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Sales Maximization
Sales Maximization
Sales Maximization
1. Learning Outcomes
After studying this module, you shall be able to
2. Introduction
Baumol’s sales maximization model was developed by an American economist W. J.
Baumol. He propounded a model of sales maximization in his book “Business behavior,
value and growth”. This model like other managerial theories is an alternative to profit
maximization model. In a dominated corporate world where management is divorced from
ownership, Baumol challenges the profit maximization assumption regarding business
behavior. He laid emphasis on how sales maximization is more valid and realistic
assumption of business behavior in dominated world. According to him, sales
maximization model is one of the managerial theories of the firm. In this model, the more
emphasis had been given to manager’s role and their interest in deciding price, output and
advertising policies. The objective in this model is not to maximize the physical volumes
of sale but to maximize the total revenue from sales. Thus, this theory is also known as
revenue maximization model. Baumol does not reject the profit motive altogether. But
according to him there is a minimum acceptable level of profits which must be earned by
the managers so as to finance growth of the firm in the future through retained profits. This
can be explained as the managers in the oligopolistic firms seek to maximize sales subject
to a minimum profit constraint. In other words, managers seek to maximize total revenue
subject to a minimum profit constraint.
To quote Baumol, “My hypothesis then is that oligopolistic firm typically seeks to
maximize their sales subject to a minimum profit constraint. The determination of the
minimum just acceptable profit level is a major analytical problem and I shall only suggest
here that it is determined by long-run considerations. Profits must be high enough to
provide the retained earnings needed to finance current expansion plans and dividends
sufficient to make future issues of stocks attractive to potential purchasers. In other words,
the firm will aim for that stream of profits which allows for the financing of maximum long
run sales. The business jargon for this is that management seeks to retain earnings in
Let us start Baumol’s sales maximization model with determination of price and output in
an oligopolistic firm, advertising expenditure incurred by oligopolistic firm and then
followed by effect of changes in overhead cost on the prices of the product.
Let us determine the price and output under oligopolistic firm in Baumol sales
maximization model graphically. It is shown in figure1. In the figure, Total revenue, total
cost and total profits are measured on Y-axis and output is measured on X-axis. TC is the
total cost curve in the long run as it starts from the origin. TR is the total revenue curve
faced by the oligopolistic firm. OP is the total profit curve which starts from the origin,
reaches a maximum and then falls thereafter as the level of output increases. Total profit is
defined as the difference between total revenue and total cost at various levels of profit.
Thus, total profit curve measures the vertical distance between total cost and total revenue
curve at various levels of output. Profit is maximum when firm is producing OB level of
output. So, if an oligopolistic firm wants to maximize profit it should produce OB units of
output.
But we have seen above that oligopolistic firm under Baumol sales maximization model
seeks to maximize sales subject to a minimum profit constraint. If the firm wants to
maximize sales then it would produce OD level of output which is greater than profit
maximizing level of output OB. It is clear from the figure that sales maximizing output is
greater than profit maximizing output. At OD level of output, total revenue is maximum
as shown by point TR2. At this level of output, the firms are earning total profit equal to
HD which is less than the maximum total profit BF. Suppose the minimum profit
constraint is denoted by line TL which indicates the minimum total profits which a firm
The firm can earn minimum profit OT as shown by the minimum profit line TL even by
producing OA units of output but the total revenue earned at output level OA is less than
at output level OC. If the objective of the oligopolistic firm is to maximize sales subject to
minimum profit constraint then it would not produce OA units of output. The output
associated with maximum sales is larger than profit maximizing output OB but less than
total revenue maximizing output OD. The oligopolistic firm under Baumol sales
maximization model would be in equilibrium at output level OC. At this output, firms are
earning total profits equal to GC. In Baumol sales maximization model, firms are
maximizing sales subject to minimum profit constraint will lead to lower prices and greater
The price that is charged at output level OC is calculated by dividing total revenue with
units of output produced. The total revenue earned by producing OC units of output is
CTR1. The price that is charged for output level OC is CTR1/OC.
The effect of reduced prices on profits is more uncertain because if it fails to raise total
revenue, it will most probably reduce profits because the increase in output as a result of
reduction in price will increase total costs. On the other hand, while the profitability of
advertising, product modification improved service is doubtful, their favorable effect on
the sales is quite certain.
Let us now turn to explain how much optimal advertising expenditure a firm will undertake
under Baumol sales maximization model.
If the firm seeks to maximize its profit then to earn GA1 units of profit, it would have to
incur advertising expenditure equal to OA1. If the firm seeks to maximize sales subject to
a minimum profit constraint TL, then it should spend OA2 advertisement expenditure. This
sales maximization advertisement expenditure OA2 is more than the profit maximizing
We have seen under Baumol that firms seek to maximize sales subject to minimum profit
constraint. Under Baumol sales maximization model, we can rationalize the change in price
of the product as a result of change in overhead costs. Suppose oligopolistic firms are in
equilibrium that is they are maximizing sales subject to a minimum profit constraint, any
increase in overhead costs would result in increase in total cost of production. This increase
in total cost of production would result in fall in the profit level below the minimum
acceptable profit level. In order to prevent this fall in the profit level below the minimum
acceptable profit level and to be in equilibrium, oligopolistic sales maximization firms
would reduce the production of the product so as to raise the price of the product. It is
shown in figure 3.
In the figure, total profits are measured on Y-axis and output is measured on X-axis. OP is
the total profit curve which starts from the origin, reaches a maximum and then falls
thereafter as the level of output increases. Now suppose for certain revenue and cost
function, the total profits curve PP as shown as in the figure. Suppose the minimum profit
constraint is denoted by line TM which indicates the minimum total profits which a firm
wants to obtain. The oligopolistic firm who seeks to maximize sales subject to a minimum
profit constraint TM is in equilibrium at OA level of output. Now suppose there is an
increase in overhead cost by the amount PP1. With any increase in overhead cost there is
an increase in total cost of production and thus a reduction in the profit earned by the firm.
This increase in overhead cost would shift the total profit curve uniformly downward by
the amount PP1. After increase in overhead cost, the new profit curve is PP1. This increase
in the overhead cost does not affect the profit maximizing level OM. This is so because
any increase in overhead cost reduces the height of the profit curve uniformly downward
with no change in the location of its peak. But the sale maximizing output with TM
minimum profit constraint will reduce output from OA to OB. This reduction in the profit
would induce firms to raise the price of the product. So, under Baumol sales maximization
model, any increase in overhead cost would result in increase in the price of the product.
Under sales maximization model of Baumol, we can easily explain the impact of
corporation tax on the price of the product and the output. Corporate income tax is defined
as tax on the profits of the public limited companies. The same can be explained as like
changes in overhead cost. It is shown in figure 3. Let us suppose that the corporation
income tax of amount PP1 has been imposed. The profit maximizing firm cannot do
anything to shift any part of the corporate income tax to the consumer. Profit maximizing
firm cannot even gain anything by raising the price of the product or changing its output
as a result of imposition of corporate income tax. Hence, the price of the product and the
output remain unaltered as a result of the imposition of the corporate income tax. The
corporation income tax reduces the height of the total product curve from PP to PP1 but it
does not make peak of the curve to move either left or right. For the sales maximization
firm with minimum profit constraint, the price of the product will be raised and output
would decline as a result of corporate income tax.