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Understanding why firms behave the way they do requires an examination of their objectives. Traditional economic theory assumes that firms are profit maximisers, but modern theories recognise a far wider range of objectives — particularly in firms where ownership is separated from control. This lesson examines the key business objectives and the revenue concepts that underpin them.
The traditional assumption in microeconomics is that firms aim to maximise profit. Profit is the difference between total revenue (TR) and total cost (TC):
Profit = TR − TC
A firm maximises profit at the level of output where marginal cost (MC) equals marginal revenue (MR), provided MC is rising and cuts MR from below. At any output below this point, MR > MC, so producing an extra unit adds more to revenue than to cost. Beyond this point, MC > MR, so additional units reduce total profit.
| Concept | Definition | Formula |
|---|---|---|
| Total Revenue (TR) | Total income from selling output | TR = P × Q |
| Average Revenue (AR) | Revenue per unit sold — equal to the price | AR = TR ÷ Q = P |
| Marginal Revenue (MR) | Additional revenue from selling one more unit | MR = ΔTR ÷ ΔQ |
| Total Profit | Difference between total revenue and total cost | π = TR − TC |
| Normal Profit | The minimum return to keep a firm in the industry — an economic cost | Included in TC |
| Supernormal Profit | Any profit above normal profit | TR > TC (including normal profit) |
Exam Tip: Normal profit is treated as a cost in economics — it is the opportunity cost of the entrepreneur's time and capital. When economists say a firm is making "zero economic profit", the firm is still earning enough to stay in business. Supernormal (or abnormal) profit means the firm is earning more than this minimum level.
William Baumol (1959) proposed that firms — particularly large corporations — may aim to maximise total revenue rather than profit. His argument rested on the separation of ownership and control: managers' salaries, bonuses, and prestige are often more closely linked to the size of the firm (measured by sales revenue) than to its profitability.
Revenue is maximised at the output where MR = 0. At this point, the firm is at the midpoint of a linear demand curve, and total revenue is at its highest.
| Feature | Profit Maximisation | Revenue Maximisation |
|---|---|---|
| Output rule | MC = MR | MR = 0 |
| Output level | Lower | Higher |
| Price | Higher | Lower |
| Profit | Maximum | Lower than maximum |
Baumol recognised a constraint: shareholders require a minimum acceptable level of profit. If the firm fails to deliver this, shareholders may sell their shares, depressing the share price and making the firm vulnerable to takeover. Revenue-maximising managers must therefore satisfy a profit constraint.
Exam Tip: The revenue-maximising level of output will always be greater than the profit-maximising level. This is because at MR = MC, marginal revenue is still positive (assuming MC > 0), so the firm could increase total revenue by producing more — but doing so would reduce profit.
Baumol also considered a more extreme objective: sales maximisation, where the firm aims to sell the greatest possible volume of output, subject to covering all its costs. The firm produces at the level of output where AR = AC — that is, where it earns only normal profit and no more.
Sales maximisation produces a higher output and lower price than either profit maximisation or revenue maximisation. It may be rational for firms entering new markets, where building market share is more important than short-run profitability.
Amazon famously prioritised sales growth and market share over profitability for many years. Jeff Bezos told shareholders in 1997 that the company would focus on long-term market leadership rather than short-term profits. Amazon made consistent losses until 2003 and reinvested heavily in logistics infrastructure. This strategy is consistent with Baumol's sales maximisation model — the firm accepted minimal or zero profit to maximise its market presence.
Deliveroo pursued rapid expansion across UK cities, accepting sustained losses to build market share before its IPO in 2021. The company prioritised being the dominant food delivery platform over short-run profitability — consistent with sales maximisation subject to surviving long enough to achieve market dominance.
Herbert Simon (1947, 1955) challenged the assumption that firms optimise at all. Simon argued that in the real world, decision-makers face bounded rationality — they lack perfect information, have limited cognitive capacity, and face time constraints. Rather than maximising anything, managers satisfice: they aim for a satisfactory level of performance across multiple objectives.
A satisficing firm might aim for a "good enough" profit, a reasonable market share, adequate investment in innovation, and acceptable working conditions — rather than pursuing any single objective to its maximum.
| Aspect | Maximising Firm | Satisficing Firm |
|---|---|---|
| Information | Perfect | Imperfect/bounded |
| Decision rule | Optimise one variable | Achieve acceptable levels across many |
| Behaviour | Calculated and precise | Pragmatic and adaptive |
| Realism | Low — a theoretical ideal | High — closer to real-world behaviour |
Exam Tip: Simon's satisficing model is excellent evaluation material. If the examiner asks whether firms profit-maximise, you can argue that bounded rationality means many firms cannot even identify the profit-maximising output, let alone achieve it. This demonstrates sophisticated understanding.
Oliver Williamson (1964) extended the analysis of managerial behaviour. He argued that where ownership is separated from control, managers maximise their own utility rather than the firm's profit. Managerial utility depends on:
Williamson predicted that managerial firms would have higher costs and lower profits than owner-managed firms, because managers divert resources towards their own interests.
The conflict between shareholders (principals) and managers (agents) is known as the principal-agent problem. Shareholders want profit maximisation; managers may pursue alternative objectives. Mechanisms to align interests include:
| Mechanism | How It Works |
|---|---|
| Performance-related pay | Bonuses tied to profit targets |
| Share options | Managers receive shares, aligning their interests with shareholders |
| Threat of takeover | Poor performance depresses the share price, making hostile takeover possible |
| Non-executive directors | Independent directors monitor managerial behaviour |
| Corporate governance codes | E.g., the UK Corporate Governance Code sets standards for accountability |
| Objective | Explanation | Example |
|---|---|---|
| Survival | In a recession or market downturn, the primary objective may be simply to stay in business | Many UK high-street retailers during the COVID-19 pandemic |
| Growth maximisation | The firm seeks to grow as fast as possible, measured by output, revenue, or assets (Robin Marris, 1964) | Tech start-ups that prioritise scaling rapidly |
| Corporate social responsibility (CSR) | The firm balances profit with social and environmental objectives | Unilever's Sustainable Living Plan |
| Ethical objectives | Some firms prioritise ethical conduct over profit | The Co-operative Group, Traidcraft |
Exam Tip: When evaluating business objectives, always consider the type of firm (small vs large, owner-managed vs PLC), the market structure (competitive vs monopolistic), and the time horizon (short run vs long run). The examiner wants to see that you can apply different theories to different contexts rather than making sweeping generalisations.
| Objective | Decision Rule | Key Economist | Output Relative to Profit Max |
|---|---|---|---|
| Profit maximisation | MC = MR | Traditional theory | — |
| Revenue maximisation | MR = 0 | Baumol (1959) | Higher |
| Sales maximisation | AR = AC (normal profit only) | Baumol (1959) | Highest |
| Satisficing | "Good enough" on multiple criteria | Simon (1947, 1955) | Varies |
| Managerial utility | Maximise salary, staff, perks | Williamson (1964) | Higher |
| Growth maximisation | Maximise rate of growth | Marris (1964) | Higher |
Understanding business objectives is essential for analysing how firms behave in different market structures — the topic of the remaining lessons in this course.