BAUMOL SALES REVENUE MAXIMIZATION MODEL PDF

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

To find the equilibrium of the firm we need an additional tool, the msximization curve. These changes will be greater than those of a profit maximiser. If total production costs are independent of advertising, that is, production costs remain constant after advertising takes place as Baumol assumes, this implies that total output X will remain constant after advertising has taken place; consequently an increase in sales revenue R, given X, can be attained only if P is raised.

If sales are increased beyond this point, money sales may increase at the expense of profits. Several reasons seem to explain this attitude of the top management. Unlike a price reduction, increased advertising always increases sales revenue. Maximizatioj the further away from the dales an iso-present-value curve lies, the higher the discounted stream of revenues it depicts. Profit is the main means of financing growth of sales, and as such is an instrumental variable whose value is endogenously determined.

Baumol’s Sales or Revenue Maximisation Theory: Assumptions, Explanation and Criticisms

However, with advertising taking place there may be conditions under which these predictions will be different. Recall that according to all versions of limit-pricing, a general increase in costs, or the imposition of a tax that affects all firms in the industry in the same way, will induce firms to increase their prices, because they know that everyone will follow the same policy and thus there is no danger of losing market share.

Among all possible values the firm will choose the pair of values of g and R that maximise the present value of the future stream of sales S. 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. Such a family of total-revenue curves is shown in figure In this case the misallocation of resources if measured as a departure of P from MC will be greater for the sales maximiser.

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This condition states that the marginal revenue of advertising commodity i must be equal to the marginal revenue of advertising commodity j.

Thus it will always pay the sales maximiser to increase his advertising outlay until he is stopped by the profit constraint. A firm, he argues, may be willing to keep sales at a high level, even though they are unprofitable in the short run, in the hope that eventually in the long run the product will become profitable once established in the market.

For the solution of the constrained maximisation problem we use the Lagrangian multiplier method. However, even in these cases the correlations between profits and sales maximizatino mostly positive. Under these circumstances we say that the minimum profit constraint is not operative. See the Haveman-DeBartolo version of the sales-maximisation model. And casual observation shows that this may not be so.

They suggested that with advertising expenditures the TR curve will shift and in the new equilibrium revenue will be higher and advertising expenditure will be higher consistent with Baumol.

This situation is shown in figure But Hawkins has shown that if the firm is engaged in any form of non-price competition such as good packaging, free service, advertising, etc. If we assume that the firm has a given amount of resources and given costs C and wants to allocate them among the various commodities it produces so as to maximise sales revenue, it will reach the same equilibrium solution as the profit maximiser, that is, it will produce the same quantities of the various products as if it were a profit maximiser.

An increase in variable costs will lead the sales maximiser to an increase midel price and a reduction in output.

The isorevenue curve has a slope equal to the ratio of the marginal revenues of the two commodities: Put in this way the argument seems plausible enough. 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

Both the sales maximiser and the profit maximiser will raise their price and reduce their output. To prove this it suffices to show that the marginal revenues of the products are positive at the equilibrium solution, that is. Hall in his analysis of firms came to the conclusion that firms do not operate in accordance with the objective of sales maximisation. Fourthly, large sales, growing over time, give maximizahion to the managers, while large profits go into the pockets of shareholders.

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Such measures create dissatisfaction and uncertainty among personnel at all levels.

Baumol’s Sales or Revenue Maximisation Theory: Assumptions, Explanation and Criticisms

Recall that from the definition of S. Their findings showed positive significant correlations between sales revenue and profits. Minimum profits refer to the amount which is less than maximum profits. Baumol, Business Behaviour, Value and Growth.

It involves the tools of the product transformation curve and of isorevenue curves. Consequently the highest attainable growth rate g will be at the point of revemue profits.

This case is amximization fact implied in figure gaumol We subsequently substitute the X i S into the demand functions of the individual products which are assumed known and obtain the prices.

The total-cost and total-revenue curves under the above assumptions are shown in figure We will develop this model using calculus so as to achieve maximum generality. 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. In particular Baumol does not examine explicitly the interrelationship between advertising, price, cost of production and level of output. The isorevenue curve 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.

The predictions of the multi maximizatipn model are the same as those of the single-period model: The imposition of a lump-sum tax will have similar effects.

The model does not show how equilibrium in an industry, in which all firms are sales maximisers, will be attained. Thus, by changing advertising we may generate a family of total-revenue curves, each representing the relationship of total salex to output at different levels of advertising expenditure. Further, so long as profits exceed the constraint, they will always be converted into advertising to increase sales.