7.8 Differing objectives and policies of firms

Profit is maximised at the output where marginal revenue equals marginal cost, MR=MC, provided marginal cost is rising through the intersection and the firm covers the relevant avoidable cost in the short run.

If MR exceeds MC, one more unit adds to profit; if MC exceeds MR, reducing output raises profit. The firm then reads price or average revenue from its demand conditions and compares total revenue with total cost.

At 100 units MR=$12 and MC=$9, expanding is profitable at the margin. At 105 units MR=$10 and MC=$10, the firm stops if MC is rising beyond the intersection.

MR=MC identifies the best output, not automatically a positive profit; a firm may still minimise loss or shut down if revenue cannot cover avoidable cost.

A firm’s objective is the outcome its decision-makers try to maximise. Possible objectives include profit, sales revenue, growth, market share, survival, satisficing or social and environmental goals.

The objective depends on ownership, competition, finance, managers’ incentives and time horizon. A firm may accept lower current profit to build a customer base or protect liquidity.

A new platform may price low to gain users and network effects, while a family firm may prefer stable income and control rather than maximum sales.

“The firm” is not a single mind: objectives can conflict between owners, managers, workers and communities, and a stated mission does not prove the actual objective.

Price discrimination occurs when a seller charges different prices to different customers for the same product or service, not because the cost of supplying them differs, and prevents effective resale.

The firm needs market power and information or a way to segment customers. It usually charges a higher price to a group with less elastic demand and may use the extra revenue to expand output.

Peak and off-peak rail fares can separate commuters from flexible travellers when tickets are not freely transferable. The price gap reflects demand conditions, not necessarily different train costs.

Different prices are not automatically price discrimination: cost differences, quality differences or competitive discounts can explain them without the required market conditions.

A pricing policy is a rule for setting prices, such as cost-plus, penetration, price skimming, limit pricing, predatory pricing, psychological pricing or dynamic pricing.

The suitable policy depends on demand elasticity, costs, product life cycle, competition, capacity, legal constraints and the objective. A low introductory price may build volume, while a high launch price may recover R&D from customers with high willingness to pay.

A new technology with strong early demand may use skimming before competitors enter; a supermarket with a low-margin strategy may use penetration to build regular traffic.

A named policy does not predict success by itself; explain the mechanism and the condition that makes the price credible.

Price elasticity of demand measures the percentage change in quantity demanded divided by the percentage change in price. If demand is elastic, a price cut raises total revenue; if demand is inelastic, a price cut lowers total revenue; unit elasticity leaves revenue unchanged at the margin.

Total revenue is price times quantity. The relationship is local and depends on where the firm is on its demand curve, so do not infer it from the sign alone.

If a 10% price cut increases quantity by 20%, demand is elastic and revenue changes approximately from P×Q to 0.9P×1.2Q=1.08PQ, an 8% rise.

The negative sign in PED indicates the inverse relationship; elasticity classification uses the absolute value, and “inelastic” does not mean quantity never changes.