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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In the case of multiproducts, Baumol has argued that revenue and profit maximisation yield the same results. TR is the total revenue curve. If the firm is a profit maximiser the imposition of the lump-sum tax will not affect the price and output in the short run the profit maximiser will bear the whole burden of the lump-tax.
Consequently it will always pay the sales maximiser to increase his advertising expenditure until he is stopped by the profit constraint. Peston ventured the idea that sales maximisation is not incompatible with the goal of long-run profit maximisation. MP is the minimum profit constraint line. The product transformation curve is concave to the origin showing the increasing difficulty increasing cost of reducing product y and reallocating the resources to the increase of product x.
Such a family of total-cost curves is shown in figure Sales revenue of the firm is measured along the vertical axis and profit on the horizontal axis.
Baumol’s Sales or Revenue Maximisation Theory: Assumptions, Explanation and Criticisms
Peston also argued that firms may increase their sales beyond the level at which profit is maximised from sheer ignorance of their demand curve. This is shown modek figure The saels hypothesis cannot be tested against competing behavioural hypotheses unless the demand and cost functions of individual firms are measured.
Its total cost and revenue curves are also of the conventional kaximization. Fourthly, large sales, growing over time, give prestige to the managers, while large profits go into the pockets of shareholders. 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.
Formally, the condition for the equilibrium of the multiproduct bajmol with given resources and costs is. This curve shows all combinations of g and R that yield the same S.
Firstly, there is evidence that salaries and other slack earnings of top managers are correlated more closely with sales than with profits. Hall in an answer to Waverman accepts that the main defect of his study lies in the method of estimation of the minimum profit constraint, but he points out that this was the best he could do with the available data.
Prof Baumol in his article on the theory of Oligopoly presented a managerial theory of the firm based on the sales maximisation. reveenue
However, this is inconsistent with what Baumol states elsewhere p. Recall that from the definition of S. It does not imply the sale of large quantities of output, but refers to the increase in money sales in rupee, dollar, etc. If the government imposes a lump-sum tax with the aim of redistributing income away from the taxed firm, its goal will not be attained, since the sales maximiser will shift the burden to his customers by charging increased prices.
These changes will be greater than those of a profit maximiser. This model can be extended to cover simultaneous changes in advertising and in output when surplus profits are earned.
Baumol’s Sales Revenue Maximization Model
So both the sales maximiser and the profit maximiser would not be producing different levels of output. Profits also will be higher for the profit maximiser.
Salaries of workers and management also depend to a large extent on more sales and the firm gives them bonus and other facilities.
Clearly there is an infinite combination of values of g and R that the firm may choose. We assume that the sales revenue R grows at a rate salss growth g per cent. By sales maximisation, Baumol means maximisation of total revenue.
Baumol’s Managerial Theory of Sales Revenue Maximization
There is nothing startling about this, since in both models we assume given resources and costs. We will first present graphically their model as modified by M. In particular, being sales maximisers and growth seekers, they are very alert to any change in their share of the market.
The firm is in equilibrium when it reaches the highest point of this curve. This, however, is ssales simplifying assumption which may be relaxed in a more general analysis.
Secondly, the banks and other financial institutions keep a close eye on the sales of firms and are more willing to finance firms with large and growing sales.
However, firms expect to earn profits once their product becomes known in the market and captures a share at least equal to the minimum optimum scale.
Baumol’s Managerial Theory of Sales Revenue Maximization
This conclusion holds for firms producing only one product, or one group of products. This behaviour, however, does not by itself provide a proof that the firm is a sales maximiser or a profit maximiser. The model ignores not only actual competition, but also the threat of potential competition from rival oligopolistic firms.
Sapes firm in an oligopolistic market will prefer to increase its sales by advertising rather than by a cut in price. Thus, by changing advertising we may generate a family of total-revenue curves, each representing the relationship of aales revenue to output at different levels of advertising expenditure.
In fact Baumol relaxes this assumption, as well as the assumption of constant price in the mathematical presentation of his model; see below. If this were not so, the firm could increase R by reallocating the total advertising expenditure A among the different products, increasing advertising on those commodities for which the marginal revenue would be reveenue. Despite these criticisms, there is no denying the fact that sales maximisation forms an important goal of firms in the present day business world.
As in the previous model the goal of the firm is sales revenue maximisation subject to a minimum profit constraint which is exogenously determined. And casual observation shows that this may not be so. Suppose the minimum profit level of the firm is represented by the line MP. But he claims that this assumption is simplifying and can be relaxed without substantially altering the analysis. It is obvious that S is positively related to both R and g: It is the dotted curve in figure