Profit vs Profit maximisation

These are two terms that have caused some trouble for students in the past, and it’s most probably because they are so closely related. How do we distinguish between them? What do they mean exactly, and when should you use them?

  • Profit is what is left after subtracting total costs from total sales (revenue).                  Profit = Total Sales – Total Costs
  • Profit maximisation is where the greatest positive difference between total revenue and total costs is achieved

Ultimately, profit is the return for the risk that business owners take for investing in the business. Remember opportunity cost? Business owners also had to deal with opportunity cost when they initially invested in the firm. Instead of starting up a business or purchasing shares in a company, the owners (or entrepreneurs) could have rather invested their finance elsewhere. They might have saved the money in an interest-bearing account, purchased shares in a different firm or started their own business.

Profit maximisation is a business objective. Just like survival, increasing market share and growth, profit maximisation is an objective that a business hopes to achieve, and makes certain decision in order to reach this outcome.

For most businesses, profit is seen as necessary for the long-term survival of the firm. The profit motive rewards the taking of risks and hard work; it gives business owners an ultimate outcome. For the sole trader, profit will always be in mind: it’s his or her “salary” earned from the business’s activity.

Profit maximisation is not always necessary or even vital for long-term success. Of course, in the competitive, globalised business world of today, ‘the bottom line’ is always of concern. But it’s not always the main aim or objective. In some cases and different contexts, the objective of survival is more important (such as during an economic recession where consumer spending is reduced). Alternatively, a business may value the objective of increasing market share more highly; gaining a greater proportion of the total market might be seen as an important step in attaining loyalty (profit maximisation could be sought thereafter).

QUESTION: In your own words, explain one situation where profit maximisation might not be the most important objective for a business. 

 

Using the term ‘public’

Hi everyone

Just a quick note on this term that can cause some students quite a bit of trouble and confusion – public. How do we use this word in Business Studies? There are 3 main situations where you should be able to use the word and know exactly what you are dealing with:

1. The ‘public’ in general. Here we are talking basically about everyone in a country or region, e.g. the South African public is made up of many different markets and market segments.

2. Public limited companies. As you know – or will see when you learn about the forms of business organisation – a public limited company (PLC) is one that has ‘gone public’. In other words, its shares are listed on a stock exchange such as the Johannesburg Stock Exchange (JSE) or the NYSE. A PLC has limited liability and a separate legal identity.

3. Public enterprises. This is where you need to be careful…many students confuse  this with public limited companies. NB: they are not the same!  A public limited company operates in the private sector; public enterprises are owned and controlled by the state, i.e. they operate in the public sector of the economy. PLCs are funded privately; public enterprises are government-funded (taxpayer money).

I hope this helps to clear up any confusion on this sometimes troubling word!

Opportunity cost and a question

“What is the ‘opportunity’ in opportunity cost?”

“How can a business take advantage of the opportunity?”

These are questions many Business Studies students have asked. Although at first it seems a straight-forward concept, there is still some effort required to fully understanding and remembering what it is that opportunity cost is all about. This might be because of its intangible nature – it’s not something we can clearly point out. Here’s a short explanation to complement what you have learnt already, with some questions for you to answer at the end of this post…

Let’s remember that opportunity is the cost of a decision expressed in terms of the next most desired option that we had to give up. In other words, I want either A or B, but can’t afford both. I purchase A. Therefore B is the opportunity cost of that decision.

Also, remember why it is that opportunity costs arise in the first place. This is because of the problem of scarcity – we have scare resources in relation to unlimited wants. Therefore we can’t satisfy all our wants and must make a choice. Since we must make choices, we encounter opportunity cost.

Bear in mind that opportunity cost is something everyone has to deal with, whether it’s individuals like you and I, governments, schools or businesses. In other words, there is opportunity cost on a “small” scale and a “large” scale.

Opportunity cost is not a tool that a business can make use of to its advantage. Rather, it is a reality that businesses and all economic units (e.g. government and families) must face and deal with…kind of a ‘universal principle’ that faces us all, whether we think or know about it or not.

The ‘opportunity’ part of opportunity cost is this:
By choosing product A, you have given up the ‘opportunity’ of using product B. By spending time at the movies, you gave up the opportunity of having lunch with friends. For each decision we make, there is an opportunity that we lost out on.
Based on what you know about opportunity cost, answer the following question by commenting on this post: Offer two examples of opportunity cost -one for business and one for government. Clearly point out how resources were used in one way and not the other.