Managerial economics, Alternative objectives of firms, Baumol's theory of sales maximisation,

1. BAUMOL’S THEORY
OF SALES
MAXIMISATION
Prof. Prabha Panth,
Osmania University
Hyderabad

2. • Profit Maximisation not the only goal of a firm.
• According to Baumol – Firm’s objective is “Sales
Maximisation” not “Profit Max.”
Why do firms prefer Sales Maximisation?
• Ownership and Management are separate.
• Managers and Owners have different goals.
• Managers’ goals based on Sales Maximisation
because of the following reasons:
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Managerial models of the firm

3. 1. Salaries and perks to managers depend on
sales, not profits.
2. Banks give loans to firms with more sales,
3. Better payment to staff, when sales, but falls
when sales decrease,
4. Sales increases prestige of managers, but large
profits go to shareholders/ owners.
5. Managers prefer steady level of profits, not
maximum profits which are difficult to
maintain.
6. Increasing sales increases firm’s market power,
7. Managers wish to avoid risky ventures that
may temporarily increase profits.
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4. Baumol’s Static Model
• Assumptions:
1. Single time period,
2. Oligopoly firm,
3. Sales Maximisation objective,
4. Minimum profit to satisfy shareholders’
expectations, keep up share prices, and meet
bank requirements,
5. U – Shaped cost curves (AC and MC), P.C. in
factor markets,
6. Downward sloping D-curve,
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5. 5
R, C
0
a
Qx
TR
TC
Rm
R, C
Rs
QsQm
R/q = 0
a
Figure 1.
BAUMOL’S SALES
MAXIMISATION
b
g

6. • In Figure 1, taking TC and TR, the usual profit
maximisation Q is Qm, where TR – TC is maximum.
• But here TR is still rising, it has not reached its
maximum, R/q > 0.
• According to Baumol, managers prefer to have
maximum sales, up to Qs.
• Here R/q = 0, and TR is maximum.
• Some minimum profits = Rs Qs = 0a, can still be
earned.
• Line aa is the minimum acceptable profits, to satisfy
shareholders, owners, etc. (Profit constraint).
• But if minimum acceptable profit > Rs, then not
possible to maximise sales revenue.
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7. Difference between Sales and Profit
Maximisation
7
Pm
Ps
Qm Qs
m
s
Sales Profits
1.Qs > Qm
2.Ps < Pm
3.Profits s < Profits m
4.Ed =1, Ed > 1
5.MR = 0, MR >0

8. Criticism
• Cost and demand functions of individual firms
are not known.
• Oligopoly interdependence has not been taken
into account. Other firms may also lower P,
leading to P wars.
• Uncertainties in oligopoly, not discussed.
• Relationship between firm and industry
equilibrium not shown.
• Owners may demand higher profits not sales.
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