Cambridge International AS and A Level Economics: Firms' objectives and pricing (9708)

This guide covers syllabus section 7.8 (Differing objectives and policies of firms), outcomes 7.8.1 to 7.8.5, in the Cambridge International AS and A Level Economics 9708 syllabus for examination in 2026, 2027 and 2028. Topic 7 is A Level content only, so it is not examined at AS. The syllabus says A Level papers assume AS knowledge, so be ready to use elasticity, costs and revenue from earlier topics.

Every firm, market and figure below is invented for illustration. None of it is real data.

Related pages: the Cambridge A Level Economics hub, the printable checklist, the revision notes, the practice set, the price elasticity guide, the oligopoly guide and the free 10-minute diagnostics.

What this unit covers

Outcome	What you must be able to do
7.8.1	Explain the traditional profit-maximising objective
7.8.2	Explain survival, profit satisficing, sales maximisation and revenue maximisation
7.8.3	Explain first, second and third degree price discrimination: conditions and consequences
7.8.4	Explain limit pricing, predatory pricing and price leadership
7.8.5	Relate PED to revenue on a normal downward sloping and a kinked demand curve

7.8.1 Profit maximisation

The traditional assumption is that a firm wants the largest possible profit, where profit = total revenue (TR) minus total cost (TC). It reaches this at the output where marginal revenue (MR) equals marginal cost (MC), with MC cutting MR from below.

• If MR is above MC, one more unit adds more to revenue than to cost, so output should rise.
• If MR is below MC, the last unit lost money, so output should fall.

Firm X is a small bakery with demand P = 60 - 2Q and total cost TC = 180 + 12Q + Q², per week, in money units (mu).

Q	P	TR	MR	TC	MC	Profit
6	48	288	38	288	23	0
7	46	322	34	313	25	9
8	44	352	30	340	27	12
9	42	378	26	369	29	9
10	40	400	22	400	31	0

MR and MC here are the extra revenue and cost of each unit. Up to 8 units MR exceeds MC. The ninth unit has MR 26 and MC 29, so it lowers profit. Profit is highest at Q = 8, P = 44, profit 12 mu.

The algebra agrees. TR = 60Q - 2Q², so MR = 60 - 4Q. MC = 12 + 2Q. Setting MR = MC gives 48 = 6Q, so Q = 8.

Evaluation. The model assumes the firm knows its demand and costs, and that owners control the firm. Real managers often lack that information, and shareholders may not monitor them (the principal-agent problem). Profit maximisation is still a useful benchmark.

7.8.2 Other objectives

Survival. A new or struggling firm may simply aim to stay in business. In the short run it must cover its average variable cost (AVC); in the long run it must cover all costs. Survival often means cutting prices to hold customers, or cutting costs.

Profit satisficing. Managers aim for a satisfactory level of profit rather than the maximum. This can happen when ownership and control are separate: managers meet shareholders’ target and then pursue other aims, such as an easier life, status or staff goodwill. If Firm X’s target is 9 mu, it can choose Q = 7 and P = 46, which gives exactly 9 mu. That is 3 mu below the maximum. The target does not fix output: 9 units at 42 mu also earns 9 mu, so the manager has room to choose.

Sales maximisation. The firm sells as many units as possible without making a loss, so it produces where average revenue equals average cost (AR = AC). Larger sales can bring market share, economies of scale and managers’ pay linked to size.

Revenue maximisation. The firm maximises TR, which is where MR = 0. At that output PED = 1.

Check with Firm X.

Objective	Output	Price	TR	Profit
Profit maximiser	8	44	352	12
Satisficer (target 9)	7	46	322	9
Sales maximiser (no loss)	10	40	400	0
Revenue maximiser (no limit)	15	30	450	-135

At Q = 10, AR = 40 and AC = 400/10 = 40. An unconstrained revenue maximiser would go to Q = 15, but that loses 135 mu a week, so a firm with a no-loss constraint stops at 10. In this example the constraint makes revenue maximisation and sales maximisation give the same answer. With lower costs the firm could break even beyond Q = 15: the revenue maximiser would stop at 15 (MR = 0), while the sales maximiser would carry on to where AR = AC.

Both objectives give a lower price and higher output than profit maximisation, which can benefit consumers, but leave less profit for reinvestment.

7.8.3 Price discrimination

Price discrimination means charging different prices for the same good or service for reasons not related to cost.

Conditions for effective price discrimination

• The firm has some price-setting power (it is not a price taker).
• It can separate the markets or customers, so the product cannot be resold from the cheap market to the dear one (no seepage or arbitrage).
• The groups have different PEDs, so the firm gains by charging them different prices.

First degree (perfect). Each customer pays the most they are willing to pay.

Illustration. A tutor has five possible customers whose maximum payments are 52, 46, 40, 34 and 28 mu, and MC is 20 mu.

Single price	Customers	Revenue	Cost	Profit
46	2	92	40	52
40	3	120	60	60
34	4	136	80	56
28	5	140	100	40

The best single price is 40, giving profit 60 and consumer surplus (52 - 40) + (46 - 40) = 18. With first degree discrimination revenue = 52 + 46 + 40 + 34 + 28 = 200, cost = 100, profit 100, and consumer surplus is zero. The fifth customer is now served (28 > 20), so output rises from 3 to 5. Perfect discrimination is rare because the firm cannot know each customer’s maximum.

Second degree. The price depends on the quantity bought, not on who the buyer is. Examples are block tariffs, bulk discounts and peak or off-peak plans that customers choose themselves.

Illustration. A data supplier charges 4 mu per GB for the first 10 GB, 2.50 mu for the next 10 GB and 1 mu beyond 20 GB. A user taking 26 GB pays 40 + 25 + 6 = 71 mu, an average of 2.73 mu per GB. Heavy users get a lower average price, light users pay more per unit, and the firm still collects revenue from every block.

Third degree. The firm splits customers into groups with different PEDs and charges each group a separate price. It sets MR = MC in each market, charging the higher price where demand is less elastic.

Illustration. A ferry has demand P = 60 - Q from business travellers (market A) and P = 36 - 2Q from leisure travellers (market B). MC is 8 mu.

• Market A: MR = 60 - 2Q = 8, so Q = 26 and P = 34.
• Market B: MR = 36 - 4Q = 8, so Q = 7 and P = 22.
• PED at A = (1/1) × 34/26 = 1.31. PED at B = (1/2) × 22/7 = 1.57. The less elastic market pays more.
• Profit = 26 × 26 + 7 × 14 = 676 + 98 = 774 mu.

With one price for all, the firm would sell 33 units at 30 mu and earn 33 × 22 = 726 mu. Discrimination adds 48 mu.

Consequences

• Producers: higher profit, which can fund investment or cross-subsidise loss-making services.
• Consumers: some gain (low-income or price-sensitive groups may get access), others lose (the group charged more).
• Welfare: in the ferry case total output stays at 33. Consumer surplus falls from 459 to 387, profit rises by 48, so total surplus falls from 1185 to 1161. Where discrimination opens a market that would otherwise not be served, welfare can rise.
• Fairness, and the cost to the firm of separating its markets, are further points.

7.8.4 Other pricing policies

Limit pricing. An incumbent sets a price low enough to make entry unprofitable, while staying above its own cost. Illustration: demand P = 80 - Q and MC = AC = 20 for the incumbent. Monopoly price: MR = 80 - 2Q = 20, so Q = 30, P = 50, profit 900. A potential entrant has lowest AC of 35. A price just below it, 34, gives Q = 46 and profit 14 × 46 = 644. The firm gives up 256 mu of profit. If entry would push the price to 40 and cut the incumbent’s sales to 20 units, its profit would fall to 400, so deterrence pays.

Limit pricing needs the incumbent to have a cost advantage and the threat to be believable.

Predatory pricing. Pricing below cost (below AVC) to drive out rivals or stop entry, then raising prices once they have gone. Illustration: the incumbent’s AVC is 18, its rival’s 22, and the usual price 26 with sales of 200 units a month (margin 1,600 mu). The incumbent cuts to 15 and sells 280 units, a monthly margin of -840 mu. Over four months the profit given up is 4 × (1,600 + 840) = 9,760. If the rival exits and the incumbent then sells 150 units at 34, its margin is 2,400 a month, 800 more than before, so recovery takes 9,760 / 800 = 12.2 months. It only pays if barriers stop the rival returning. Competition authorities treat it as anti-competitive, and proving it is hard.

Price leadership. One firm changes its price and the others follow. A dominant firm leader is the largest. A barometric leader is the one best placed to read market conditions. Firms like the stability, but it can be tacit collusion. Followers risk losing share if a rival does not follow.

7.8.5 PED and revenue

Normal downward sloping demand. Revenue changes depend on PED.

PED	Price rise	Price fall
Elastic (above 1)	TR falls	TR rises
Unitary (1)	TR unchanged	TR unchanged
Inelastic (below 1)	TR rises	TR falls

On Firm X’s demand curve (P = 60 - 2Q, or Q = 30 - 0.5P):

P	Q	TR	PED
50	5	250	5.0
40	10	400	2.0
30	15	450	1.0
20	20	400	0.5
10	25	250	0.2

Cutting price from 40 to 30: quantity up 50%, price down 25%, PED = 2, TR rises 400 to 450. Cutting 20 to 10: quantity up 25%, price down 50%, PED = 0.5, TR falls 400 to 250. TR peaks at P = 30, where PED = 1 and MR = 0. On a straight-line demand curve the upper half is elastic and the lower half inelastic.

Kinked demand curve (oligopoly). Firms assume rivals will not follow a price rise but will follow a price cut. Demand is elastic above the current price and inelastic below it.

Illustration: price 50, output 20. Above the kink, P = 70 - Q. A rise to 55 cuts sales to 15, so TR falls from 1,000 to 825 (PED = 2.5). Below, P = 150 - 5Q. A cut to 45 raises sales only to 21, so TR falls to 945 (PED = 0.5). Either move cuts revenue, so the price stays at 50.

The MR curve has a vertical gap at Q = 20: MR is 30 on the upper section (70 - 2Q) and -50 on the lower (150 - 10Q). Any MC curve passing through this gap leaves price and output unchanged.

Limits: the theory does not explain how the price was set, and firms do sometimes change prices.

Common errors

• Using the highest-revenue output as the profit-maximising output.
• Saying sales and revenue maximisation are the same thing.
• Describing first degree discrimination as “different prices for different groups” (that is third degree).
• Giving price discrimination “conditions” without market separation.
• Saying predatory pricing is any price cut. It needs a price below cost, with the aim of recovering later.

Official syllabus

Cambridge International AS and A Level Economics (9708) syllabus for examination in 2026, 2027 and 2028, published by Cambridge University Press & Assessment, section 7.8.