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Baumol’s theory of sales maximisation

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Managerial economics, Alternative objectives of firms, Baumol's theory of sales maximisation,

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Baumol’s theory of sales maximisation

  1. 1. BAUMOL’S THEORY OF SALES MAXIMISATION Prof. Prabha Panth, Osmania University Hyderabad
  2. 2. • Profit Maximisation not the only goal of a firm. • According to Baumol – Firm’s objective is “Sales Maximisation” not “Profit Max.” Why do firms prefer Sales Maximisation? • Ownership and Management are separate. • Managers and Owners have different goals. • Managers’ goals based on Sales Maximisation because of the following reasons: 2Prabha Panth Managerial models of the firm
  3. 3. 1. Salaries and perks to managers depend on sales, not profits. 2. Banks give loans to firms with more sales, 3. Better payment to staff, when sales, but falls when sales decrease, 4. Sales increases prestige of managers, but large profits go to shareholders/ owners. 5. Managers prefer steady level of profits, not maximum profits which are difficult to maintain. 6. Increasing sales increases firm’s market power, 7. Managers wish to avoid risky ventures that may temporarily increase profits. Prabha Panth 3
  4. 4. Baumol’s Static Model • Assumptions: 1. Single time period, 2. Oligopoly firm, 3. Sales Maximisation objective, 4. Minimum profit to satisfy shareholders’ expectations, keep up share prices, and meet bank requirements, 5. U – Shaped cost curves (AC and MC), P.C. in factor markets, 6. Downward sloping D-curve, Prabha Panth 4
  5. 5. 5 R, C 0 a Qx TR TC Rm R, C Rs QsQm R/q = 0 a Figure 1. BAUMOL’S SALES MAXIMISATION b g
  6. 6. • In Figure 1, taking TC and TR, the usual profit maximisation Q is Qm, where TR – TC is maximum. • But here TR is still rising, it has not reached its maximum, R/q > 0. • According to Baumol, managers prefer to have maximum sales, up to Qs. • Here R/q = 0, and TR is maximum. • Some minimum profits = Rs Qs = 0a, can still be earned. • Line aa is the minimum acceptable profits, to satisfy shareholders, owners, etc. (Profit constraint). • But if minimum acceptable profit > Rs, then not possible to maximise sales revenue. Prabha Panth 6
  7. 7. Difference between Sales and Profit Maximisation 7 Pm Ps Qm Qs m s Sales Profits 1.Qs > Qm 2.Ps < Pm 3.Profits s < Profits m 4.Ed =1, Ed > 1 5.MR = 0, MR >0
  8. 8. Criticism • Cost and demand functions of individual firms are not known. • Oligopoly interdependence has not been taken into account. Other firms may also lower P, leading to P wars. • Uncertainties in oligopoly, not discussed. • Relationship between firm and industry equilibrium not shown. • Owners may demand higher profits not sales. Prabha Panth 8

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