EJC Econs N2022 H2 EQ1

Suggested answer for 2022 A-Level Paper 2 Question 1 Economists usually begin their analysis of decision -making by firms by assuming that the objectives of a firm is to maximise their profit. In reality, however, there are many different objectives that a firm might adopt. a) Explain the likely effects on a f irm’s price and output when its objective changes from profit maximisation to profit satisficing. [10] b) Discuss the most appropriate strategy that a firm could adopt if its objective was to reduce the competition that it faces. [15] Part (a) - Question Analysis Approach Command Word Explain Question Type Cause and effect Start point Objective of firm End Point Price and output Content and Context Content • Marginalist principle • Profit satisficing Context None Introduction State essay approach: Traditional economic theory suggest that r ational producers will seek to maximize profits when making decisions using the marginalist principle. However, a firm may only seek to achieve a level of profits that is satisfactory, instead of the maximum level possible due to various factors such as imperfect information. Body Point 1: Explaining a profit-maximizing firm’s price and output level • A firm, such as Apple, will produce up to a point where marginal revenue (MR) equals to marginal costs (MC) to maximize profits. • Marginal revenue is the additional revenue gained from selling an additional unit of Apple product such as iPhone, and revenue is obtained by price multiplied by quantity. • Marginal cost is the additional cost incurred from producing an additional unit of Apple product, which include wages paid to workers and manufacturing costs such as costs of raw material for the different components of iPhone and costs of machinery to assemble the iPhone. • With reference to Figure 1, if Apple produces iPhone only up to Q1 where MR > MC, his profits can be increased by producing additional unit of iPhone as it will add more to his revenue than the costs. Hence, to maximize profits, a rational producer will increase production until MR = MC at Qm. • On the other hand, if Apple produces iPhone at Qs where MC > MR, the additional production has decreased its overall profits. Thus, to maximise profits, Apple should decrease production until MR = MC at Qm.

• The Marginalist principle states that an economic agent should pursue an activity up to the point where Marginal Benefit (MB) = MC. Thus, at Qm where MR = MC, there is no incentive for the producer to either increase or reduce production hence the profit-maximising firm will produce at the output Qm, with a price of P m, earning a supernormal profit of area PmEDCm. Body Point 2: Explaining a profit-satisficing firm’s price and output level • Profit-satisficing behaviour arises due to the separation of ownership and management. While the owners wish to maximum profits, the employees (managers and workers) might aim for a