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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We will first present graphically their model as modified by M.
Sales maximisation is incompatible with an elasticity of demand of less than unity. Given that g is financed mainly or totally by the internal profits one might ask whether sales maximisation makes sense as the goal of the firm in a multi period analysis.
If prices were constant, the isorevenue curve would be a straight line with a negative slope, equal to the ratio of the prices of x and y.
When the sales maximiser spends more on advertising, his output will be more than that of the profit maximiser. It depends on the responsiveness of demand to advertising rather than price cuts.
Baumol’s Sales or Revenue Maximisation Theory: Assumptions, Explanation and Criticisms
However, in the Haveman-DeBartolo generalized model this prediction may not be true. Price will depend on the shift of the demand and the cost conditions of the firm. Baumol, Business Behaviour, Value and Saoes.
Growth is financed out of current profits, and the growth curve is therefore derived from the profit curve On in figure If he is constrained to maxinization a maximum profit equal say, to the shaded area P S CBA, the sales maximiser will produce X s and sell it at P s.
The sales maximising firm prefers larger sales to profits. The isorevenue curve has a slope equal to the ratio of the marginal revenues of the two commodities: This claim is not necessarily true. Thus he says that the sales-maximisation reveue has a better predictive performance than the traditional profit-maximisation hypothesis.
Baumol’s Sales Revenue Maximization Model
To find the equilibrium of the firm we need an additional tool, the iso-present-value curve. Advertising outlay is measured on the horizontal axis and the advertising function is shown as a 45 line. In the case of multiproducts, Baumol modek argued that revenue and profit maximisation yield the same results. Beyond that point, however, current sales revenue continues to increase but the rate of growth declines.
Despite these criticisms, there is no denying the fact that sales maximisation forms an important goal bamuol firms in the present day business world.
Sixthly, large, growing sales strengthen the power to adopt competitive tactics, while a low or declining share of the market weakens the competitive position of the firm and its bargaining power vis-a-vis its rivals. If these costs are added to the advertising cost line we obtain the total-cost curve TC as a function of advertising outlay. The isorevenue curves have the same convex shape as previously.
However, the above reasons do not imply that businessmen are completely indifferent to actions of competitors. A firm, he argues, may be willing to keep sales at a high level, even though they are unprofitable in the short run, in the hope that eventually in the long run the product will become profitable once established in the market.
The reason for a lower price under sales maximisation is that both total revenue and total output are equally higher while.
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 is oligopolistic whose cost cures are U-shaped and the demand curve is downward sloping. Under our assumptions maximixation iso-present-value curves will be downward-sloping and will be parallel to one another.
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’s Managerial Theory of Sales Revenue Maximization
By sales maximisation, Baumol means maximisation of total revenue. As in the previous model the goal of the firm is sales revenue maximisation subject to a minimum profit constraint which is exogenously determined. Thus for any two products X i and X j we have. That is, the equilibrium of a sales maximiser is defined by a rsvenue of tangency of the isorevenue and the isoprofit curves; it will be a point on the curve Bxumol.
Baumol’s Managerial Theory of Sales Revenue Maximization
Their results suggest that the correlation between executive incomes and sales revenue is stronger than the correlation between executive incomes and profits. The sales maximiser will earn lower profits than the profit maximiser. But Hawkins has shown that if the firm is engaged in any form of non-price competition such as good packaging, free service, advertising, 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.
From the solution of this constrained maximisation problem we obtain the levels of output X i s and the levels of advertising a i s that maximise sales revenue and earn the minimum acceptable profit. Such behaviour is common for new products, for which the firm expects no profits or even losses at the initial stage of their introduction.
The further away from the origin, the higher the total revenue earned. An increase in variable costs will lead the sales maximiser to an increase in price and a reduction in output.