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There are often reports in the press that company profits have not risen as much as in previous years.

As a result the company receives adverse criticism. (a) Explain what a company might do if it wished to try to increase its profits. [13] The total profit of a firm is the difference between the total revenue and the total cost of production.Asides from bringing more revenues, firms can further increase its profits by reducing costs. There are several ways of reducing costs and one of them is by exploiting economies of scale. Economies of scale (EoS) are the cost advantages exploited by expanding the scale of production in the long run. A firm experiences EoS if cost per unit of output falls as scale of production increases..In effect, this reduces the total cost of production, thus increasing the companys profits. One of the effects of economies of scale is seen in the specialisation of labour, which is a managerial economies of scale. For example, a larger firm is able to employ specialists to supervise production systems. And better management will increase investment in human resources and better use of equipment, such as networked computers can improve communication, raise productivity and hence reduce unit costs. Although, this method of increasing profit assumes that the increase in supply will be met by an increase in demand, thus allowing increasing output without risking a fall in price due to a surplus in supply. Besides that, if the firm possesses sufficient reserves, it can engage in research and development (R&D)which in the long run, can bring in many benefits to the firm, most significantly reducingthe costs of production. R&D allows lower cost production processes to be discovered, which provides firms with the ability to increase its profit margin with the same selling price, or to increase its total revenue by reducing price in a market with elastic demand. For a firm to reduce cost in the short run, it is only possible for them to reduce variable cost as variable cost is a cost that varies with output. Wage can be classified as a variable cost. A firm can negotiate with the trade union to lower the wage rate or increase redundancies as part of the cost reduction measure.If lower profits are caused an economic slowdown, the company may opt to temporarily lay off workers until demand levels increase. Firms can also increase profit by increasing their total revenue. There are 3 main ways by which they can do this, increasing their market share, manipulating the price elasticity of demand and price discrimination. The first includes trying to become a price setter in the long run. It would do this in a number of ways, most notably predatory pricing. Predatory pricing is when a firm attempts to increase its market share by selling at artificially low prices, in order to put other firms out of business. Although this would cause the firm to experience reduced profits in the short run, in the long run the firm may hold enough of the market share to be a price setter, this would allow them to increase the market price of a good, which would result in a more than proportionate increase in revenue should demand be inelastic, and thus make large profits. However, only firms which already have a large portion of the market share would be able to do this. As, small firms are more likely to experience the short run shut down condition than big firms, and thus make them incapable of predatory pricing. I.e., when revenue doesnt cover the variable costs. This power of price setter would also allow firms to manipulate elasticity of demand. Increasing a firms market share is an important measure to decrease a firms elasticity of demand. When there are a few firms in the market, once a firm has a large enough market share, consumers may not have many rival firms/products to choose from. Thus, due to this lack of substitutes, consumers would be unresponsive to a change in price, i.e. the producer now is the price setter and the consumer becomes the price taker. Another important factor that would affect elasticity of demand is consumer loyalty. This is an inverse relationship, the higher a consumers loyalty to a brand, the lower the price elasticity of demand. The most effective way to increase consumer loyalty

is by advertising. Eg, in 2012 Pepsi is expected to spend in access of 1 billion us dollars on advertising. If elasticity of demand becomes inelastic, then firms can increase price and receive a more than proportionate increase in revenue. Thus, by increasing revenue the firm would have increased its profit margin. The last way, is through price discrimination. Price discrimination occurs when a firm charges different prices for identical goods, when there are no differences in the cost of supplying the goods. This can usually only occur in imperfect markets, where certain conditions are satisfied. Firstly, the firm must have certain degree of monopoly power, There must also be different elasticities of demand for different consumer markets. Arbitrage, or the ability to buy cheaply from one market and resell at a profit in another market, can be prevented at relatively low cost.By price discriminating, rather than having a common pricing policy for the good in all markets, the firm charges according to the price elasticity of demand for the respective markets. This transfers existing consumer surpluses into producers surplus, allowing the firm to further increase its total revenue.

In a perfect competition, all firms will make normal profit in the long run as the ability of the firm to increase profits is constrained by market competition and the lack of monopoly power. However, a firm operating in an imperfect market can only continue to reap high profits by ensuring its monopoly power. b) Discuss what alternative objectives a company might have apart from profit maximisation (12m) Traditional economic theory suggests that a firms main aim is to maximise profits. Firms can achieve that aim by producing at a level of output where the difference between total revenue and total cost is maximised, or where marginal revenue is equal to marginal cost. However, firms may choose instead to pursue other objectives. This includes sales revenue maximisation, growth maximisation, average cost (AC) pricing, marginal cost (MC) pricing, or limit pricing. Revenue/ Cost



Q1Q2 Q3

AR Output

Figure Firms may choose to maximise sales revenues over profits. To do so, the firm will produce at the output where marginal revenue is zero, which is at Q1 in the above figure. In part, this will allow the firm to grow in size and increase its market share in an industry, which both will allow the firm to

attain economies of scale, and prevent takeovers by other firms. Managers of firms may also opt to maximise sales revenue if their salaries and bonuses are linked to the firms sales revenue. Another objective a firm may pursue is productive efficiency, at which the firm produces a given output at the lowest possible average cost (AC), shown as at Q2 in the figure. This occurs when the condition AC=MC is fulfilled, as the MC curve will cut the AC curve at its minimum point. Managers of the firm will pursue this objective in order to minimise average cost of production, particularly as a measure of remaining cost-competitive in the industry. The government may also direct the firm towards the objective as a means of maximising utilisation of resources. Although highly unlikely in an imperfect market, a firm may choose to aim for allocative efficiency. Allocative efficiency, or MC pricing is achieved when the condition P=MC=MU is fulfilled. This means that the price that consumers pay for the last unit of good they consume (P) is equal to the marginal utility (MU), or extra utility gained from consuming an additional unit of the good. The price charged is also equal to the marginal cost of producing the last unit of good. As illustrated in the above figure, the firm will produce at the output Q3 where the price charged is P. Usually, nationalised firms will opt for allocative efficiency, where resources have been allocated optimally, in line with the government policy of maximising welfare. Besides the above mentioned objectives, a firm can also choose to maximise growth instead of profits. The objective is to increase the size of the company in the long run, which is measured in terms of number of capital or workers employed. Having a larger firm not only increases the companys pool of resources, it also increases promotion prospects for managers. A firm may also implement limit pricing objectives in the short run rather than to maximise profits. This is achieved by setting a low price, coupled together with high output, so as to make it difficult for new entrants to make profit. As explained in part (a), this will allow the firm to increase its monopoly power in the long run, thus allowing it to make larger potential profits. Firms will usually pursue a number of aims at the same time. Particularly in large companies, where there is a clear distinction between ownership and control, it is not unusual for there to be compromise between the different objectives.