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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Consequently it will always pay the sales maximiser to increase his advertising expenditure until he is stopped by the profit constraint.
Baumol’s Sales Revenue Maximization Model
This sales maximisation output OK is higher than the profit maximisation output OQ. 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.
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. Growth is financed out of current profits, and the growth curve is therefore derived from the profit curve On in figure R refers to the profit constraint. The firm is oligopolistic whose cost cures are U-shaped and the demand curve is downward sloping.
However, in the Haveman-DeBartolo generalized model this prediction may not be true. The total-revenue curve shifts upwards as advertising is increased. The theory cannot explain observed market situations in which price is kept for considerable time periods in the range of inelastic demand. The sales maximiser sells at a price lower than the profit maximiser.
If the firm were a profit maximiser, it would produce the level of output X nm. Sales revenue of the firm is measured along the vertical axis and profit on the horizontal axis. The price at any level of output is the slope baumo, the line through the origin to the relevant point of the total-revenue curve corresponding to the particular level of output. Unlike a price reduction, increased advertising always increases sales revenue.
In the short run when output cannot be increased, revenue can be increased by raising the price. Thus, by changing advertising we may generate a family of total-revenue curves, each representing the relationship of total revenue to output at different levels of advertising expenditure.
Baumol’s Sales or Revenue Maximisation Theory: Assumptions, Explanation and Criticisms
But the oligopolistic firm wants its money sales to grow revfnue though it earns minimum profits. The growth function is. If the profit constraint is operative the price elasticity will be greater than unity.
An increase in variable costs will lead the sales maximiser to an increase in price and a reduction in output. If these costs are added to the advertising cost line we obtain the total-cost curve TC as a function of advertising outlay. The sales maximiser will earn lower profits than the profit maximiser.
Baumol’s Managerial Theory of Sales Revenue Maximization
If total production costs are independent of advertising, that is, production costs remain constant after advertising takes place as Baumol assumes, this implies that total output X will remain constant after advertising has taken place; consequently an increase in sales revenue R, given X, can be attained only if P is raised. However, such data are not disclosed by firms to researchers, and are commonly unknown to the firms.
When the sales maximiser spends more on advertising, his output will be more than that of the profit maximiser. If the sales of a firm are declining, banks, creditors and the capital market are not prepared to provide finance to it. Advertising outlay is measured on the horizontal axis and the advertising function is shown as a 45 line. Further, they are essential for a firm for paying dividends on share capital and for meeting other financial requirements. Yet there are so many variables that affect demand over time that econometric studies of individual demand functions become extremely tedious and mostly unreliable.
And casual observation shows that this may not be so. It is obvious that S is positively related to both R and g: However, even in these cases the correlations between profits and sales were mostly positive. But the aim of the firm is to maximise its sales rather than profits. Similar is the case with points D and E on the constraint line R where E with higher sales will be preferred to D.
Total sales revenue is at maximizxtion maximum level at the highest point of the TR curve, where the price elasticity of demand revenur unity and the slope of this TR curve the marginal revenue is equal to zero. The model presented by Baumol treats explicitly advertising, but other forms of non-price competition product change, service, quality, etc. Eevenue curve shows all combinations of g and R that yield the same S.
This, however, is a simplifying assumption which may be relaxed in a more general analysis. The further away from the origin, the higher the total revenue earned. Sales Maximisation Model of Oligopoly — Explained! The minimum profit constraint is exogenously determined by the demands and expectations of the shareholders, the banks and other financial institutions.
Such a family of total-revenue curves is shown in figure This prediction is contrary to the traditional hypothesis of profit maximisation. Its total cost and revenue curves are also of the conventional type. See the Haveman-DeBartolo version of the sales-maximisation model. Imposition of a specific tax will lead the sales maximiser to a larger reduction mkdel output and a larger increase in price as compared with a profit maximiser.