Description
Describing about theory of profit maximization, Baumoul Sales Revenue Maximizing Model and Willamson Model of Managerial Discretion.
Theory of Profit Maximization
Main Propositions of the Model
• Firm is a unit that transforms valued inputs to outputs given the state of Technology. • Firm strives towards the goal of profit maximization. • Market conditions for firm to operate are given. • While choosing alternatives firm chooses the one which helps it to maximize profits. • Primary concern is to analyze the changes in the prices and quantities of input and output.
Assumptions of the theory
• The firm has a single goal of profit maximization • The firm acts rationally to attain this goal • The firm is a single ownership one.
The Model
• Generation of profit over the time period being analyzed. • Two time periods : Short run and long run • There might be a conflict in profit maximization under two terms might exist. Examples are: • Higher profits in the short run may in the long run induce worker to demand high wages. • Maximization of profit in the short run may give an impression of a exploitative firm, this would affect long term profits. • A firm trying to build up reputation might earn long term profits. • Firms can’t have independent periods.
Determination of Profit Maximizing Output & Price
First Marginal Condition:
? ? TR ? TC
?? ?TR ?TC Condtion1 : ? ? ?0 ?X ?X ?X ?TR ?TC or : ? ?X ?X MR ? MC
The second derivative of the production function is negative
? ? ? (TR) ? (TC ) Condtion 2 : ? ? ?0 ?X ?X ?X ? (TR) ? (TC ) or : ? ?X ?X MR ? MC
2 2 2 2 2 2 2 2 2
This Implies the slope of MR curve is less than the slope of MC curve.
Profits
Revenue and Cost
Q1 Q1 Q2 Q2 Q3 Q3 K2
K1
?
TC
TR
Critique of the NC Model
• Insufficiently realistic • Based on oudated view of competition 1. Organizational goals • Max. of profits or ??? 2. Rationality ?? 3. Perfect information ?? 4. Decision making ??
• The emphasis of the neoclassical theories is that they miss dynamics • The entrepreneur is the personification of the firm, plays an unimportant role in the long run. • Price competition is the only form of rivalry • Schumpeter (1942) and the Austrian school give the enterpreneur a central role within a more dynamic model of competition
Separaton of Ownership from Control
• Two implications: – Increasing organizational complexity meant that it was impossible for the large firms to be managed solely by the owner • Teams of managers • Functional divisions – Impractical for the enterpreneur to finance solely by personal resources • Presence of capital markets
• Baumoul Sales Revenue Maximizing Model • The oligopolistic firms aim at maximizing their sales revenue. • Financial institution judge the health of a firm by the rate of growth of sales revenue. • There is a evidence that slack earnings of top management is correlated with firms sales than its profits. • Increase in Sales revenue provides over time provides prestige to the top management, profit go to shareholders. • Growing salaries keeps a healthy personnel policy. • Managers prefer a steady performance with satisfactory profits. • Large growing sales maintaining or increasing the share of a firm increases competitive power.
Baumol’s Sales Revenue Maximization
• Maximize sales revenue subject to minimum profit constraint • Why sales revenue and not profits??
– Sales are good general indicator of organizational performance – Executive power, influence, status tend to be linked to the sales performance – Lenders tend to rely on sales data
Assumptions of the Model
• Goal of the firm is sales maximization subject to minimum profit constraint. • Advertisement is the major instrument of the firm. • Production cost are independent of advertising • Advertising creates favorable condition for the product • Price of the product is assumed constant
Sales Maximization Model
MR = 0 where
Q = 50
MR = MC where Q = 40
Managerial Theories of the firm
• • • •
Ownership and control are divorced Managers have a primary role Maximize managerial Objectives Managerial utility is a combination of salary, status, power, growth and job security. • Managerial theories have been classified as :
– Sales revenue maximization model – Managerial Utility Model – Growth Maximization Model
Willamson Model of Managerial Discretion
• Managers are free to pursue their own self interest once they have achieved a level of profit that will pay satisfactory dividends to shareholders and still ensure growth. • Self interest depends on many other things besides salary • Incase Goodwill of the firm serves their own ends and ambitions the managers would be concerned else would bypass it.
Assumptions
• Market is not perfectly competitive • Ownership and management are divorced • Minimum profit constraint imposed on managers by the capital market.
The Model
• There are a set of factors that give rise to management satisfaction. • Managers at their own discretion pursue policies which maximize their own utility rather than maximizing profit. • Managerial Satisfaction depends on : prestige, status, responsibility, dominance, professional excellence, salary etc. • Williamson introduces a concept of expense preference: which is defined as satisfaction which managers derive from certain type of expenses. • Expenses are thereby pecuniary and non-pecuniary
Model
• Expense here is measured with the aid of three variables
– A. Additional expenditure on staff – B. Managerial Emoluments – C. Discretionary Investment
• U= f(S,M,Id)
Criticism
• Managers take up projects that appeal to him but which may not be in the best interest of firm in terms of profit generation. • Profit deemed as scientific progress may not be economically efficient.
Growth Maximization Model • Rate of growth and potential of growth are yardsticks to measure corporate success • Growth can be financed from retained earnings or from market borrowing or both • Internal Financing is preferred to growth through borrowed funds • Internal funds grow only through profit maximization. • Decision to maximize growth is also the decision to maximize profit.
Marris
• Executive are limited by the need for management to protect itself from dismissal or takeover in the event of failure. • Like Williamson he believes that management and ownership are different. • Um= f(salaries, power, status, job security) • Uo= f( profits, market share, output, capital and public esteem) • These two variables are correlated with size of the firm.
• Variables that measure size are listed as : capital , output, revenue and market share. • Marris defines them in terms of corporate capital. • Corporate capital “ sum total of book value of assets, inventory, and short term assets including cash revenue. • Managers and owners aim to maximize the rate of growth of size rather than absolute size. • Rate of growth has a positive effect on the prospects of promotion of managers, and also keeps the shareholders satisfied.
• Rate of growth has two constraints: – Sure limit in the rate of managerial expansion – Voluntary slowing down process from the desire of job security. • Marris proposes concept of financial constraint (a), determines the risk attitude of top management. risk loving prefers high a and risk averting a lower a. a is the weighted average of the three: • Liquidity Ratio (a1) = Liquid Assets/Total Assets • Leverage Ratio (a2) = Value of Debts/Total Assets • Profit Retention Ratio (a3) = Retained Profits/Total Profits
The Model
• Max g= gd=gc
• Where – Max g: Maximum Balanced growth – Gd=growth rate of demand of products – GC= growth rate of capital supply
doc_641230307.pptx
Describing about theory of profit maximization, Baumoul Sales Revenue Maximizing Model and Willamson Model of Managerial Discretion.
Theory of Profit Maximization
Main Propositions of the Model
• Firm is a unit that transforms valued inputs to outputs given the state of Technology. • Firm strives towards the goal of profit maximization. • Market conditions for firm to operate are given. • While choosing alternatives firm chooses the one which helps it to maximize profits. • Primary concern is to analyze the changes in the prices and quantities of input and output.
Assumptions of the theory
• The firm has a single goal of profit maximization • The firm acts rationally to attain this goal • The firm is a single ownership one.
The Model
• Generation of profit over the time period being analyzed. • Two time periods : Short run and long run • There might be a conflict in profit maximization under two terms might exist. Examples are: • Higher profits in the short run may in the long run induce worker to demand high wages. • Maximization of profit in the short run may give an impression of a exploitative firm, this would affect long term profits. • A firm trying to build up reputation might earn long term profits. • Firms can’t have independent periods.
Determination of Profit Maximizing Output & Price
First Marginal Condition:
? ? TR ? TC
?? ?TR ?TC Condtion1 : ? ? ?0 ?X ?X ?X ?TR ?TC or : ? ?X ?X MR ? MC
The second derivative of the production function is negative
? ? ? (TR) ? (TC ) Condtion 2 : ? ? ?0 ?X ?X ?X ? (TR) ? (TC ) or : ? ?X ?X MR ? MC
2 2 2 2 2 2 2 2 2
This Implies the slope of MR curve is less than the slope of MC curve.
Profits
Revenue and Cost
Q1 Q1 Q2 Q2 Q3 Q3 K2
K1
?
TC
TR
Critique of the NC Model
• Insufficiently realistic • Based on oudated view of competition 1. Organizational goals • Max. of profits or ??? 2. Rationality ?? 3. Perfect information ?? 4. Decision making ??
• The emphasis of the neoclassical theories is that they miss dynamics • The entrepreneur is the personification of the firm, plays an unimportant role in the long run. • Price competition is the only form of rivalry • Schumpeter (1942) and the Austrian school give the enterpreneur a central role within a more dynamic model of competition
Separaton of Ownership from Control
• Two implications: – Increasing organizational complexity meant that it was impossible for the large firms to be managed solely by the owner • Teams of managers • Functional divisions – Impractical for the enterpreneur to finance solely by personal resources • Presence of capital markets
• Baumoul Sales Revenue Maximizing Model • The oligopolistic firms aim at maximizing their sales revenue. • Financial institution judge the health of a firm by the rate of growth of sales revenue. • There is a evidence that slack earnings of top management is correlated with firms sales than its profits. • Increase in Sales revenue provides over time provides prestige to the top management, profit go to shareholders. • Growing salaries keeps a healthy personnel policy. • Managers prefer a steady performance with satisfactory profits. • Large growing sales maintaining or increasing the share of a firm increases competitive power.
Baumol’s Sales Revenue Maximization
• Maximize sales revenue subject to minimum profit constraint • Why sales revenue and not profits??
– Sales are good general indicator of organizational performance – Executive power, influence, status tend to be linked to the sales performance – Lenders tend to rely on sales data
Assumptions of the Model
• Goal of the firm is sales maximization subject to minimum profit constraint. • Advertisement is the major instrument of the firm. • Production cost are independent of advertising • Advertising creates favorable condition for the product • Price of the product is assumed constant
Sales Maximization Model
MR = 0 where
Q = 50
MR = MC where Q = 40
Managerial Theories of the firm
• • • •
Ownership and control are divorced Managers have a primary role Maximize managerial Objectives Managerial utility is a combination of salary, status, power, growth and job security. • Managerial theories have been classified as :
– Sales revenue maximization model – Managerial Utility Model – Growth Maximization Model
Willamson Model of Managerial Discretion
• Managers are free to pursue their own self interest once they have achieved a level of profit that will pay satisfactory dividends to shareholders and still ensure growth. • Self interest depends on many other things besides salary • Incase Goodwill of the firm serves their own ends and ambitions the managers would be concerned else would bypass it.
Assumptions
• Market is not perfectly competitive • Ownership and management are divorced • Minimum profit constraint imposed on managers by the capital market.
The Model
• There are a set of factors that give rise to management satisfaction. • Managers at their own discretion pursue policies which maximize their own utility rather than maximizing profit. • Managerial Satisfaction depends on : prestige, status, responsibility, dominance, professional excellence, salary etc. • Williamson introduces a concept of expense preference: which is defined as satisfaction which managers derive from certain type of expenses. • Expenses are thereby pecuniary and non-pecuniary
Model
• Expense here is measured with the aid of three variables
– A. Additional expenditure on staff – B. Managerial Emoluments – C. Discretionary Investment
• U= f(S,M,Id)
Criticism
• Managers take up projects that appeal to him but which may not be in the best interest of firm in terms of profit generation. • Profit deemed as scientific progress may not be economically efficient.
Growth Maximization Model • Rate of growth and potential of growth are yardsticks to measure corporate success • Growth can be financed from retained earnings or from market borrowing or both • Internal Financing is preferred to growth through borrowed funds • Internal funds grow only through profit maximization. • Decision to maximize growth is also the decision to maximize profit.
Marris
• Executive are limited by the need for management to protect itself from dismissal or takeover in the event of failure. • Like Williamson he believes that management and ownership are different. • Um= f(salaries, power, status, job security) • Uo= f( profits, market share, output, capital and public esteem) • These two variables are correlated with size of the firm.
• Variables that measure size are listed as : capital , output, revenue and market share. • Marris defines them in terms of corporate capital. • Corporate capital “ sum total of book value of assets, inventory, and short term assets including cash revenue. • Managers and owners aim to maximize the rate of growth of size rather than absolute size. • Rate of growth has a positive effect on the prospects of promotion of managers, and also keeps the shareholders satisfied.
• Rate of growth has two constraints: – Sure limit in the rate of managerial expansion – Voluntary slowing down process from the desire of job security. • Marris proposes concept of financial constraint (a), determines the risk attitude of top management. risk loving prefers high a and risk averting a lower a. a is the weighted average of the three: • Liquidity Ratio (a1) = Liquid Assets/Total Assets • Leverage Ratio (a2) = Value of Debts/Total Assets • Profit Retention Ratio (a3) = Retained Profits/Total Profits
The Model
• Max g= gd=gc
• Where – Max g: Maximum Balanced growth – Gd=growth rate of demand of products – GC= growth rate of capital supply
doc_641230307.pptx