48727302-baumol’s-sales-maximisation-model

7/30/2019 48727302-Baumols-Sales-Maximisation-Model

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Baumols Sales Maximisation

Model

Pankaj Kumar


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Prof. Baumol in his article on the theory of oligopoly

presented a managerial theory of the firm based on sales

maximisation.

Assumption:

Theory is based on the following assumptions:

There is a single period time horizon of the firm.

Firm aims at maximising its total sales and revenue in thelong run subject to the profit constraint.

Firms minimum profit constraint is set competitively in

terms of the current market value of its shares.

Firm is oligopolistic whose cost curves are U-shaped andthe demand curve is downward sloping.Its total revenue

and cost curves are also of conventional type.

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Baumols findings of oligopoly firms suggest that the business firms are muchconcerned about their total increase in sales than profits. He gives number ofarguments to support his point of view:

A firm attaches great importance to the magnitude of Sales and is muchconcerned about declining sales.

If sales are declining,banks,creditors and capital market are not prepared toprovide finance to it.

Its own distributors and dealers might stop taking interest in it.

Consumers might not buy the products because of lack of popularity

Firm reduces its managerial and other staff with the fall in sales

If the firms sales are large, there are economies of scale, the firm expands andearns profits

Salaries of workers and management also depends on the large sale

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By sales maximisation Baumol means maximisation of total revenue

It does not imply the sales of large quantities of output, but refers to

the increase in the money sales.

Sales can be increase upto the point of profit maximisation where themarginal cost is equal to the marginal revenue

If sales are increased beyond this point, money sales may increase at

the expense of profits. But oligopolist firms wants its money sales to

grow even though it earns minimum profits.

Minimum profits are determined on the basis of firms need tomaximise sales and also to sustain the growth of sales.it is required

either in the form of retained earnings or new capital from the market.

The firm also needs minimum profits to finance the future sales, to pay

the dividends on the share capital and for meeting other financial

requirements. Thus minimum profits serve as a constraint on themaximisation of a firms revenue

maximum revenue will be obtained only at the output at which the

elasticity of demand is unity,i.e.at which MR is equal to zero.This is

the condition which replaces the MC=MR profit maximisation rule

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TC

TR

TP

EL

B

BaumolS Model

C

Q D K

M

S

P

OUTPUT

TR/

TC/

P

R

O

F

I

T

S

X

Y

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In the fig.TC is the total cost curve and MP the minimumprofit or profit constraint line..

Firm maximises its profits at OQ level of output

corresponding to the highest point B on the TP curve.

But aim of firm is to maximise sales rather than profits The sales maximisation output is OK where the total

revenue KL is maximum at the highest of TR.

the sales maximisation output OK is greater than the profit

maximisation output OQ. But the sales maximisation issubject to the minimum profit constraint.

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If minimum profit constraint is represented by line MP

The output OK will maximise the sales as minimum profits

OM are not being covered by the total profits KS.

For sales maximisation the firm should produce OD level

of output where minimum profits DC (=OM) are consistent

with DE amount of total revenue at the price DE/OD,( total

revenue /total output) Baumols model of sales maximisation points out that the

profit maximisation output OQ willl be smaller than the

sales maximisation output OK, and price higher than under

sales maximisation

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Model With Advertising

Baumol has further shown that the profitconstraint under sales maximisation is also

effective in advertising and thereby

increases the firms revenue.

This is shown in the diagram given on the

next slide

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o Q D

M

CP

AdC

TR

TC

T

S A

E

TP

X

Y

Advertising Outlay

TR/TC/

P

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In the fig., expenditute on advertising is shown on the

horizontal axis .

TR is the total revenue curve. The 45 line AdC is the

advertisement cost curve.

By adding a fixed amount of other costs equal to OC to

AdC curve we get the total cost curve TC.

Here production costs OC are assumed independent of

advertising costs.

TP is the total profit curve which is the difference between

TR and TP curve.

MP is the minimum profit constraint line.

The profit maximisation firm will spend OQ on

advertising and its total revenue will be OS(=QA).

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On the other hand given the profit constraint MP,

the sales maximisation firm will spend OD on

advertising and earn OT (=DE) as the totalrevenue.

Thus the sales maximisation firm spends more on

advertising OD than the profit maximising firm

(OQ), OD>OQ and also earns higher revenue

(DE) than the latter (QA), DE>QA, at the profit

constraint MP.

Thus it will always pay the sales maximiser toincrease his advertising outlay until he is stopped

by the profit constraint.

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Conclusion

The theory leads to the conclusion that the

sales revenue maximisation firm:

Will produce at a higher level

Will keep the prices low

Will invest in such a manner,as on

advertisement, that the demand for its

product will increase.

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48727302-baumol’s-sales-maximisation-model

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