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Baumol’s Model of

Sales Revenue Maximisation


W.J.Baumol suggested
Sales Revenue maximisation as an alternative goal to profit
maximisation.
Managers only ensure acceptable level of profit, pursuing a goal
which enhances their own utility.
Rationale of the Hypothesis:
1. Management has been separated from ownership in modern times.
2. This has given powers to Managers who pursue their own goals rather
than the goal of the owners.
3. Managers ensure a minimum acceptable level of profit to satisfy the
shareholders, but would pursue a goal which enhances their own
utility.
Why Managers attempt to maximise sales rather than profits:-
1. Incomes of top executives are closely related to sales rather than
profits.
2. Banks and financial institutions are impressed by the amount of sales
and treat this as a good indicator of the performance of the firm.
3. Large and continuing sales enhance prestige of the Managers, who
ensure regular distribution of dividends.

4 A steady performance with satisfactory amount of profits is preferably to irregular


spectacular profits in some one or two years. Having shown high profits, if the level is
not maintained, it will lead to discontent of shareholders.
5. Large sales strengthens the competitive power of the firm vis-a-vis
competitors, while low or declining sales diminishes this power of
bargaining.

Separation of ownership and management combined with the desire for


steady performance which ensures satisfactory profits, tend to make the
managers risk avoiders. Top Managers in the modern firm are generally
reluctant to adopt highly promising but risk-prone projects. But this
approach stabilises the economic performance of the firm and leads to
development of orderly markets.

Basic assumptions in Baumol’s Static Models:


1. A firm’s decision making is limited to a single period. During this
period, the firm attempts to maximise total revenue rather than
physical volume of sales.
2. Sales revenue maximisation is subject to provision of minimum
required profit to ensure a fair dividend to shareholders, thus ensuring
stability of his job.
3. Conventional Cost and Revenue functions are assumed – Cost curves
are U-shaped, Demand curve is downward sloping.

Uses of Elasticity of Demand for Managerial Decision Making


For taking decisions on a pricing policy, the businessman has to know the
likely effects of price changes on the demand for his product in the market.
He can calculate if the demand will increase by lowering of the price and to
what extent, and whether it will result in substantial increase in revenue and
profits. Some businessmen do not pay any attention to the aspect of
elasticity of demand, and suffer heavy losses by wrong decisions. In
scientific management decision making, on has to have as precise an idea as
possible of the degree of elasticity of demand.
By knowing the type of elasticity, it is possible to fix the precise price of the
product in a very profitable way. Unitary elastic demand will not bring in
more revenue. Demand elasticity being more than unity, a price cut would
lead to increase in revenue.
If the product has inelastic demand, raising price will fetch better revenue
and profits. A monopolist can have a rational price discrimination policy.
E.g., BSES, BWSSB.
In items which are highly responsive to change in income, such as TV sets,
when per capita income rises, larger number of TV sets are sold even at
slightly higher prices.
Cross elasticity helps businessmen to mould their business policies. Demand
for oil increases when ghee price rises. Sugar prices has a relationship to
changes in price of gur. Rise in umbrella prices may push demand for
raincoats. So businessmen can fix their prices appropriately in such cases.