137315101-Baumols-Sales-Maximisation-Model.pdf

Baumols sales maximization

1. Baumol’s Sales Maximisation
Model
Pankaj Kumar

2. 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 the
long 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 and
the demand curve is downward sloping.Its total revenue
and cost curves are also of conventional type.


2

3. Baumol’s findings of oligopoly firms suggest that the business firms are much
concerned about their total increase in sales than profits. He gives number of
arguments to support his point of view:

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

•If sales are declining,banks,creditors and capital market are not prepared to
provide 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 and
earns profits

•Salaries of workers and management also depends on the large sale




3

4. 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 the
marginal 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 to
maximise 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 the
maximisation 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”
4

5. TC
TR
TP
E
L
B
Baumol’S Model
C
Q D K
M
S
P
OUTPUT
TR/

TC/

P
R
O
F
I
T
S
X
Y
5

6. In the fig.TC is the total cost curve and MP the minimum
profit 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 is
subject to the minimum profit constraint.
6

7. 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
7

8. Model With Advertising
Baumol has further shown that the profit
constraint 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
8

9. o Q D
M
C
P
AdC
TR
TC
T
S
A
E
TP
X
Y
Advertising Outlay
TR/
TC/
P
9

10. 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).
10

11. On the other hand given the profit constraint MP,
the sales maximisation firm will spend OD on
advertising and earn OT (=DE) as the total
revenue.
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 to
increase his advertising outlay until he is stopped
by the profit constraint.
11

12. 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.
12