# Differing objectives and policies of firms (incl. price discrimination)

> Economics · CIE A-Level 9708
> Source: https://www.owlsprep.com/study/cie-9708-u2-differing-objectives-and-policies-of/

We cover non-profit firm objectives, their pricing rules, three degrees of price discrimination, and welfare effects for CIE exam short answer and essay questions.

**Prerequisites:** [Understand marginal and average cost/revenue concepts](https://www.owlsprep.com/study/cie-9708-u2-marginal-average-cost-revenue/); [Recall basic monopoly model assumptions](https://www.owlsprep.com/study/cie-9708-u2-monopoly-market-structure/)

## Learning objectives

- Distinguish between traditional profit maximisation and alternative firm objectives arising from principal-agent problems
- Derive pricing and output rules for revenue maximisation, sales maximisation and limit pricing
- Explain the three degrees of price discrimination and their required preconditions
- Evaluate the net welfare impacts of price discrimination for consumers and producers

## Traditional and Alternative Firm Objectives

The traditional model assumes firms maximise profit, but modern separated ownership and control (where shareholders own the firm and managers run it) creates a principal-agent problem that leads to alternative objectives.

**Principal-agent problem** — A conflict of interest where agents (managers) pursue their own goals rather than the principals' (shareholders') goal of maximum profit.

- Profit maximisation: The long-run default objective for most small, owner-run firms
- Sales revenue maximisation: Managers aim to maximise total firm revenue to earn performance bonuses linked to firm size
- Sales maximisation: Firms maximise market share to gain first-mover advantages and reduce new competition
- Satisficing: Managers balance competing stakeholder demands to hit acceptable, not maximum targets

**Worked example:** A firm faces a total cost function $TC = 200 + 10Q$ and total revenue function $TR = 50Q - 0.5Q^2$. Find the profit maximising and revenue maximising output levels.

1. First, calculate profit maximising output using MC = MR:
2. $$MC = \frac{dTC}{dQ} = 10, \quad MR = \frac{dTR}{dQ} = 50 - Q$$
3. $$10 = 50 - Q \implies Q_{\pi max} = 40$$
4. Next, calculate revenue maximising output using MR = 0:
5. $$MR = 50 - Q = 0 \implies Q_{R max} = 50$$

**Check your understanding**

Test your understanding of the principal-agent problem:

1. Which of the following is a direct consequence of the principal-agent problem?

   - Firms always maximise long run profit
   - Managers may prioritise firm size over maximum shareholder returns
   - Perfectly competitive firms earn zero abnormal profit in the long run
   - Price discrimination reduces total consumer surplus

   *Why:* This is the core conflict between manager goals and shareholder profit goals.

## Pricing and Output for Non-Profit Maximising Firms

Each objective produces a distinct output and price point that can be plotted on a standard average cost / average revenue diagram. For constrained sales maximisation, the firm will produce at the point where AR = ATC, but only if it meets a pre-set minimum profit requirement.

$$\text{Profit Maximisation: } MC = MR \implies P_{\pi max} > P_{R max} \text{ and } Q_{\pi max} < Q_{R max}$$

**Worked example:** Using the earlier TC and TR functions, calculate the price at the revenue maximising output level Q=50.

1. First derive the average revenue (demand) function from total revenue:
2. $$TR = P \times Q = 50Q - 0.5Q^2 \implies P = 50 - 0.5Q$$
3. Substitute Q=50 into the demand function:
4. $$P = 50 - 0.5(50) = 25$$

> **exam_tip**
>
> CIE examiners award up to 4 marks for fully labelled diagrams showing all three output points (profit max, revenue max, constrained sales max) on the same cost-revenue axis.

## Conditions and Types of Price Discrimination

**Price Discrimination** — A firm with market power charges different prices to separate groups of customers for identical units of a good, with no corresponding difference in production costs.

- The firm must have sufficient market power to set prices above marginal cost
- The firm can separate customers or markets at low cost, preventing resale (arbitrage) between groups
- Different customer groups have different price elasticities of demand

| Degree | Description | Real World Example |
| --- | --- | --- |
| First Degree | Firm charges each customer their exact maximum willingness to pay | Independent car dealership haggling over individual prices |
| Second Degree | Firm uses self-selection to segment customers via quantity discounts | Supermarket multi-buy offers for larger product packs |
| Third Degree | Firm explicitly segments customers into distinct, identifiable markets | Student discounts for cinema tickets, peak/off-peak train fares |

**Worked example:** A monopolist operates two separate markets with price elasticities of demand of -2 and -4. The marginal cost of production is \$12. Use the inverse elasticity pricing rule to find the optimal price in each market.

1. The inverse elasticity rule states $P = \frac{MC}{1 + \frac{1}{PED}}$
2. For market 1, PED = -2:
3. $$P_1 = \frac{12}{1 - 0.5} = 24$$
4. For market 2, PED = -4:
5. $$P_2 = \frac{12}{1 - 0.25} = 16$$

## Welfare Impacts of Price Discrimination

Price discrimination transfers consumer surplus to producers, but can also increase total market output, potentially raising total social surplus relative to a single-price monopoly.

**Derivation:** Compare total surplus under single pricing vs third degree price discrimination

*Starting from:* Single price monopoly sets P above MC, restricts output below the socially optimal level

1. Under third degree price discrimination, the firm can lower prices in the elastic demand market, raising total output
2. If the firm would not supply the low-demand market at all under single pricing, price discrimination makes that market available to consumers
3. Total producer surplus rises unambiguously, while consumer surplus may rise or fall depending on market conditions

*Conclusion:* Price discrimination is not always welfare reducing, and can in some cases be more socially efficient than single price monopoly.

**Exam command terms**

CIE uses specific command terms for this topic:

- **Analyse** — Explain step by step how price discrimination changes output and surplus *(Analyse the effects of third degree price discrimination on consumer welfare)*

- **Evaluate** — Present arguments for and against the welfare benefits of price discrimination before reaching a supported judgement

## Common pitfalls

- **Wrong:** Assuming all firms always maximise profit in all scenarios
  - Why it fails: This ignores the principal-agent problem that is explicitly tested in CIE 9708 exams
  - Correct: State your assumed firm objective clearly at the start of any analysis
- **Wrong:** Confusing revenue maximisation with profit maximisation
  - Why it fails: Forgetting that revenue maximisation occurs at MR=0, not the MC=MR profit maximisation rule
  - Correct: Label both output points separately on all cost-revenue diagrams
- **Wrong:** Claiming price discrimination requires different costs across markets
  - Why it fails: Pure price discrimination depends only on differing demand elasticities, not cost differences
  - Correct: Explicitly note that cost parity is the baseline assumption for pure price discrimination
- **Wrong:** Stating price discrimination is always bad for consumers
  - Why it fails: Third degree price discrimination can open up new markets that would not exist under single pricing
  - Correct: Evaluate both consumer surplus losses and gains before drawing a final welfare conclusion
- **Wrong:** Mixing up second and third degree price discrimination
  - Why it fails: Failing to distinguish between customer self-selection (2nd degree) and explicit market segmentation (3rd degree)
  - Correct: Use standard CIE-approved examples to categorise each type correctly in exam answers

## Cheatsheet

| Firm Objective | Output Rule | Key Outcome |
| --- | --- | --- |
| Profit Maximisation | MC = MR | Maximum abnormal profit for shareholders |
| Sales Revenue Maximisation | MR = 0 | Higher output, lower price than profit max |
| Constrained Sales Maximisation | AR = ATC (minimum profit constraint) | Maximum possible market share |
| Limit Pricing | P < potential entrant ATC | Blocks new market entry |
| First Degree Price Discrimination | P = MC for last unit sold | Captures 100% of consumer surplus |

## What's next

Mastering firm objectives and price discrimination gives you a robust framework to analyse real-world firm behaviour across oligopoly and monopolistic competition topics, which are heavily weighted in CIE Paper 4 extended essays. You will next apply these frameworks to game theory and oligopoly interdependence, where competing firm objectives directly shape collusive and non-collusive outcomes. This subtopic also links directly to government micro intervention policies, as regulators often assess price discrimination practices for consumer exploitation risks. Ensure you practice drawing fully labelled cost-revenue diagrams for each objective, as CIE examiners award up to 4 marks for accurate, correctly annotated diagrams in 12-mark responses.

- [Monopolistic Competition](https://www.owlsprep.com/study/cie-9708-u2-monopolistic-competition/)

---

From [OwlsPrep](https://www.owlsprep.com) — free study guides for A-Level, IB, AP and IGCSE, written against the official syllabus. Canonical page: https://www.owlsprep.com/study/cie-9708-u2-differing-objectives-and-policies-of/