Select your language

Suggested languages for you:
Log In Start studying!
StudySmarter - The all-in-one study app.
4.8 • +11k Ratings
More than 3 Million Downloads
Free
|
|

All-in-one learning app

  • Flashcards
  • NotesNotes
  • ExplanationsExplanations
  • Study Planner
  • Textbook solutions
Start studying

Objectives of Firms

Save Save
Print Print
Edit Edit
Sign up to use all features for free. Sign up now
Objectives of Firms

Every firm has an objective according to which it behaves in the market structure. Let’s study the objectives of firms and their motives.

What is a firm?

In simple terms, firms are companies. They are legally recognised bodies that provide goods and/or services to their consumers, government bodies, and other businesses.

A firm is an organization that combines and organizes resources for the purpose of producing goods and services for sale at profits.¹

Firms can be divided on the basis of their legality, nature of work, number of owners, size, and need for its resources. Firms can be broadly classified into three main categories. These categories are then divided into subcategories:

  1. Private sector

    1. Proprietary firms

    2. Partnerships

    3. Companies

    4. Cooperatives

  2. Public sector

    1. Companies

    2. Corporations

    3. Departments

  1. Joint sector

Figure 1 should help you remember.

All the firms may have varied objectives depending on their production capacity, nature of business, competition, and other factors.

The main objective of firms: profit maximisation

The first and most important objective of any firm is to maximise its profit. The basic profit calculation is the total revenue minus the total cost. In economics, profit refers to the returns over and above the opportunity cost. It is also sometimes referred to as pure profits.

There are a few reasons why profit maximisation is the main objective of most firms:

  • Re-investment: firms want to maximise their profit to re-invest the amount for further buying new technology, research, and development, etc.

  • Dividends: firms may wish to have better profits to allow for greater dividends for the shareholders.

  • Maximum profit is also one form of reward for entrepreneurship for the owners’ risk-taking.

The profit-maximising rule (MC = MR)

Profit maximisation occurs at a production quantity where marginal cost is equal to marginal revenue. This is easier to understand with the help of a diagram.

The Profit maximising rule states that MC = MR as shown in Figure 1 at point M. Let’s see why the profit is maximised at this point.

Objectives of Firms Profit maximisation StudySmarter OriginalsFigure 2: Profit maximisation, StudySmarter Originals

If we move to the right of the profit-maximising point, M, the marginal cost curve is above the marginal revenue curve. This means that there is only loss for any units above the profit-maximising quantity, Qm. This results in the reduction of profits.

On the other hand, if we move to the left of the profit-maximising point, M, the marginal revenue curve is above the marginal cost curve. This means that any additional unit produced will increase profits until the profit-maximising quantity, Qm is reached. This happens at the point where the marginal revenue curve meets the marginal cost curve. Hence, the firm will choose to produce at this profit-maximising point where MC = MR. The price that the firm will set is read off the AR curve at the profit-maximising quantity, Qm (point P in Figure 2.)

Other possible objectives of firms

Most firms have a basic objective of profit maximisation. However, for many reasons, some firms may also try to fulfill other objectives:

  1. If a firm has a too large level of profit, this may result in the regulators' investigating it. They may scrutinise the firm's processes and ask to reduce prices to meet customers’ demands.

  2. Sometimes, firms may not have a profit-maximisation objective as they are not able to ascertain their actual marginal cost and marginal revenue.

  3. Other objectives may be more crucial for the firm over profit maximisation.

Growth maximisation/sales maximisation

The firms may pursue the objective of sales maximisation which can also be referred to as growth maximisation. A firm achieves sales maximisation when the average cost (AC) is equal to the average revenue (AR) which is also a point at which a firm breaks even (makes zero profit.) This is represented by point S in Figure 3 below:

Objectives of Firms Profit maximisation StudySmarter OriginalsFigure 3. Growth Maximisation, StudySmarter Originals

Here are some reasons why firms would have sales maximisation as their objective:

1. Economies of scale

When the firm increases the production levels to reduce its cost of production, it helps to create economies of scale. As the output increases, firms aim for higher sales.

2. Market flooding

This is the marketing tactic a firm uses to hammer the consumer’s memory with the firm’s product by showing it everywhere possible. This kind of strategy helps the firms to gain more market share and at the same time loyal customers.

3. Limit pricing

Here the firm prices its product at the break-even point. The price allows it to make only normal profit, which takes away the incentive for new firms to enter the market.

Revenue maximisation

Revenue maximisation occurs when marginal revenue is equal to zero (MR = 0.) This is also a point where the MR curve crosses the quantity axis. The price, as always, is read off the AR curve. This is represented by point R in Figure 4 below:

Objectives of Firms Revenue maximisation StudySmarter OriginalsFigure 4. Revenue maximisation, StudySmarter Originals

Revenue maximisation (at point R) can help the firms increase their produced quantities whilst lowering their prices compared to the prices in profit (at point P) or sales maximisation (at point S.)

Again, profit maximisation occurs at the point M where MC = MR. We read the price from the average revenue (AR) curve at point P, which gives us the price, Pm, and quantity, Qm, for profit maximisation.

Similarly, revenue maximisation occurs when marginal revenue equals 0. We read the price from the average revenue (AR) curve at point R, which gives us with the price, P2, and quantity, Q2, for revenue maximisation.

Clearly, at the point of revenue maximisation, the prices are lower and the quantities are higher than those determined for profit maximisation. Hence, firms may be willing to go for revenue maximisation over profit maximisation.

With the objective of revenue maximisation, the firm may cut down the competition by charging lower prices and taking the market share away from its competitors.

The satisficing principle

The satisficing principle refers to sacrificing profits to satisfy as many key stakeholders as possible. The word satisficing comes from ‘satisfy’ and ‘sacrificing.’ A satisficing principle often happens when stakeholders have conflicting interests. Stakeholders can be anyone associated with the firm including consumers, employees, shareholders, trade unions, or the government.

Each stakeholder may have a different motive for running the business, resulting in not having profit maximisation as their main objective.

Workers may be unhappy if they are underpaid due to cost-cutting and would want firms to pay them better sacrificing the profit margin. Similarly, the government may also want a firm to reduce its profit margin and pass the benefits to the consumer who might be overcharged.

Survival

Survival is another objective some firms might pursue in the short run. Some firms decide to survive to capture market share and gain consumers’ loyalty over profits or sales. In fact, in some cases, the firm may also experience losses. However, if they can survive in the short run, they would be able to sustain and reverse the losses in the long run.

Corporate social responsibility

Corporate social responsibility has been gaining importance recently. More firms are aiming to be socially responsible to gain more customers’ trust and to be environmentally friendly. This allows them to be within the rules and regulations of the government.

Increasing market share

The firm may want to increase its market share, which will help it expand and result in a better position in the market over its competitors. Also, some firm managers like to manage big companies and create more opportunities for employees.

Effects of divorce of ownership from control on firms’ objectives

In many companies, the owners are different from those who manage the business. The owners don’t control the company. This isn’t usually the case in small companies. In larger companies, the owners are the shareholders while those who manage the company are the directors. The owners’ objectives may be different from the directors’ objectives.

This is known as a divorce of ownership from control or the principal-agent problem. The principals are the owners and the agents acting on behalf of the owners are the managers.

The managers who control the company know the day in and day out of the business and may have objectives of revenue maximisation, such as giving their employees better perks, good health benefits, bonuses, etc.

On the other hand, the owners or shareholders may have an objective of profit maximisation so they can get better returns and the value of their shares increases.

Objectives of Firms - Key takeaways

  • Firms are legally recognised bodies that work to provide goods and/or services to their consumers, government bodies, and other businesses.
  • In economics, profit refers to the returns over and above the opportunity cost. It is also referred to as the pure profits.
  • The main objective of most firms is profit maximisation. They can use it for re-investments, giving better dividends, rewards for entrepreneurship, etc.
  • Profit maximisation occurs when marginal cost is equal to the marginal revenue.
  • The objective of sales maximisation is achieved when the average cost is equal to the average revenue which is also breakeven.
  • Revenue maximisation occurs when marginal revenue is equal to zero.
  • The satisficing principle refers to sacrificing profits to satisfy as many key stakeholders as possible.
  • The divorce of ownership from control is also called the Principal-Agent problem.

Sources

1. Dominick Salvatore, Managerial Economics in a Global Economy, 2010.

Frequently Asked Questions about Objectives of Firms

Every firm may have different objectives according to which it behaves in the market structure.

The four main objectives of a business are:

  1. Profit maximisation

  2. Sales maximisation

  3. Revenue maximisation

  4. Surviving in the market

In conventional theory, profit maximisation is the main objective of firms. However, many firms may have other objectives like sales maximisation, surviving in the market, revenue maximisation, among others.

The six business objectives are: 

1. Profit maximisation

2. Sales maximisation

3. Revenue maximisation

4. Surviving in the market

5. Satisficing principle

6. Corporate social responsibility

7. Increasing market shares

Final Objectives of Firms Quiz

Question

What is a firm’s main objective?

Show answer

Answer

Profit maximisation.

Show question

Question

Who are the customers of a firm?


Show answer

Answer

Individual customers, businesses, or governments.

Show question

Question

What are the financial goals of a firm?


Show answer

Answer

Profit maximisation, market share expansion.

Show question

Question

What is a firm's profit?


Show answer

Answer

The difference between the total costs and revenues.

Show question

Question

How to maximise a firm’s profit?


Show answer

Answer

 Profit is maximised when marginal costs equal marginal revenues.

Show question

Question

What are some non-financial objectives of a firm?


Show answer

Answer

Customer satisfaction, job satisfaction, corporate social responsibility.

Show question

Question

How to improve employees’ job satisfaction?


Show answer

Answer

Activities to boost job satisfaction can be taking care of employees’ well-being, offering incentives for good performance, providing an opportunity to learn, and communicating.

Show question

Question

Why is corporate social responsibility important?


Show answer

Answer

Corporate social responsibility (CSR) includes activities taken by companies to create a positive impact on the society and environment.

Show question

Question

What is a firm?

Show answer

Answer

A firm is an organisation that combines and organises resources to produce goods and services for sale at profits.


Show question

Question

What are the types of firms?

Show answer

Answer


  1. Private sector 

    1. Proprietary firms

    2. Partnerships

    3. Companies

    4. Cooperatives

  2. Public sector 

    1. Companies

    2. Corporations

    3. Departments

     3. Joint Sector

Show question

Question

What is the profit maximsation rule?

Show answer

Answer

Profit maximisation occurs when marginal cost is equal to marginal revenue. 

Show question

Question

State few reasons why firms should go for the sales maximization?

Show answer

Answer

Few reason why firms would go for sales maximization as their objectives are as follows:

  1. Economies of scale - When the firm increases the production levels to reduce its cost of production, it helps to create economies of scale and as the output increases, firms aim for higher sales

  2. Market flooding - This is the marketing tactic a firm uses to hammer the consumer's memory with the firm's product by seeing it everywhere possible. This kind of strategy helps the firms to gain more market share and at the same time loyal customers. 

  3. Limit Pricing - Here the firm prices its product at the break-even point where the price allows it to make an only normal profit, which results in taking away the incentive for the new firms to enter into the market. 


Show question

Question

What does satisficing principle mean?

Show answer

Answer

The satisficing principle refers to sacrificing profits to satisfy as many key stakeholders as possible. The word satisficing comes from 'Satisfy' and 'Sacrificing'. A satisficing principle often happens when stakeholders have conflicting interests. 

Show question

Question

Firms can be broadly classified into three main categories:

  1. ___________
  2. ___________
  3. Joint sector  


Show answer

Answer

  1. Private sector  
  2. Public sector 

Show question

Question

All the firms may have varied objectives depending on their ___________, nature of business, competition, and other factors. 

Show answer

Answer

production capacity 

Show question

Question

A satisficing principle often happens when stakeholders have ___________

interests. 

Show answer

Answer

conflicting 

Show question

Question

Firms are aiming to be socially responsible to gain more customers’ trust and to be environmentally friendly. 

Show answer

Answer

True

Show question

Question

In many companies, the owners are different from those who manage the business. This is called ___________

Show answer

Answer

The divorce of ownership from control  

Show question

Question

The divorce of ownership from control is also called ___________

Show answer

Answer

the Principal-Agent problem. 

Show question

Question

The objective of sales maximisation is achieved when the average cost is equal to the average revenue which is also ___________. 

Show answer

Answer

breakeven 

Show question

Question

In economics, profit refers to the returns over and above the opportunity cost. It is also referred to as the ___________.

Show answer

Answer

pure profits 

Show question

Question

Firms can provide services and goods to consumers, ___________, and ___________

Show answer

Answer

government bodies, and other businesses.  

Show question

Question

The main objective of most firms is ___________

Show answer

Answer

profit maximisation 

Show question

Question

The managers may have objectives of ___________ while the owners or shareholders may have an objective of ___________. 

Show answer

Answer

revenue maximisation, profit maximisation 

Show question

60%

of the users don't pass the Objectives of Firms quiz! Will you pass the quiz?

Start Quiz

Discover the right content for your subjects

No need to cheat if you have everything you need to succeed! Packed into one app!

Study Plan

Be perfectly prepared on time with an individual plan.

Quizzes

Test your knowledge with gamified quizzes.

Flashcards

Create and find flashcards in record time.

Notes

Create beautiful notes faster than ever before.

Study Sets

Have all your study materials in one place.

Documents

Upload unlimited documents and save them online.

Study Analytics

Identify your study strength and weaknesses.

Weekly Goals

Set individual study goals and earn points reaching them.

Smart Reminders

Stop procrastinating with our study reminders.

Rewards

Earn points, unlock badges and level up while studying.

Magic Marker

Create flashcards in notes completely automatically.

Smart Formatting

Create the most beautiful study materials using our templates.

Sign up to highlight and take notes. It’s 100% free.