AQA A-Level Economics – Objectives of
Firms (15 Mark Essays)
1. Divorce of Ownership from Control (2021)
Divorce of ownership refers to the separation between shareholders (owners) and
managers (controllers), leading to a principal-agent problem where managers may pursue
their own objectives rather than profit maximisation.
Firstly, shareholders typically aim to maximise profit, achieved where MR = MC. However,
managers may pursue revenue maximisation (MR = 0) as their pay and bonuses are often
linked to sales growth. This can lead to higher output and lower prices, reducing profit
margins and potentially harming long-run investment and efficiency. For example, Disney’s
CEO compensation rose significantly due to revenue growth strategies.
Secondly, conflicts arise between directors and employees. Directors may pursue empire
building to enhance prestige, while employees may prioritise job security and higher wages.
These conflicting incentives can lead to X-inefficiency, increasing costs and reducing
productive efficiency. For instance, poor managerial decisions in firms like Boeing have
been linked to cost-cutting at the expense of long-term performance.
Finally, shareholders often take a long-term view, while managers may focus on short-term
gains to maximise bonuses. This can lead to risky decisions or profit satisficing, where
managers achieve just enough profit to satisfy shareholders while prioritising personal
benefits. Such behaviour may damage long-term firm performance and shareholder value.
2. Shutdown Decisions (Short Run vs Long Run)
A profit-maximising firm produces where MR = MC. However, whether it continues
operating depends on its ability to cover costs.
In the short run, firms consider whether they can cover variable costs. If price (AR) is
greater than average variable cost (AVC), the firm continues producing to contribute
towards fixed costs. If AR < AVC, the firm shuts down as losses exceed fixed costs.
In the long run, firms must cover total costs (AC). If AR < AC, firms make losses and will exit
the market. Only firms making normal or supernormal profit will remain.
Non-price factors also influence decisions, such as expectations of future demand,
confidence, and sunk costs. Firms may continue operating in the short run despite losses if
they expect future profitability.
Firms (15 Mark Essays)
1. Divorce of Ownership from Control (2021)
Divorce of ownership refers to the separation between shareholders (owners) and
managers (controllers), leading to a principal-agent problem where managers may pursue
their own objectives rather than profit maximisation.
Firstly, shareholders typically aim to maximise profit, achieved where MR = MC. However,
managers may pursue revenue maximisation (MR = 0) as their pay and bonuses are often
linked to sales growth. This can lead to higher output and lower prices, reducing profit
margins and potentially harming long-run investment and efficiency. For example, Disney’s
CEO compensation rose significantly due to revenue growth strategies.
Secondly, conflicts arise between directors and employees. Directors may pursue empire
building to enhance prestige, while employees may prioritise job security and higher wages.
These conflicting incentives can lead to X-inefficiency, increasing costs and reducing
productive efficiency. For instance, poor managerial decisions in firms like Boeing have
been linked to cost-cutting at the expense of long-term performance.
Finally, shareholders often take a long-term view, while managers may focus on short-term
gains to maximise bonuses. This can lead to risky decisions or profit satisficing, where
managers achieve just enough profit to satisfy shareholders while prioritising personal
benefits. Such behaviour may damage long-term firm performance and shareholder value.
2. Shutdown Decisions (Short Run vs Long Run)
A profit-maximising firm produces where MR = MC. However, whether it continues
operating depends on its ability to cover costs.
In the short run, firms consider whether they can cover variable costs. If price (AR) is
greater than average variable cost (AVC), the firm continues producing to contribute
towards fixed costs. If AR < AVC, the firm shuts down as losses exceed fixed costs.
In the long run, firms must cover total costs (AC). If AR < AC, firms make losses and will exit
the market. Only firms making normal or supernormal profit will remain.
Non-price factors also influence decisions, such as expectations of future demand,
confidence, and sunk costs. Firms may continue operating in the short run despite losses if
they expect future profitability.
