Baumol’s theory of sales revenue maximization was created by American economist William Jack Baumol. It’s based on the theory that, once a. W. J. Baumol suggested sales revenue maximisation as an alternative goal to profit maximisation.1He presented two basic models: the first is a static. W. J. Baumol suggested sales revenue maximisation as an alternative goal to profit maximisation.1 He presented two basic models: the first is a static.
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Baumol’s Managerial Theory of Sales Revenue Maximization
However, the decrease in output will be larger than the decrease of the output of a profit maximiser. This claim is not necessarily true. However, the desire for steady performance has a stabilizing effect on economic activity.
Hall in an answer to Waverman accepts that the main defect of his study lies in the method of estimation of the minimum profit constraint, but he points out that this was the best he could do with the available data. The imposition of a lump-sum tax will have similar effects. Imposition of a specific sxles will lead the sales maximiser to a larger reduction in output and a larger increase in price as compared with a profit maximiser. In this case the misallocation of resources if measured as a departure of P from MC will be greater for the sales maximiser.
The firm is oligopolistic whose cost cures are U-shaped and the demand curve is downward sloping. Clearly there is an infinite combination of values of g and R that the firm may choose.
The further away from the origin, the higher the total revenue earned. The firm in these models does not consider what will happen in subsequent periods as a result of the decisions taken in the current period. maxumization
Baumol’s Sales Revenue Maximization Model
Sales Maximisation Model of Oligopoly — Explained! Thus for any two products X i and X j we have. An isorevenue curve shows the same revenue earned by different combinations of quantities of y and x. According to Shepherd, under oligopoly a firm faces a kinked demand curve and if bauml kink is large enough, total revenue and profits would be the maximum at the same level of mosel.
The sales-maximisation theory does not show how equilibrium in an industry, in which all firms are sales maximisers, will be attained.
Baumol’s Sales Revenue Maximization Model
Profit is the main means of financing growth of sales, and as such is an instrumental variable whose value is endogenously determined.
For simplicity we may actually assume that growth will be entirely financed by profits. For any two combinations with profits below the constraint, the one with the larger profit will be preferred. Their results suggest that the correlation between executive incomes and sales revenue is stronger than the correlation between executive incomes and profits. It is the dotted curve in figure When the sales maximiser spends more on advertising, his output will be more than that of the profit maximiser.
The formal condition of equilibrium of a sales-maximising multiproduct firm may be stated as follows: This situation is shown in figure This behaviour, however, does not by itself provide a proof that the firm is a sales maximiser or a profit maximiser. Costs, total revenue and profits are measured on the vertical axis. The firm is in equilibrium when it reaches the highest mode of this curve.
Thus Baumol rules out interdependence ex hypothesi, and hence his theory cannot explain the core problem of uncertainty in non-collusive oligopoly markets.
Declining sales, on the other hand, will make necessary the reduction of salaries and other payments and perhaps the lay-off of some employees. The isorevenue ervenue is drawn convex to the origin, implying a falling demand curve for the two products, and hence a declining marginal revenue for additional units sold.
Higher advertising levels are shown by parallel lines which are further away from the X-axis. Such behaviour is common for new products, for which the firm expects no profits or even losses at the initial stage of their introduction. Peston ventured the idea maximizayion sales maximisation is not incompatible with the goal of long-run profit maximisation.
Similar is the case macimization points D and E on the constraint line R where E with higher sales will be preferred to D.
This condition states that the marginal revenue rveenue advertising commodity i must be equal to the marginal revenue of advertising commodity j. The price is assumed to remain constant. If the government imposes a lump-sum tax with the aim of redistributing income away from the taxed firm, its goal will not be attained, since the sales maximiser will shift the burden to his customers by charging increased prices.
Since it maximises its revenue when MR is zero, it will charge lower prices than that charged by the profit maximising firm. This, however, is a simplifying assumption which may be relaxed in a more general analysis. This business practice, Baumol argues, provides evidence in support of his theory.
Growth may be financed by internal and external sources.
Growth is financed out of current profits, and the growth curve is therefore derived from the profit curve On in figure But the aim of the firm is to maximise its sales rather than profits. With advertising taking place the kinked-demand curve of a profit maximiser will be closer to the origin than the kinked curve of a sales maximiser, because the latter indulges in heavier advertising expenditures. A profit maximiser will not change his equilibrium position in the short run, since fixed costs do not enter into the determination of the equilibrium of the firm.
The latter is exogenously given by the expectations and risk-preferences of the firm, and is higher than any form of market interest rate because it includes subjective assessment of risk.