Business Objectives

Profit maximisation

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Profit is maximised where MC = MR, with MC rising through MR.

The reasoning is marginal, and stating it earns the marks rather than the rule alone:

While MR > MC, the next unit adds more to revenue than to cost, so producing it raises profit. While MR < MC, the next unit adds more to cost than to revenue, so producing it destroys profit. Profit is therefore greatest at the output where they are equal.

The second-order condition matters: MC must cut MR from below. Where MC is falling through MR the firm is at a profit minimum, which is a point Edexcel occasionally probes.

Why firms pursue it: it maximises shareholder returns and dividends; it generates retained profit, the main source of investment finance; and it is the assumption underpinning the whole of standard microeconomic theory.

Why firms may not profit maximise

The explanation is the divorce of ownership from control (3.1). Shareholders own but managers control, and because of asymmetric information shareholders cannot fully observe managerial behaviour, the principal–agent problem. Managers' pay and prestige track firm size more closely than profitability.

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There are practical reasons too: firms rarely know their MR and MC curves with any precision, so in practice many use cost-plus pricing and approximate.

Alternative objectives

The ordering is the examinable insight. For a firm with market power, moving down that list means:

Output is lowest under profit maximisation, higher under revenue maximisation, and highest under sales maximisation, while price moves the opposite way.

So consumers benefit when firms depart from profit maximisation. That is a strong evaluation point and reverses the intuition that profit maximisation is what firms "should" do from a welfare perspective.

Revenue maximisation and elasticity. At MR = 0 total revenue is at its maximum and demand is unit elastic. Note that a profit maximiser never operates where demand is inelastic: it could raise price, sell less, earn more revenue and incur lower costs simultaneously.

Satisficing comes from Herbert Simon's bounded rationality, managers lack the information and time to optimise, so they aim for an acceptable outcome that keeps shareholders, workers, customers and regulators sufficiently content. It is arguably the most realistic description of how large firms actually behave.

Working the numbers

Different objectives produce different output and price from identical cost and demand conditions, and the figures make the divergence concrete.

A firm faces demand P = 100 − 2Q with constant MC = 20 and ATC = 30 at the relevant range.

Profit maximisation, MC = MR:

TR = 100Q − 2Q², so MR = 100 − 4Q
100 − 4Q = 20 → Q = 20, and P = 100 − 2(20) = £60
Profit = (£60 − £30) × 20 = £600

Revenue maximisation, MR = 0:

100 − 4Q = 0 → Q = 25, and P = 100 − 2(25) = £50
Revenue = £50 × 25 = £1,250, against £60 × 20 = £1,200 under profit maximisation
Profit = (£50 − £30) × 25 = £500

Compare the two. Revenue maximisation gives higher output, a lower price, more revenue and less profit. So consumers gain and shareholders lose, which is exactly the tension the divorce of ownership from control creates, since managers' pay and status track size rather than profit.

Sales maximisation goes further still, to the largest output consistent with normal profit, where AR = ATC:

100 − 2Q = 30 → Q = 35, and P = £30

The ordering is worth remembering because it is the answer to most evaluation questions here: output rises and price falls as the objective moves from profit → revenue → sales, and profit falls the whole way. The evaluative twist is that lower profit means lower retained earnings, the main source of investment finance, so the consumers who gain today may lose through weaker innovation tomorrow.

Worked example

A monopolist's managers switch from profit maximisation to revenue maximisation.

Profit maximisation sets output where MC = MR. Revenue maximisation sets output where MR = 0, which lies further right → output rises and, reading up to the AR curve, price falls.

Consequences:

• Consumers gain: lower price, higher output, greater consumer surplus, and allocative efficiency improves as price moves closer to marginal cost.
• Shareholders lose: profit is no longer maximised, so dividends and the share price fall.
• The firm now operates where demand is unit elastic; a further price cut would reduce revenue.
• Higher output may deliver economies of scale, lowering average cost and partly offsetting the lost margin.

Evaluation.

• The switch depends on the divorce of ownership from control. Shareholders can close the gap with performance-related pay or share options, realigning managerial incentives with profit.
• Lower profit means lower retained earnings, the main source of investment finance, so long-run innovation and capacity may suffer, harming the very consumers who gained in the short run. This is the strongest counter-argument available.
• Firms rarely know MR and MC precisely, so in practice they satisfice using cost-plus pricing rather than applying any exact rule.
• Sustained supernormal profit is what attracts entry. A firm holding profit down may be pursuing entry deterrence rather than managerial self-interest, in which case its long-run profit is higher, not lower.

Judgement: revenue maximisation raises short-run consumer welfare relative to profit maximisation, but the long-run effect depends on whether the forgone profit would have funded investment. Where the market is contestable, the behaviour may be strategic rather than a genuine departure from profit maximisation at all.

Common exam mistakes

• Stating MC = MR without the marginal reasoning behind it.
• Forgetting that MC must be rising through MR.
• Confusing revenue maximisation (MR = 0) with sales maximisation (AR = AC).
• Saying sales maximisation means "selling as much as possible"; it is the maximum output consistent with normal profit.
• Treating normal profit as zero profit. It is zero economic profit, and it is counted as a cost.
• Discussing alternative objectives without explaining the principal–agent cause.
• Ignoring the consumer welfare implication, which is where the evaluation marks sit.

Exam technique

Draw one diagram and mark all the objectives on it, MC = MR, MR = 0, and AR = AC, then read price and output off each. That single diagram answers most questions in this section and shows the comparison at a glance.

When asked why a firm might not profit maximise, name the divorce of ownership from control and the principal–agent problem explicitly; describing managerial self-interest without naming the mechanism scores lower.

For evaluation, compare objectives on price, output, consumer surplus and long-run investment, and note that firms rarely have the information to apply any rule precisely.

Quick revision

• Profit maximisation: MC = MR, MC rising. Marginal reasoning earns the marks.
• Revenue maximisation: MR = 0, where TR is at a maximum and demand is unit elastic.
• Sales maximisation: AR = AC, the largest output giving normal profit.
• Satisficing: a good-enough outcome, from bounded rationality.
• Alternative objectives arise from the divorce of ownership from control and asymmetric information.
• Moving away from profit maximisation means lower price and higher output, consumers gain.
• But lower profit means lower retained earnings, so long-run investment may suffer.
• Remedies: performance-related pay and share options.

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