AN

ASSIGNMENT

ON

“BAUMOL’S SALES

MAXIMIZATION MODEL”

SESSION: 2013-2015

SUBMITTED TO: SUBMITTED BY:

Mr. Anand Gupta Sonia gupta

(Assist. Prof. at KAIM) MBA 1st sem

Ch. Dadri 13031

KEDARNATH AGGARWAL INSTITUTE

OF MANAGEMENT

(Affiliated by MDU, ROHTAK)

CONTENTS

Baumol sales maximization model Assumption of sales maximisation model A single product model without

advertisement: Implementation of this model Single Product model with Advertisement Assumption of this model Applicability of this model Critism Bibliography

Baumol sales maximization model;

Advertising and price output decisions

Prof. W. J. Baumol suggested sales revenue maximization in his book “Business Behaviour, value and growth” as an alternative goal to profit maximization.

Assumption of Sales Maximization Model:

1. Time horizon of a firm is single period.

2. During this period the firm attempts to maximize its total sales revenue subject to profit constraints. The firm in this model does not consider what will happen in subsequent periods as a result of the decisions taken in the current periods.

3. The minimum profit constraints is exogenously determined by the demand and expectation of the shareholders, banks and other financial institutions. The firm must realise a minimum level of profits to keep shareholders happy and avoid a fall of the price of shares on the stock exchange.

4.The firm is oligopolistic whose cost curve are U- shaped and the demand curve is downward sloping .Its total cost and revenue curves are also of the conventional type.

A single product model without advertisement:

The total sales revenue is at its maximum level at highest point of the TR curve, where the price elasticity of demand is unity and the slope of this TR curve is equal to zero.

A profit maximize firm will produce at OQ2 level of output. However in Baumol sales maximization models the firm is a sales maximiser, but it must also earn a minimum level of profit acceptable to shareholder and those who finance its operations .if the minimum acceptable levels of profit are π . the firm will produce the level of output OQ1 that maximize its sales revenue, with this level of output OQ1 the firm will earns profit π which are greater than the minimum required to keep the shareholders satisfied .if the minimum profit constraints is above the level of profits where MR=0 the sales revenue maximize is ‘constraints’ to stop at OQ3 output where minimum profit constraints is met. The sales maximize will produce a higher level of output as compare to profit maximizer.

Implication of Baumol’s model

1. If both the profit maximizer and a constraints sales maximizer face the same demand curve, the latter will charge a lower price to sell the extra output (Q3-Q2)

2. A sales maximizer will spend more on advertisement than does a profit-maximizing firm.

A single product model, with advertisement:

Baumol argues that in real world the price competition is the typical form of competition in oligopolistic markets. The model represented by Baumol treats explicitly advertisement, but other form of non-price competition may be analyzed on similar lines.

Assumption of this model:

1. The sales revenue increases with advertising expenditure thus implies that advertising will always shifts the demand curve of the right and the firm will sell a large quantity and earn large revenue.

2. The production cost is independent of advertisement for simplifying however he recognises that this is an unrealistic assumption.

From the above assumption we can say that a firm is an oligopolistic market will prefer to increase its sales by advertisement rather than by a cut in price. While in increase in physical volume induced by a price cut may or may not increase sales revenue depending on whether demand is elastic or inelastic an increase in volume brought about by increase in advertisement will always increase sales revenue since by assumption the marginal revenue of advertisement is positive.

Advertising outlay is measured on the horizontal axis and the advertising function is shown as 45° line. Cost, total revenue and profits are measured on the vertical axis. production cost are shown as being independent of the level of advertising if these cost are added to the

advertising cost line we obtain the total profit curve p1.

If the price is such to enable the firm to sell an output yielding profits above their minimum acceptable level, it will pay the firm to increase advertisement and reach higher level of sales revenue. The advertising outlay of sales maximiser (OA2) is higher than that of the profit

maximiser (OAp1). In short Baumol assume that advertisement does not affect the product price but it does lead to increase output sold. It is also assumed that advertising will always lead to raise TR and MR will never become negative. Since advertising will always increase TC, the management will increase advertising until prevented by the profit constraints.

Applicability of the model:

According to Baumol, business manager pursue the goal of sales maximisation rather than profit maximisation for the following reasons:

1. Financial institution consider sales as an index of performance of the firm and are willing to finance the firm with growing sales.

2. Profit figures are available only annually sales figure can be obtained easily and more frequently to access the performance of management.

3. Maximisation of sales is more satisfying for managers than the maximisation of profits, which go the pocket to the shareholders.

4. Salaries and slack earnings of the top managers are linked more closely to sales than profit.

5. Routine personnel problems are more easily handled with growing sales. Higher payments to be offered to employees if sales figures indicate better performance.

6. Sales growing more than proportionally to market expansion indicate growing market share and a greater competitive strength and bargaining power of a firm in a collusive oligopoly.

CRITICISM:

1. Profit constraints: in practical it is very difficult to decide about the minimum level of profit. Change in minimum level of profit cause change in level of sales maximisation.

2. Unrealistic theory: the theory is unrealistic as it ignores actual competition as well as threat of potential competition .in an oligopolistic market if a firm to capture the market of the rival firm, reaction would definitely set limits to its direction in expanding sales.

3. No explanation of industry equilibrium.

4. It is not applicable in all situations that advertising always increases sales revenue.

5. Total production is not independent from advertisement cost and not remains constant.

6. Baumol does not examine explicitly the interrelationship between advertising cost price cost of production and level of output.

7. Unrealistic assumption: in this model it is also assumed that the price will remain constant is unrealistic .infect, prices keep on changing.

Bibliography Business economics

www.google.com Dr. Raj kumar Prof. Kuldeep Gupta