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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From his experience as a consultant to large firms Baumol found that managers are preoccupied with maximisation of the sales rather than profits. Price will depend on the shift of the demand and the cost conditions of the firm.
Baumol’s Managerial Theory of Sales Revenue Maximization
Bumol 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. But the aim of the firm is to maximise its sales rather than profits. Further, so long as profits exceed the constraint, they will always be converted into advertising to increase sales.
This evidence was interpreted as refuting the sales-maximisation hypothesis. The isorevenue curves have the same convex shape as previously. The sales maximiser sells at a price lower than the moodel maximiser. Maaximization firm in these models does not consider what will happen in subsequent periods as a result of the decisions taken in mldel current period. Thus he says that the sales-maximisation hypothesis has a better predictive performance than the traditional profit-maximisation hypothesis.
For any two combinations with profits below the constraint, the one with the larger profit will be preferred.
An increase in the fixed costs will affect the equilibrium position of a sales maximiser he will reduce his level of output and increase his price, since the increase in fixed costs shifts the total-profit curve downwards. Shepherd has suggested that if the reveenue curve has a steep kink, so that to the right of the kink the MR is negative figure Sales maximisation is not only a means but an end in itself He gives a number of arguments in support of his theory.
Demand and costs reevenue the traditional shape: If sales are increased beyond this point, money sales may increase at the expense of profits. In any case advertising cannot be less in a sales-maximising model. Further, they are essential for a firm for paying dividends on share capital and for meeting other financial requirements.
MP is the minimum profit constraint line.
Baumol’s Sales or Revenue Maximisation Theory: Assumptions, Explanation and Criticisms
Baumol claims that an increase in overheads, or the imposition of a lump-tax, both lead to an increase in the price charged by firms. The firm aims at sales revenue maximisation subject to a minimum profit constraint. The price at any level of output is the slope of the line through the origin to the relevant point of the total-revenue curve corresponding to the particular modsl of output.
Thus, Peston concludes, if firms are observed to sell too large an output, this does not show their preference for sales over profits, but may well be attributed to ignorance of demand conditions and the eagerness of firms to exploit technological changes which reduce costs at higher scales of output.
These changes will be greater than those szles a profit maximiser. This revenuw, however, does not by itself provide a proof that the firm is a sales maximiser or a profit maximiser.
It should be stressed that the validity of this model rests on the crucial assumption that advertising always increases sales revenue. In this case the misallocation of resources if measured as a departure of P from MC will be greater for the sales maximiser. But sales maximisation is subject to minimum profit constraint.
Baumol’s Managerial Theory of Sales Revenue Maximization
This solution is identical with the equilibrium of a profit maximiser. In the short run when output cannot be increased, revenue can be increased by raising the price.
Roberts using a cross-section sample of 77 American firms for the period found that executive earnings are correlated with the size of sales but not with the level of profits.
The further away from the origin, the higher the total revenue earned. In particular, being sales maximisers and growth seekers, they are very alert to any change in their share of the market.
The product transformation curve is xales to the origin showing the increasing difficulty increasing cost of reducing product y and reallocating the resources to the increase of product x. He applied regression analysis to a sample of the largest American corporations, which operate in markets which fulfill the conditions of the sales-maximisation model.
Thus for any two products X i and X j we have. Thus profits will be the main source for financing the rate of growth of sales revenue. In summary, if the resources and costs are not given, the multiproduct firm will reach a different product mix, depending on whether it is a profit maximiser or a sales maximiser. Baumol cites evidence to suggest that short-run revenue maximisation may be consistent with long-run profit maximisation.
Thus Bsumol rules out interdependence ex hypothesi, and hence his theory cannot explain the core problem of uncertainty in non-collusive oligopoly markets. Sales revenue of the firm is measured along the vertical axis and profit on the horizontal axis.
The model ignores not only actual competition, but also the threat of potential competition from rival oligopolistic firms. This is the same condition as the one for model 3.
For simplicity we may actually assume that growth will be entirely financed by profits. For each industry Hall estimated a minimum profit constraint equal to the five-year mean profit rates for firms in the industry and he assumed that this is the same for all the maximiization of his sample belonging to that industry.
Consequently the highest attainable growth ,aximization g will be at the point of maximum profits. Both the sales maximiser and the profit maximiser will raise their price and reduce their output. The firm aims at maximising its total sales revenue in the long run subject to a profit constraint. Assumptions, Explanation and Criticisms.