Differing objectives and policies of firms

The traditional assumption is that firms maximise profit, producing where MC = MR. However, firms often pursue other objectives, for several reasons.

The main reason is the principal-agent problem: in large firms, the owners (shareholders) are separate from the managers who run the firm (a divorce of ownership and control). Managers (agents) may pursue their own objectives — higher salaries, status, job security or firm growth — rather than maximising profit for owners (principals), aided by asymmetric information that limits owners' monitoring. Other reasons include the difficulty of identifying the exact profit-maximising output and pressures such as survival in a recession.

The alternative objectives include: survival (simply staying in business, especially for new firms or in a downturn); profit satisficing (earning enough profit to keep shareholders content while pursuing other goals); sales (output) maximisation (the largest output earning at least normal profit, where AR = ATC); and revenue maximisation (where MR = 0, total revenue at its peak), often linked to managers' pay/status rising with firm size or to gaining market share.

These objectives affect price and output. Compared with profit maximisation (MC = MR), both revenue maximisation (MR = 0) and sales maximisation (AR = ATC) require a larger output and therefore a lower price. So a firm pursuing these goals produces more and charges less than a profit-maximiser. This benefits consumers (lower prices, more output) but earns the owners less profit — which is precisely the tension at the heart of the principal-agent problem. Thus a firm's chosen objective directly shapes how much it produces and the price it sets.

Price discrimination is charging different prices to different consumers for the same good, where the difference is not based on cost, in order to capture consumer surplus. The view that it always benefits firms at consumers' expense is partly right but too simple.

The case that it benefits firms at consumers' expense. Price discrimination is designed to convert consumer surplus into producer profit. By charging the inelastic group a higher price (e.g. business travellers, commuters), the firm extracts more from consumers who have few alternatives — which can seem exploitative and inequitable, as those most dependent on the good pay most. First-degree discrimination extracts all consumer surplus. So firms clearly gain higher profit, and the inelastic group is worse off, supporting the view.

The case that consumers can also benefit. Price discrimination has mixed effects, not purely negative for consumers. The elastic group pays a lower price and may gain access they would otherwise lack — e.g. student, child, senior or off-peak discounts let lower-income or price-sensitive consumers consume the good. The extra revenue can keep a service financially viable that would otherwise not be provided at all (e.g. some transport routes), and supernormal profits may cross-subsidise other users or fund investment and innovation that benefits consumers over time. So some consumers are clearly better off.

Distribution and judgement. The effect on consumers therefore depends on which group they are in and on the alternative. Price discrimination does raise firm profit, and it does harm the inelastic group, so part of the statement holds. But it does not harm all consumers — the elastic group benefits, access can widen, and provision can be sustained. The most defensible conclusion is that price discrimination always benefits the firm (that is its purpose), but it does not always come purely at consumers' expense: its effect on consumers is mixed, harming some (the inelastic) while benefiting others (the elastic) and sometimes enabling provision and access. Whether it is 'against consumers' interests' overall is partly a value judgement about equity and depends on the counterfactual — making the blanket claim too strong.

Profit maximisation occurs where MC = MR, giving the largest gap between total revenue and total cost. Sales (output) maximisation means producing the largest output the firm can while still earning at least normal profit — i.e. up to the point where AR = ATC (price equals average total cost, so the firm just breaks even in economic terms).

Compared with profit maximisation, sales maximisation implies:

• Higher output: the firm produces well beyond the profit-maximising MC = MR output, expanding to the point where AR = ATC.
• Lower price: to sell the larger output, the firm must move down its demand curve, so it sets a lower price than the profit-maximiser.
• Lower profit: instead of supernormal profit, the firm earns only normal profit (AR = ATC), so its profit is lower than under profit maximisation.

Why managers might do this: managers' pay, status and job security often rise with the size of the firm (more output/sales), and a larger market share can deter entry — reflecting the principal-agent problem (managers' goals differ from owners').

So sales maximisation benefits consumers (more output, lower prices) and managers (larger firm), but the owners receive less profit than they would under profit maximisation — a clear example of how the firm's objective shapes its price, output and profit.

The kinked demand curve model is designed to explain price rigidity in oligopoly. It assumes that if a firm raises its price, rivals will not follow (keeping their prices low to win customers), so the firm loses many sales — demand is elastic above the current price. If the firm cuts its price, rivals will follow (to avoid losing customers), so the firm gains few extra sales — demand is inelastic below the current price. The result is a kink at the current price and a discontinuity (gap) in the marginal revenue curve.

Its usefulness. The model is useful because it provides a clear explanation of two real features of oligopoly. First, it explains price stability/rigidity: since a price rise loses a lot of revenue and a price cut gains little, firms have no incentive to change price, so prices stay stable. Second, the MR discontinuity shows that marginal cost can change within a range without altering the profit-maximising price, reinforcing price stability. It also helps explain why oligopolists rely on non-price competition (advertising, branding) rather than price competition. As a description of interdependence, it captures the strategic thinking of oligopolists.

Its limitations. The model has significant weaknesses. It does not explain how the original price is set — it only explains why firms stay there. It assumes a particular pattern of rival reactions that may not hold; in reality oligopolists sometimes do change prices (e.g. price wars, or coordinated rises under price leadership or collusion). It also ignores collusion, which is a major feature of oligopoly, and it cannot explain the price changes seen during inflation or cost shocks. Game theory (e.g. the Prisoner's Dilemma) and collusion models often explain oligopoly behaviour better.

Judgement. The kinked demand curve is a useful but limited model. It is genuinely useful for explaining price rigidity and the reliance on non-price competition, which are real oligopoly features. However, it is incomplete: it cannot explain how prices are set, ignores collusion, and does not fit all observed behaviour. The most defensible conclusion is that the kinked demand curve is a helpful partial explanation of oligopoly price stability, best used alongside other models such as game theory and collusion, rather than as a complete account of oligopoly behaviour.