The most common motive of firms is profit maximisation. Profit is maximised where the difference between total revenue and total costs is greatest (see diagram below). Where the TC and TR curves first meet, normal profit is being made. As the firm produces more from this point, total cost falls and total revenue rises. This means that more and more profit is being made with each additional unit of output. The profit maximising position is indicated by the red arrow. Beyond this point the firm is losing profit with each additional unit of output.
Profit is maximised where marginal revenue is equal to marginal cost as long as marginal cost is rising. As you can see on the below diagram, the firm is profit maximising when it produces at price Pm and quantity Qm.
Not all firms choose to profit maximise however.
Revenue Maximisation
Revenue is maximised where marginal revenue is equal to 0, therefore the firm is making as much revenue as possible. Under revenue maximisation firms are willing to sell until the last unit sold adds nothing to revenue.
The above diagram shows the difference between the profit maximising position (p1, q1) and the revenue maximising position (p2, q2) of a monopoly. Under revenue maximisation, the firm produces more output at a lower price.
Sales Maximisation
Sales maximisation occurs when a firm sells the maximum amount possible without making a loss. This is achieved when average total cost is equal to average revenue. Firms may adopt this approach to gain more market power through a larger market share.
Satisficing
Satisficing occurs due to the principal agent problem. Shareholders (principles) and managers (agents) may have different motivations when it comes to running a business. Shareholders want the maximum amount possible in terms of dividends and so often push for firms to profit maximise. Managers may want to pursue other objectives. If this is the case, managers can make sure the firm makes enough profit to satisfy shareholders, and then pursue other objectives.
Pricing strategies to gain market share
Predatory Pricing - pricing at a level low enough to drive out firms currently in the industry by reducing their profitability. A firm must have considerable market power to employ this strategy.
Limit Pricing - deterring new entrants into an industry by pricing low enough that any price they set would be uncompetitive.
Both of these practices are anti-competitive and therefore illegal as they limit consumer choice. Although consumers benefit from low prices in the short run, in the long run it is likely the firms will become monopolys in which case they can raise the price reducing consumer surplus once more.
Firms can also employ non-pricing strategies
these strategies are often employed by firms in oligopoly as the kinked demand curve shows that price competition is not worthwhile. This is because a rise in price means that people buy from other firms, and a fall in price tends to encourage other firms to cut prices aswell leading to little overall gain. Examples of non-pricing policies are:
- Customer service
- Advertising
- Branding
- Packaging
- Product Placement
Penetration...skimming...?
ReplyDeleteWhat if the firm is:
a. government owned
b. in the third sector
c. a sole trader
d. as social enterprise?
yes - sorry, i left out quite a few pricing policies. There's also price discrimination (charging different prices to different consumers based on elasticity of demand), which i meant to write about.
ReplyDeleteThese are guesses:
a. If the firm is government owned (I may be wrong) but there are no shareholders in the business, so there is no pressure on managers to pursue high profits. These firms are usually provided to aid the public e.g. the NHS and so would focus more heavily upon non pricing policies like customer service. A government business is not often competitive with other firms so doesnt need to use competitive methods described above.
b. a charity is a non profit organisation - any profit made must used for the charities own purposes. for this reason the firm would not profit maximise, however i would have thought that they would want as much financial surplus as possible to pass on to the cause they are helping. I do not know what their motivations would be except to be a public benefit.
c. a sole trader would be driven by profit as they get to keep any profit made - it is not passed on to shareholders. They may act cautiously however as any losses incurred by the firm must also be paid by them alone.
d. as far as i can tell there are two kinds of social enterprise: in a traditional social enterprise, 'capital hires labour' with the overriding emphasis on making a profit over and above any benefit either to the business itself or the workforce. Contrasted to this is the social enterprise where labour hires capital with the emphasis on social, environmental and financial benefit.