Differing Objectives and Policies of Firms: four questions to try now
Real past-paper questions, the answer key from the mark scheme, and the explanation that goes with it. No account needed to answer them.
Question 1
A firm abandons its policy of horizontal expansion and switches to a policy of backward vertical growth.
What does this suggest is most likely about the firm’s objectives?
Answer: D.
Backward vertical growth means acquiring the firms that SUPPLY the business, which secures its inputs and protects it against disruption or price rises by suppliers. Horizontal expansion, the policy being abandoned, means acquiring rivals at the same stage of production, which is a way of buying MARKET SHARE. The switch therefore signals a change of priority from market share towards security of supply, which is D. A contrasts revenue maximisation with cost minimisation, and neither type of merger is chosen on that basis. B contrasts sales maximisation with satisficing, and again neither growth strategy tells you which of those the firm now pursues. C names security of SALES, which would point towards buying distributors or retailers, and that is FORWARD vertical growth, the opposite direction of travel from the one the question describes.
Question 2
A firm that raises capital through a share issue has to satisfy both shareholders' expectations and management aims. The management aims to produce at a non-profit maximum output.
Which strategy would necessarily prevent this aim?
Answer: A.
The correct answer is A: fixing output where MC = MR in the long run.
MC = MR is the profit-maximising condition. If the firm sets output at that point, it is by definition maximising profit, so a management aim of producing at a non-profit-maximising output is defeated. The word "necessarily" is satisfied: this is not a policy that might frustrate the aim depending on circumstances, but one that logically contradicts it.
Why the other options are wrong:
MC = MR is the profit-maximising condition. If the firm sets output at that point, it is by definition maximising profit, so a management aim of producing at a non-profit-maximising output is defeated. The word "necessarily" is satisfied: this is not a policy that might frustrate the aim depending on circumstances, but one that logically contradicts it.
Why the other options are wrong:
- B, price discrimination to maximise revenue, is not the same as maximising profit. Revenue maximisation occurs where MR = 0, at a higher output and lower price than profit maximisation, so it is itself a non-profit-maximising objective, consistent with management's aim rather than preventing it.
- C, rewarding shareholders more than returns to innovation, is a decision about how surplus is distributed, not about what output to produce. It could occur at any output level.
- D, separating ownership and control, is the very condition that allows management to pursue non-profit-maximising aims. It is the source of the principal–agent problem, not a solution to it, so far from preventing the aim it makes it possible.
Question 3
What is the main aim of cost-benefit analysis?
Answer: D.
Cost-benefit analysis values ALL the costs and benefits of a project, including those falling on third parties, and then asks whether it is worth doing and which version is worth doing most. The aim is the largest net gain, the biggest positive difference between total benefit and total cost, which is D. B describes the point at which the net gain has been driven to ZERO, which is where you would stop expanding a project, not the objective of the exercise. A misstates whose interests are being weighed: cost-benefit analysis takes society's view, not the firm's, and it does not exist to help firms shift costs onto others. C confuses the analysis with one policy that might follow from it, a tax is one way to internalise an external cost, but calculating the tax is not what cost-benefit analysis sets out to do.
Question 4
A government regards fresh fruit and vegetables as merit goods, and subsidises agriculture to boost their production.
What could be a government failure arising from these subsidies?
Answer: B.
Government failure means an intervention producing a harm that was not intended and was not part of the problem it set out to solve. Subsidising agriculture to raise the output of fruit and vegetables makes farming more profitable at the margin, and one response is to bring more land into cultivation, so hedgerows and habitat are cleared and wildlife is lost. That cost falls on people who were never party to the subsidy, it was no part of the policy's purpose, and it may outweigh the gain, which is exactly what government failure describes. The other three options are the policy working. Cheaper fresh fruit and vegetables is the immediate intended effect, since a subsidy shifts supply outwards and lowers price. Lower spending on treating dietary illnesses is the ultimate objective, the reason the goods were called merit goods in the first place. More jobs picking fruit and vegetables is a further benefit rather than a cost, and reading any consequence a government did not announce as a failure is the mistake being tested.
What this practice covers
These questions are drawn from past CIE 9708 papers. You answer, you find out immediately whether you were right, and you get the reasoning for the correct option and for each distractor. Wrong answers go to a mistakes locker so you can come back to exactly those.
Practice is free. You need an account only so your progress and your mistakes are still there next time.
What examiners see students get wrong here
These are the errors that cost marks on differing objectives and policies of firms, taken from our own topic notes. Read them before you practise and you will recognise the traps in the questions.
- Applying MC = MR to a firm that is not maximising profit.
- Confusing revenue maximisation (MR = 0) with sales maximisation (AR = AC).
- Explaining the principal-agent problem as managerial dishonesty rather than divergent objectives under asymmetric information.
- Calling any price difference price discrimination, when a cost difference makes it something else.
- Forgetting that preventing resale is a necessary condition.
- Stating that price discrimination always harms consumers, ignoring the output effect.
- Confusing limit pricing with predatory pricing. Limit pricing is above cost and aimed at entrants; predatory pricing is below cost and aimed at existing rivals.
- Drawing the kinked demand curve without the discontinuity in marginal revenue, which is the whole point of the model.
Revise it first
If any of the above is unfamiliar, work through the notes before practising: Differing Objectives and Policies of Firms revision notes.