Differing Objectives And Policies of Firms (Copy)
7.8.1 Traditional Profit-Maximising Objective of Firms
- Firms aim to maximize profit by choosing output where Marginal Revenue (MR) = Marginal Cost (MC).
- Profit = Total Revenue – Total Cost.
- Profit maximization assumes rational behaviour and full information.
- Output and price determined to maximise difference between TR and TC.
7.8.2 Other Objectives of Firms
| Objective | Explanation |
|---|---|
| Survival | Firms aim to cover costs and continue operating, especially in tough markets or early stages. |
| Profit Satisficing | Achieving satisfactory profits rather than maximum, balancing other objectives (e.g., manager benefits). |
| Sales Maximisation | Increasing sales volume or market share, possibly sacrificing short-term profits. |
| Revenue Maximisation | Focus on maximising total revenue, sometimes ignoring profit maximisation. |
- Firms may choose different objectives due to market conditions, management incentives, or strategic reasons.
7.8.3 Price Discrimination
- Charging different prices for the same product based on consumer segments or purchase quantities.
Types:
- First Degree (Perfect Price Discrimination):
- Charging each consumer their maximum willingness to pay.
- Requires perfect knowledge of consumer preferences.
- Second Degree:
- Price varies according to quantity bought or version of product.
- Examples: bulk discounts, versioning.
- Third Degree:
- Different prices for different consumer groups or regions based on elasticity of demand.
- Example: student discounts, geographic pricing.
Conditions for Effective Price Discrimination:
- Market power to set prices.
- Ability to segment markets and prevent resale between segments.
- Different price elasticities of demand in segments.
Consequences:
- Increased producer surplus (profits).
- Consumer surplus transfers to producers.
- Can increase efficiency if output expands.
- Potential equity concerns.
7.8.4 Other Pricing Policies
- Limit Pricing:
- Setting prices low to deter entry of new competitors.
- Price set below potential entrant’s average cost.
- Predatory Pricing:
- Temporarily reducing prices below cost to drive competitors out of the market.
- Followed by price increase once competition is reduced.
- Price Leadership:
- A dominant firm sets price and others follow, stabilizing prices in oligopoly.
- Types: dominant firm price leadership, barometric price leadership.
7.8.5 Relationship Between Price Elasticity of Demand and Firm’s Revenue
- Normal Downward Sloping Demand Curve:
- If demand is elastic (Ed > 1), lowering price increases total revenue.
- If demand is inelastic (Ed < 1), lowering price decreases total revenue.
- At unit elasticity (Ed = 1), total revenue is maximized.
- Kinked Demand Curve:
- Demand more elastic above current price, less elastic below.
- Explains price rigidity: firms reluctant to change prices due to asymmetric reaction by rivals.
- MR curve has a discontinuity leading to stable prices despite cost changes.
Diagrams
Diagram 1: Profit Maximization (MR=MC)
Price / Cost
↑
| MC
| /
| /
| / _____
| /
|/_____________________ MR
|
|
|
|_______________________→ Quantity
Profit maximised where MR=MC
Diagram 2: Types of Price Discrimination
| Degree | Description | Example |
|---|---|---|
| First Degree | Perfect price discrimination | Individual negotiation |
| Second Degree | Price varies with quantity | Bulk discounts |
| Third Degree | Different prices by groups | Student vs adult pricing |
Diagram 3: Revenue and Elasticity
Total Revenue
↑
| /
| /
| / Maximum Revenue at Unit Elasticity
|_______/________________→ Price
Diagram 4: Kinked Demand and MR Curves
Price
↑
| Demand
| /
| /
| /
|_____/_____________________→ Quantity
| MR Curve has gap where price changes unlikely.