Objectives of Business (Grade 11 NSC Matric Economics): Revision Notes
Objectives of Business
What do businesses really want to achieve?
The primary goal that drives most businesses is profit maximisation - essentially, making as much money as possible from their operations. Understanding how businesses define and measure profit is crucial for grasping how they make decisions in the marketplace.
Understanding profit
Profit represents the financial reward businesses receive for their efforts and can be understood in several ways:
- The difference between production costs and selling price
- The money remaining after paying all production expenses
- Any extra income entrepreneurs receive from their business activities
These different ways of understanding profit might seem similar, but they lead to very different methods of calculation and business decision-making, as we'll explore in the following sections.
The concept of opportunity cost
Before diving into different types of profit, it's essential to understand opportunity cost. This refers to the value of the next best option you give up when making a choice. In business terms, when entrepreneurs use their resources (time, money, skills) for one venture, they sacrifice the potential returns from alternative uses of those same resources.
Since resources like money, labour, and materials are limited, both consumers and businesses must constantly make choices about how to use them most effectively.
Opportunity cost is fundamental to understanding why businesses make certain decisions. It's not just about what you gain from a choice, but what you lose by not choosing the alternative.
Three types of profit
1. Accounting profit
This is the most straightforward way businesses calculate profit, but it has significant limitations.
How it works: Accounting profit only considers explicit costs - expenses that are easy to identify and measure, such as:
- Employee wages and salaries
- Rent for premises
- Raw materials and supplies
- Utility bills
- Equipment purchases
The problem: This method ignores implicit costs - the intangible expenses like the entrepreneur's time, effort, and skills invested in running the business. These hidden costs are difficult to measure but represent real economic sacrifices.
Common Mistake Alert: Many new business owners rely solely on accounting profit to judge their success, but this can lead to poor decision-making because it ignores the true cost of their own time and resources invested in the business.
Why this matters: Accounting profit can create a misleading picture of business success because it doesn't account for all the resources actually used. A business might show healthy accounting profits while still being economically inefficient.
2. Economic profit
This provides a more comprehensive and accurate measure of business performance.
The calculation: Economic profit = Revenue from sales - (Explicit costs + Opportunity costs of all inputs)
What makes it different: Economic profit considers both explicit costs and the opportunity costs of using resources for this business instead of their next best alternative. This gives a clearer picture of whether the business is genuinely creating value or simply using resources that could be more productive elsewhere.
Worked Example: Comparing Accounting vs Economic Profit
Sarah runs a small bakery and calculates her annual results:
- Revenue: $100,000
- Explicit costs (rent, ingredients, utilities): $70,000
- Accounting profit: $30,000
However, Sarah gave up a job that paid $25,000 per year to run the bakery:
- Economic profit = 70,000 + 5,000**
While her accounting profit looks good, her economic profit shows she's only earning $5,000 more than her next best alternative.
Key insight: It's entirely possible for a business to show positive accounting profit whilst having zero or negative economic profit. This indicates that the resources could generate better returns if used differently.
3. Normal profit
This represents the minimum profit level needed for a business to survive and remain competitive in its market.
What it means: Normal profit occurs when a business is using its resources efficiently and couldn't achieve better results by switching to alternative activities. At this point, the business is earning just enough to justify staying in the market rather than pursuing other opportunities.
Normal profit is essentially the break-even point when opportunity costs are included. It's the level where entrepreneurs are indifferent between continuing their current business and pursuing their next best alternative.
The difference: Unlike accounting profit, normal profit calculations include opportunity costs, making it a more realistic benchmark for business viability.
Why these distinctions matter
Understanding these different profit concepts helps explain business behaviour and decision-making in the real world.
- Accounting profit is useful for basic financial record-keeping and tax purposes
- Economic profit reveals whether businesses are truly creating value or wasting resources
- Normal profit indicates the minimum threshold for market participation
When businesses make strategic decisions about expansion, market entry, or resource allocation, they're often guided by economic rather than accounting considerations.
This is why some businesses that appear profitable on paper may still choose to close down or change direction - their economic analysis reveals better opportunities elsewhere.
Key Points to Remember:
- Profit maximisation is the primary objective driving most business decisions
- Opportunity cost represents the value of sacrificed alternatives when making choices
- Accounting profit only includes explicit costs and can be misleading
- Economic profit provides the most accurate measure by including opportunity costs
- Normal profit represents the minimum needed for market competitiveness
- Businesses often make decisions based on economic rather than accounting profit considerations