Firms and their objectives

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  • Created by: Jade
  • Created on: 28-11-12 21:08
What is the agent-principal problem and how does it affect firms?
In companies ownership and management are separate. Shareholders (the principal) elect directors (the agent) to act on their behalf e.g. maximise shareholder value. Managers may take decisions that maximise their own objectives
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In the theory of a firm, what is the fundamental assumption?
A firm will seek to make as high a level of profit as possible - profit maximisation.
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Where does profit maximisation occur?
Where MC=MR
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Profit maximsation means that the last unit of output is exactly equal to what?
The revenue the firm receives from the customer
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If the firm produces below MC=MR, where MR>MC, how can more profit be made?
By expanding output
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If the firm produces above the profit maximsation level of output, MC>MR - the firms profit is?
Below its maximum
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Reasons why in practice firms might not operate exactly at the profit max level of output. It is difficult to identify the profit max position, why?
Since firms are unlikely to know their MC and MR. What is more likely is that they know their long-run average cost and will use this to determine prices by adding on a profit margin.
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Large profits might attract the attention of whom?
Government watchdogs, damage employee relations and attract new entrants into a market to alienate consumers.
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In transport, a particular complication is that in some markets, firms make a loss and rely upon external subsidies from central and local government in order to provide services. This is true for most TOCs as they?
Rely on an annual handout from the government in order to meet their franchise obligations.
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In local bus operation, certain routes or part routes are ?
Subsidised to ensure their continuation. If firms were working only towards profit max, these services would NOT operate.
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What is network rail and why is it different to other firms?
A track authority, any profits it generates go directly back into the organisation for use in future improvement projects.
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What is profit satisficing?
Profit satisficing is where a firm makes a reasonable level of profit that satisfies its stakeholders without maximising profit.
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State reasons for this objective
The firms managers may be unwilling to take unnecessary risks that are likely to occur with a profit max objective. A second reason - it may be consistent with keeping stakeholders satisfied.
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Explain how a firm having close business rivals might be a reason for profit satisficing?
It makes owners or managers cautious, as there is a risk of failure if an aggressive 'go for growth at all costs' policy is followed. Customers may take exception and switch to a competitor.
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How is road haulage an possible example of profit satisficing
Thousands of small firms, rising fuel costs affect all businesses, very low profit margins - survival is the main objective for many businesses in the short run.
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What is revenue maximisation?
An objective where a firm produces where marginal revenue =0.
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A firm is prepared to accept a _____ market price in order to increase its _______
Lower, market share
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Revenue maximisation can be used as predatory pricing, what is predatory pricing designed to do?
This is designed to drive rivals out of a market or prevent new firms from entering. This may be good news for customers in the short run, it is likely to be bad in the long run if the firm establishes a monopoly position and then raises prices.
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Revenue maximisation is normally a feature of ?
A growing market. Profits will still be earned if total revenue is greater than total costs. Firms may choose this obj as a way of boosting sales, especially if this helps secure cheaper loans or generate large bonuses for its managers.
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Predatory pricing was an early feature of markets after bus deregulation. Large firms used this tactic to gain?
Market share and force competitors out of business
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What is sales maximisation?
An objective that involves the maximisation of the volume of sales.
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Where does sales maximsation occur?
AC=AR
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Firms increase output up to the break even level, where total revenue just covers?
Total costs
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The only circumstance where this might be justified is where there is?
Cross subsidisation - profit from some activities is being used to support other activities that are not covering their costs.
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Why is cross subsidisation bad to the economist?
It is inefficient, since some passengers are paying higher fares than they should, while others are paying fares that are below marginal cost.
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Growth often allows benefits to enjoy the benefits of ?
Economies of scale and the competitive advantage that comes from the resultant lower unit costs, market leadership, higher profits - higher salaries - high share price for owners.
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Other cards in this set

Card 2

Front

In the theory of a firm, what is the fundamental assumption?

Back

A firm will seek to make as high a level of profit as possible - profit maximisation.

Card 3

Front

Where does profit maximisation occur?

Back

Preview of the front of card 3

Card 4

Front

Profit maximsation means that the last unit of output is exactly equal to what?

Back

Preview of the front of card 4

Card 5

Front

If the firm produces below MC=MR, where MR>MC, how can more profit be made?

Back

Preview of the front of card 5
View more cards

Comments

davidsalter

32 flash cards which give the student the chance to test their understanding of some of the key definitions required in the theory of the firm.

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