAAAAlwAAAOEAAQAAAAMAXgAFAAAAAAACAIAEAAAAAAAEAADeAAAAAAAAABUBAgAAAAAAAAABABIAAAAAAAAAAAACAA4AEgAAAAAAAAADADAAIAAAAAAAAAAEABIAUAAAAAAAAAAFABYAYgAAAAAAAAAGAAkAeAAAAAAAAAAIABwAgQABAAAAAAABABIAAAABAAAAAAACAA4AEgABAAAAAAADADAAIAABAAAAAAAEABIAUAABAAAAAAAFABYAYgABAAAAAAAGAAkAeAABAAAAAAAIABwAgQADAAEECQABABIAAAADAAEECQACAA4AEgADAAEECQADADAAIAADAAEECQAEABIAUAADAAEECQAFABYAYgADAAEECQAGAAkAeAADAAEECQAIABwAgQBNAGEAdABoACAARgBvAG4AdABSAGUAZwB1AGwAYQByAE0AYQB0AGgAcwAgAEYAbwByACAATQBvAHIAZQAgAE0AYQB0AGgAIABGAG8AbgB0AE0AYQB0AGgAIABGAG8AbgB0AFYAZQByAHMAaQBvAG4AIAAxAC4AME1hdGhfRm9udABNAGEAdABoAHMAIABGAG8AcgAgAE0AbwByAGUAAAMAAAAAAAAB9AD6AAAAAAAAAAAAAAAAAAAAAAAAAAC5BxEAAI2FGACyAAAAFRQTsQABPw%3D%3D)format(‘truetype’)%3Bfont-weight%3Anormal%3Bfont-style%3Anormal%3B%7D%40font-face%7Bfont-family%3A’round_brackets18549f92a457f2409’%3Bsrc%3Aurl(data%3Afont%2Ftruetype%3Bcharset%3Dutf-8%3Bbase64%2CAAEAAAAMAIAAAwBAT1MvMjwHLFQAAADMAAAATmNtYXDf7xCrAAABHAAAADxjdnQgBAkDLgAAAVgAAAASZ2x5ZmAOz2cAAAFsAAABJGhlYWQOKih8AAACkAAAADZoaGVhCvgVwgAAAsgAAAAkaG10eCA6AAIAAALsAAAADGxvY2EAAARLAAAC%2BAAAABBtYXhwBIgEWQAAAwgAAAAgbmFtZXHR30MAAAMoAAACOXBvc3QDogHPAAAFZAAAACBwcmVwupWEAAAABYQAAAAHAAAGcgGQAAUAAAgACAAAAAAACAAIAAAAAAAAAQIAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAAACAgICAAAAAo8AMGe%2F57AAAHPgGyAAAAAAACAAEAAQAAABQAAwABAAAAFAAEACgAAAAGAAQAAQACACgAKf%2F%2FAAAAKAAp%2F%2F%2F%2F2f%2FZAAEAAAAAAAAAAAFUAFYBAAAsAKgDgAAyAAcAAAACAAAAKgDVA1UAAwAHAAA1MxE