Microeconomics Notes Profit and Goals of Firms

University:
Minnesota State University Moorhead
Course:
ECON-202 | Principles of Economics I: Micro
Academic year:

2020
Views:

81

Pages:

3
Author:

Braiden Lam

Profit and Goals of Firms: Economic Profit: Total Revenue (TR) – Economic Costs (explicit + implicit costs). Economic profit may be positive, zero, or negative. Abnormal Profit: Positive economic profit, arising when total revenue is greater than economic costs. It is profit over and above normal profit. Normal Profit: Zero economic profit arises when total revenue equals economic costs. Occurs when a firm is earning the minimum revenue required to keep running. Loss: Negative economic profit, arising when total revenue is less than economic costs. The importance of normal profit: Normal profit: Arising when economic profit is zero is the revenue required by a firm to keep in business. The firm that earns zero economic profit will not shut down because its revenue is sufficient to cover all of its costs, including its implicit costs, which cover payment for the entrepreneurship used in the firm, as well as the opportunity costs of all other self-owned factors of production. Profit Maximization as a goal of firms: Standard economic theory assumes that firms are driven by their goal to maximize profit, where profit is interpreted to mean economic profit. Profit x=maximization occurs at the level of output where MC = MR. Also occurs at the level of output where TR-TC is greatest. Understanding why MR= MC gives rise to maximum profit: In the diagrams above, if QMC and the extra revenue of producing one more unit of the good is greater than the cost of producing that same unit; therefore, it is worthwhile for the firm to produce more. If Q>Q*, then MC>MR and the extra cost of producing one more unit of the good is greater than the extra revenue gained for producing the same unit, the form should produce less. At A*, where MR=MC, the firm can't change its output level to improve its position; therefore, profit is maximized. Alternative goals of firms: Growth maximization: Firms may be interested in maximizing growth (in the quantity of output produced) rather than profits (i.e., giving up some profit for more growth). Advantages of greater growth include greater economies of scale, lower average costs, greater diversification into other products, greater market power (ability to influence price), and lower risk of takeovers by other firms. Managerial Utility Maximization: Large firms run by managers who are not owners may try to maximize their potential utility (satisfaction) by giving themselves larger benefits, such as higher salaries, use of luxurious company cars, and expensive accounts, all of which may work to reduce profits. Satisficing: This is an alternative to maximizing behavior. Firms have many different goals, some of which may conflict, and they may not want to maximize anything (profit, revenue, growth, managerial utility) that could require a significant sacrifice of something else. They may prefer a strategy that compromises among different objectives and achieves a satisfactory outcome with respect to all the important goals. Revenue maximization: Firms may be interested in maximizing revenues instead of profits for several reasons, such as the impression of success with large sales and the relative ease with which revenues can be measured (as compared with profits). TR is maximum when MR = 0. This leads to a higher Q and a lower P than in the case of profit maximization. Corporate social responsibility involves avoiding activities that may lead to negative production externalities (such as pollution or environmental degradation) or other undesirable activities (such as using child labor or hazardous working conditions), all of which may create a negative image with consumers. Such firm behavior is encouraged by consumers who prefer to buy goods and services from socially responsible firms.