Profit Constraint and Revenue maximization

According to Baumol, every business firm aims at maximization it sales revenue (price x quantity0 rather than its profit. Hence his hypothesis has come to be known as sales maximization theory & revenue maximization theory. According to baumol, sales have become an end by themselves and accordingly sales maximization has become the ultimate objective of the firm. Hence, the management of a firm directs its energies in promoting and maximizing its sales revenue instead of profit.

The goal of sales maximization is explained by the management’s desire to maintain the firm’s competitive position, which is dependent to a large extent on its size. Unlike the shareholders who are interested in profit, the management is interested in sales revenue, either because large sales revenue is a matter of prestige or because its remuneration is often related to the size of the firm’s operations than to its profits. Baumol, however does not ignore the cost of production which has to be covered and also a margin of profit. In fact, he advocates the adoption of a price, which will cover the cost and also will yield a minimum rate of profits. That is, while the firm is maximizing its revenue from sales, it should also “enough or more than enough profits” to keep the shareholders satisfied. According to Baumol the typical digopolists objective can usually be characterized approximately as sales maximization output does not yield adequate profit, the firm will have to choose that output which will yield adequate profit even through it may not achieve sales maximization.

According to sales revenue maximization theory, graphs, cost and revenue curves are given as in conventional theory of pricing, suppose that the total cost (TC) and the total revenue (TR) curves are given, the profit curves (TP) is obtained by plotting the difference between TR and TC curves. Profit are zero where TR = TC. The total sales revenue is maximization where slope of TR curve i.e MR = is equal to zero. Such a point lies at the highest point of the TR curve. The highest point on the TR curve can be obtained easily by drawing a line parallel to the horizontal axis and tangent to the TR curve. The point H on the TR curve represents the total maximum sales revenue. A line drawn from point H to output axis shows sales revenue is maximized at output OQ3 and its price equals HQ3 / DQ3.

Profit Constraint and Revenue maximization :At output OQ3, the firm maximizes the total revenue and makes profit HM = TQ3. If the profit is enough or more than enough to satisfy the shareholders, the firm will produce output OQ3 and charge a price = HQ / OQ3. But if profit at output OQ3 is not enough to satisfy the shareholders, then the firm’s output must be say OQ2 which yields a profit LQ2> TQ3.

Thus, there are two types of probable equilibrium: one is which the profit constraint does not provide as effective barriers to sales maximization, and second in which profit constraint does provide as effective barriers to sales maximization. In the second type of equilibrium, the firm will produce an output which yields a satisfactory ar target profit. It may be an output between OQ1 and OQ2 .e.g if minimum required profit is OP1, than the firm will stick to its sales maximization goal and produce output OQ3 which yields a profit much greater than the required minimum.

Since actual profit (TQ3) is much greater than the minimum required, the minimum profit constraint is not operative, But, if required minimum profit level is OP2, OQ3 will not yield sufficient profit to met the profit target. The firm will, therefore, produce an output OQ­2 where its profit is just sufficient to meet requirement of minimum profit. This output OQ2 is less than the sales maximization output OQ3. Evidently the profit maximization output OQ1 is less than th