Economic agents and what they are trying to achieve

Overview

Why profit maximisation is the standard assumption about firms, three objectives a firm might pursue other than maximum profit and four objectives a government typically pursues in managing an economy.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   Who are the main economic agents, and what is each usually assumed to be maximising?

   Model answer

   The main agents are consumers, producers, workers and government. Consumers are assumed to maximise utility from a limited income, producers to maximise profit, workers to maximise the net advantages of work including pay and conditions, and government to maximise social welfare. These are simplifying assumptions rather than descriptions of every decision each agent makes.

2. 2

   What does it mean to say a consumer maximises utility subject to a budget constraint?

   Model answer

   Utility is the satisfaction gained from consuming goods and services. A consumer wants as much satisfaction as possible but can only spend what income and borrowing allow, so the choice is about which combination of goods within that limit yields the greatest satisfaction. The budget constraint is what turns unlimited wants into a genuine choice.

3. 3

   Explain why profit maximisation is the standard assumption about firms.

   Model answer

   Profit is the reward to the owners of a firm, and in competitive markets a firm that persistently fails to earn a competitive return will lose investors or be driven out. Assuming profit maximisation also gives a clear, single-valued objective that predicts behaviour: the firm expands output as long as an extra unit adds more to revenue than to cost.

4. 4

   Give three objectives a firm might pursue other than maximum profit, and explain why each might be chosen.

   Model answer

   A firm may pursue revenue or sales maximisation because managers' pay and status often depend on the size of the business rather than its profit. It may pursue growth or market share, accepting thin margins now to secure a dominant position later. It may pursue survival, especially when new or in a downturn, doing whatever keeps cash flowing rather than what maximises returns.

5. 5

   What is satisficing, and why might a firm satisfice rather than maximise?

   Model answer

   Satisficing means aiming for an outcome that is good enough to keep the various stakeholders content rather than the best possible on any one measure. A firm may satisfice because its managers must balance shareholders wanting dividends, workers wanting pay, customers wanting low prices and regulators wanting compliance, and because they lack the information needed to identify the true maximum in any case.

6. 6

   Explain the principal-agent problem in a large company and one consequence of it.

   Model answer

   The owners of a large company are the shareholders, but the day-to-day decisions are taken by managers who act as their agents. The two groups have different interests and the owners cannot observe everything the managers do, so managers may pursue larger budgets, prestige projects or an easier life rather than maximum profit. One consequence is that firms may grow beyond the size that would give owners the greatest return.

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