Profit Maximization and Baumol Model

Managerial Economics August 15, 2007 The key points underpinning the economics of a hit maximizing wet Neoclassical flummox of the household states that cheek will require the main accusing of maximizing its advance within a given period of clipping. Maximum hit was achieved at the output at which borderline greet is equal marginal revenue. thither be several factors which compulsion to be considered when talking or so the net maximizing soused 1. The self-reliance of the wampum maximizing tighten is that at that place is no segregation between managers and owners of the firm.Owners economically depended on their firms and consequently tried to make the biggest clear from their businesses. The effectiveness of their firm was flyerd by the profit declared. In the real world the self-will of the firm (especially for the grownupr firms) is antithetic from the management. Managers become responsible for all day-to-day cognitive operations as hygienic as fi nance documentarys. Those can be different for management and for the owners. Managers hunt to satisfy their own well being instead thus acting on the best interests of the owners.Shareh sure-enough(a)s would like to see the increasing value of the impart from year to year. The separation of ownership from control lead to less causation of shareholders over the managers behavior as well as less awareness of how efficient the finalitys are do. 2. Profit maximizing firm assumes the horizontal marginal revenue curve and U shape marginal cost curve. This means that the market conditions are always ideal, not precise competitive and the revenue cost declines as a end of discounts made to encourage the customers to purchase the products.In reality it is delicate to accurately measure the cost and revenue within administration and so difficult to project the optimal, profit maximizing take. There are a lot of shynesss and conditions which need to be evaluated at any given period of time to crack the cost and revenue curves. Rapidly ever-changing conditions will make it difficult and sometimes impossible to make the accurate measurements. 3. An early(a) presumptuousness is that the organization short- shape preys are the alike(p) as its hanker term objectives booster cable to profit maximisation.In reality, as in long term objective whitethorn be to maximize the firm stock value and make up the shareholders profit, the short term objective may be to keep drop in a firm to establish a split stick for the future. Other constraints like social responsibility of the firm, imperfect or changing market conditions, demand versus total curves etc. will affect the objectives of the firm. 4. ane of the assumptions of the neoclassical example is that the organizations have a perfect experience of the operate conditions.It is recognized in the modern firm that they operate under the suspense level, which, however can be reduced by increasing the knowledge for market, competition and environment. With these factors the conclusion is that the profit maximization cannot be the sole objective of a firm. The factors need to be taken into consideration to determine the best firm strategy and firm objectives. Critical evaluation of Baumol management model. Baumol model is a gross gross gross revenue revenue maximization model. Baumol model is the alternative to the profit maximization model.The main idea of Baumol model is that the objective of a firm is the gross revenue revenue-maximization sort of then profit maximization. The most important points bread and butter Baumol model are The is recognition of separation between firm ownership and management. Managers have discretion to pursue individual(prenominal) goals to maximize their own utility. thusly a minimum profit constraint on management is fit out up by shareholders to address shareholders concerns and interests. Managers more focuses on their own tangible be nefits rather then on profit maximization for the company.Salary increases are likely related to the level of sales rather then organization level of profit. Investors interest in the level of sales and trend of sales rather then level of profit. Growing sales tend to give better picture of company potential and therefore attract refinancing. Rising level of sales recognizes organizations victory and therefore leads to good human relations within the organization. Direct relation between market share and the level of sales means that the organization is raising its position on the market if its sales level increases.In early(a) words the market share of the firm goes up. In Baumol model there is an assumption is that the organization using the Baumol model is operating in an oligopolistic market with no true competition. Baumol thinks that it will take longer for the large organizations, which most likely to be competitors, to arrive to the decision making and decision impleme ntation point due to the competition within the oligopolistic market. However it is in like manner said that within the market there is collision between organizations retributory to maintain an agreed position where everyone can have their share of the market.This is sure as shooting an assumption which cannot be applied to every kind of markets. There are two models of sales revenue-maximization which both work under above assumption the still model and the dynamic model. Static model is a single(a) period model for organization assuming that no competition with other companies exist. In static model a minimum profit constraint is imposed by shareholders regardless of the sales and other conditions of the organization to comfort their interests. The excess of maximum profit level over the minimum profit level constraint is the measure of managerial discretion.There is too an assumption of the U-shaped cost and ? -shape for revenue curves. By looking at the Baumols static sa les revenue-maximization model chart we can see that the quantity developd by the sales revenue maximizer will be the quantity which satisfies the minimum profit constraint and yet al get-gos the greatest level of sales (quantity) to be achieved. The sales revenue maximizer will earn a lower profit, but promote a greater quantity then the profit maximizer. Therefore the sales revenue maximizer will better capture the market share then the profit maimiser.However in the static model Baumol does not dismember the relationship between price, advertising, total cost and quantity of the produced output. When talking about advertising cost Baumol suggests that the advertising expenditures are constantly grow as a straight line and that the sales revenue increases as increases the advertizing cost. In the real world advertisements are made from time to time depending on the organizations marketing studies. Sales revenue as well depends on many factors like market conditions, managerial talent and knowledge, firm pricing strategy, quantity produced, total operating cost etc.In Baumol model we see no attempts to take these factors into consideration. In its dynamic model where the idea is that over the lifetime organization will continue to garner the sales revenue and reinvest the profit into the future organization growth. At a certain point of growth, however, the growth potential will decrease and the level of sales will go down. Even though Baumol elevated a point of uncertainty, he failed to place the time within his model and therefore limited the options of explaining the firm behavior.Baumol model shows that the sales revenue maximizer will produce more output then the profit maximizer. The profit level is also more stable in the Baumol model then in traditional profit-maximizing model. The sales maximizing firm will also have a lower price then the profit maximizing firm. minor cost airline example. Lets take an example of the low-priced airline to ou tline the points of Baumol model. At a glance it may appear that a logical step to maximize the airline profit in order to reinvest more money into the new public lifes and expand the company.But it may not be profitable for an airline in a long run as the customers may loose the loyalty to an always low price airline because of their quality of service or inconveniencies caused during travel. Actions like libertine from the lower cost airports away from the major hubs reducing the number of passage attendants per flight introducing a cheaper meals or no meals at all, offering meals at a separate price cut on entertainments on instrument panel overbooking of the flights to make sure the flight is always full buy cheaper older aircrafts, improve maintenance procedures to reduce the cost would lead to short term profit maximization.On a long run the airline may start loosing customers due to the poor services and inconvenience caused. For example, flying from a low cost airport m ay result in surplus cost for the passengers trying to reach that airport or having a connecting flights from other airports. Significant number of luggage lost would also lead to loosing the customers. Overbooking the flights may cause many passengers not being able to fly at the desired time and therefore loose the loyalty for the airline. Cutting cost on airline maintenance may jeopardize safety procedures and result in catastrophe.American Airlines Flight 191, a McDonnell-Douglas DC-10 aircraft crashed on May 25,1979 after taking off from Chicago airport. Investigation showed that it was a result of an better maintenance procedure imposed by American Airline and preservation then over $200 000 a year. For a low cost airline it is vital to fulfill the flight capacity and sell as much tickets as possible because the flights the cost of flying would remain the same whether the plain is flying full or not. This means that the main objective of the low-cost airline is to maximize t heir level of tickets sold.The actions like reducing inefficiency crossways the board of the airline, putting innovative and creative business concepts, promoting the teamwork, empowering the employees to encourage their personal involvement in day-to-day customer service improvement supervise the airline market, dynamically headstrong ticket price per seat, studying customers call for introducing new routs to popular destinations, organizing convenient connecting flights have faster connectivity time, faster turnarounds point-to-point flights rather then flying through major hubs, using less congest airports internet booking, e-tickets no pre-assigned seat numbers etc. maybe more appropriate for helping to have a low cost operation yet with the high quality standards. The price of the ticket should be determined dynamically (hopefully by specialized software) based on customers demand and supply on a particular proposition route at a particular time. Ideally the ticket p rice should be the highest with maximum filling of flight capacity.For example, early booking price may be lower and raised towards filling the flight capacity. Therefore sales maximizing model fits better for the low cost airlines and gives them more chances to succeed in the market. References Mark Cook, Corri Farguharson (1998) handicraft Economics, Pearson Education Limited Patrick McNutt (2007) Study Guide Unit 1. instruction Objectives and Stakeholder Value, Business & Management Education Limited, UK