OxfordAQA International AS and A-level Economics: Objectives and growth of firms (9640) – Revision Notes

Quick recall for sections 3.3.1.3 (the objectives of firms) and 3.3.1.4 (the growth of firms) of the OxfordAQA International AS and A-level Economics (9640) specification, version 1.2. This is extra International A2 content. For the full explanations, read the study guide. Then test yourself with the practice questions, tick off the checklist, visit the course hub and try a free diagnostic. All figures here are invented for revision.

Key terms

Term	Meaning
Profit maximisation	Producing where MR = MC, with MC cutting MR from below
Normal profit	The minimum return needed to keep the factors in their current use; counted as a cost
Supernormal (abnormal) profit	Profit above normal profit
Contribution	Revenue minus variable cost
Satisficing	Aiming for a satisfactory outcome, not the maximum
Divorce of ownership from control	Shareholders own the firm, but managers run it
Principal-agent problem	Agents (managers) may not act in the interests of principals (owners)
Organic growth	Growth using the firm’s own resources
Merger / takeover	Two firms combine by agreement / one gains control of another

Profit maximisation and the production decision

Method in steps

1. Find MR and MC at each output (or set them equal if you have equations).
2. Choose the highest output at which the last unit still adds at least as much to revenue as to cost.
3. Read price from the demand curve at that output, then work out TR, TC and profit.

Worked reminder (Country F, illustrative). A pickle maker faces fixed cost of £30.

Q	TR	MR	TC	MC	Profit
1	60	60	58	28	2
2	110	50	80	22	30
3	150	40	106	26	44
4	180	30	138	32	42
5	200	20	178	40	22

At Q = 3, MR 40 exceeds MC 26. At Q = 4, MR 30 is below MC 32. Profit is highest at Q = 3 (£44).

Shutdown rule

• Short run: produce if price (or revenue) covers average variable cost (or variable cost).
• Long run: produce only if price covers average total cost, which includes normal profit.

Worked reminder (Country G, illustrative). A street-food stall sells 120 portions, with fixed cost £250 and variable cost £4 per portion (£480).

Price	TR	Contribution	Profit or loss	Decision
£6.50	£780	£300	+£50	Produce
£4.80	£576	£96	−£154	Produce (shutting costs £250)
£3.20	£384	−£96	−£346	Shut down

Long-run average cost is 250 ÷ 120 + 4 = £6.08. Price must reach that for the stall to stay in business in the long run.

Other objectives

Objective	What the firm does	Typical effect
Survival	Cuts price to cover variable cost; trims costs	Low price and thin profit for a time
Growth	Reinvests, expands, accepts lower profit now	More output and a larger firm
Quality	Spends on design, service or staff	Higher cost and perhaps higher price
Sales revenue maximisation	Produces where MR = 0	Higher output, lower price and lower profit than the profit maximum
Market share	Prices low or spends on promotion	Lower margin now; may deter entry
Other aims	Ethical, environmental or employee aims; managers’ status	Costs or output chosen for non-profit reasons

At the revenue-maximising output, PED = 1 in absolute value, because MR = 0. A profit maximiser always sells where demand is elastic (MR is positive); the revenue maximiser goes further, to the point where MR = 0.

Satisficing. Using the pickle table, suppose the owner wants at least £40 profit. Q = 3 gives £44 and Q = 4 gives £42, so either meets the target. Q = 2 (£30) fails. A satisficer might pick Q = 4 for the larger share. Satisficing is realistic when information is poor, owners are content, or the firm faces little competition.

Ownership and control

Reasons for the divorce	Consequences	Ways to control managers
Growth needs outside capital	Managers may pursue sales, growth, status or security	Profit-related pay and share options
Limited liability attracts investors	Asymmetric information lets managers hide slack	Independent directors and audits
Large firms need specialist managers	Shareholders have little incentive to monitor	Shareholder votes
Share ownership is dispersed	Short-term targets may harm long-term investment	Takeover threat

Worked reminder. A manager receives 1.5% of revenue. In the pickle table, a move from Q = 3 to Q = 5 lifts the bonus from £2.25 (1.5% of 150) to £3.00 (1.5% of 200), a gain of £0.75, while profit falls from £44 to £22. Pay linked to revenue rewards the wrong thing; pay linked to profit aligns interests.

Evaluation: the problem is weaker if managers hold shares, if competition punishes slack, or if the stock market threatens takeover. It is stronger when ownership is widely spread and the firm has market power.

Government ownership and control

• Objectives can include universal service, jobs, low prices, strategic supply and correcting externalities, not only profit.
• Pricing may be set at average cost (break even) or below it with a subsidy.
• Example: average cost £5.50 at 800 units, price set at £4. Subsidy needed = (5.50 − 4.00) × 800 = £1,200.
• Benefits: lower prices, wider access, less external cost. Costs: weaker cost control, political interference, and the opportunity cost of subsidy funds.

Objectives, conduct and performance

Chain to use: objective → price and output decisions (conduct) → profit, efficiency and consumer outcomes (performance). A revenue or market-share aim implies lower prices and higher output than profit maximisation. A quality aim implies higher cost. A growth aim implies reinvestment and possibly mergers.

The growth of firms

	Organic (internal)	External
Method	Own investment, new products, new sites	Merger or takeover
Speed	Slower	Faster
Risk	Lower	Higher; culture clash, debt
Control	Kept	Shared or complicated

Reasons for growth: economies of scale, market power, risk spreading, new markets, survival, managers’ ambition.

Type	Meaning	Benefit	Cost
Horizontal	Same industry, same stage	Scale, market power	Less competition, diseconomies
Vertical backward	Buys a supplier	Secure input, cost saving	Inflexible
Vertical forward	Buys a distributor	Control of sales, margin	Needs retail skills
Conglomerate	Unrelated industries	Risk spreading	Few synergies

Worked reminders

• Merged share: 22% + 9% = 31%.
• Forward integration: a jam maker sells jars to shops for £2.40, and shops charge £3.20. The retail margin is £0.80 per jar. If running its own shops costs £0.50 per jar, net gain is £0.30 a jar, or £60,000 on 200,000 jars.
• Takeover premium: offer £4.20 against a market price of £3.50 is (4.20 − 3.50) ÷ 3.50 = 20%. For 25m shares the cost is £105m against £87.5m, so the premium is £17.5m.

Evaluation prompts

• Depends on market power: a monopoly can afford slack, a competitive firm cannot.
• Depends on the time period: low prices now may support higher profit later.
• Depends on ownership: owner-managers, listed companies and governments differ.
• For mergers: are the cost savings real, is the price paid too high, and how will regulators react?

Quick self-test

1. State the profit-maximising rule.
2. In the pickle table, at what output is profit highest?
3. A stall’s price covers variable cost but not total cost. What should it do in the short run?
4. In the stall example, what price is needed to stay in the long run?
5. Define satisficing.
6. What is the rule for maximising sales revenue, and what is PED there?
7. State two causes of the separation of ownership from day-to-day management.
8. Sales grow from £40m to £46m organically. Calculate the growth rate.
9. A furniture firm buys its timber supplier. Name the type of integration.
10. State one benefit and one cost of a conglomerate merger.

Answers

1. MR = MC, with MC cutting MR from below.
2. Q = 3 (profit £44).
3. Keep producing, because the contribution helps to pay fixed costs.
4. At least £6.08 (250 ÷ 120 + 4).
5. Aiming for a satisfactory outcome, such as a minimum profit, instead of the maximum.
6. MR = 0; PED = 1 in absolute value.
7. Any two: need for outside capital, limited liability, specialist managers, dispersed shareholders.
8. (46 − 40) ÷ 40 × 100 = 15%.
9. Vertical (backward) integration.
10. Benefit: spreads risk. Cost: few cost synergies or weaker management focus.

Where marks are usually lost

• Naming MR = MC but not showing where MC cuts MR, or giving no numbers when data is given.
• Shutting a firm down because it makes a loss, when revenue covers variable cost.
• Forgetting that normal profit is already inside costs.
• Writing a list of objectives with no link to price and output.
• Saying managers always maximise sales, with no mention of shareholder controls.
• Treating all mergers as horizontal.
• Giving benefits of integration with no costs, or no judgement at the end.
• Quoting a percentage without showing the working.

Official syllabus

OxfordAQA International AS and A-level Economics (9640), version 1.2, sections 3.3.1.3 and 3.3.1.4. First teaching September 2020, first AS exams May/June 2021, first A-level exams May/June 2022. Published by OxfordAQA.