MANAGERIAL THEORIES NOF THE FIRM

This can be considered as a part of behavioral theory. A firm is a

coalition of managers, workers, shareholders, customers, suppliers,
and dealers etc. who have conflicting goals which have to be
considered, so that the firm can survive. In practice the management
would like to pursue goals which maximize their utility, subject to a
minimum profit constraint.

Baumols’s Theory of sales revenue maximization

He has given 2 basic models. The first one is a static single model
and the second is a multi period dynamic model. Both the models
have 2 versions – one without advertisement and the other with
advertisement expenditure.

Static Models

• A firm’s decision making is subjected to a single period.

• The firm’s objective is to maximize sales revenue rather than

volume of sales during the period.

• The sales revenue maximization goal is related to minimum

profit constraint and the critical minimum profit is exogenously
determined by the demands and expectations of the shareholders
(owners) and other members of the firm.

• Conventional cost and average revenue functions are assumed

which implies U shaped cost curves and negative sloping
demand curve.

Price and Output Determination under Single Product Firm –

Without Advertisement
 B
TC

A
TR
Profit constraint
P P

Q1 Q2

TP

• The firm will try to maximize TR than physical volume of

output.

• Sales Revenue maximizing output is OQ2, because at this

level sales revenue is max at BQ2 because, this is the level at
which the elasticity of demand is unity.

• Profit is represented by the difference between TR and TC.

• TP is the total profit taking TR – TC which is maximum at

OQ1. However sales is not maximized because AQ1 < BQ2.

• According to Baumol’s model, the firm is interested in only

sales and not profit.

• OQ1 level of output does not satisfy minimum profit-PP –

firm needs to change output which is met by OQ2. Price is =
BQ2.

Model with Advertising TC

 AE

TR

L
N

P P

45*

A1 A2
TP

Advertising Cost

Assumptions

• Sales maximization
• Advertising as a tool helps the organization generate demand.
• Price remains constant
• Production costs are not affected due to advertisement
• Increased advertisement costs will result in increased volume
of sales, though it may decline after a certain point.
• 45* represents advertising expenditure.
• TC curve is independent of advertising
• TP is the difference between TR and TC.
• Advertising expenditure will always result in increasing the
sales of the firm.
Dynamic Models – Multi Product Firm

In a modern economy an oligopolistic firm is not a single product

enterprise. It generally produces a large number of different items.
It therefore becomes necessary to examine the effects of sales
revenue maximization on the amounts and allocations of the firms
various outputs.
Given the level of expenditure, the sales maximizing firm will
produce the same quantity of each output and market it in the same
ways as does the profit maximizer.
M

C
dy
O
N dx
Product Y

IR4
IR3
IR2
IR1
C1

Product X

IR = Iso Revenue Curves

• The prices of X and Y are assumed to be fixed and hence the

revenue curves are linear.
• They are convex to the origin depicting the diminishing
marginal revenues from the sale of Products X and Y.
• The quantities sold increases as price increases.
• In the same manner, given the total outlay and all the
combinations that can be produced represented by the curve
CC1 represents
• The equilibrium is reached at point E where the curve CC1
is tangent to IR2 which is the point of profit maximization.
• Moreover point E is also the point of revenue maximization
because it is on the highest Iso Revenue curve that is
attainable with the given outlay.

Criticisms

• The sales maximization theory is not easy to verify because

the general data required are not generally available.
• In the long run, both the sales and profit maximization result
in the same solutions. In the long run the firms can earn only
normal profit due to the competition and therefore the
maximum profit constraint automatically coincides with it.

• The theory does not distinguish between the firm and the
industry and also does not explain how a change in the firms
sales maximization will effect the industry’s equilibrium.

• It ignores the actual competition and the threat of potential

competition. In an Oligopolistic market if the firm wants to
capture the rival’s market, then it cannot maximize its sales,
because of the reaction by his rivals in the market.

• Increased outlay on advertisement will not always yield

desired result of increase in sales.
MARRIS MODEL OF THE MANAGERIAL ENTERPRISE

According to Marris, he does not consider that a corporate firm is

a profit maximizer. The goal of the firm is the maximization of
the balanced rate of growth of the firm.

According to him there is a difference in the approaches of the

owner and the manager which leads to a difference in the
interest also.

The owner being more interested in the growth of the firm wants
the maximization in the growth of capital. His utility function
could be described as:

Uo = f(Gc) where:
Uo = utility of the owners
Gc = growth of capital.

The managers believe the growth of the firm depends on the

growth of demand for the products of the firm. Further salaries,
status and power are strongly correlated with the growth of
demand. His function can be described as:

Um = f(Gd,S) where:
Um = Utility of managers
Gd = growth of the products of the firm
S = measure of job security

In pursuing the balanced growth objective, the firm faces two

constraints:
a) Financial constraints – set by skill and efficiency of
the managerial team
 b) Managerial constraints – set by the desire of
managers to attain the maximization of their own
utility function and their owner’s utility function.

The managers and the owners can attain equilibrium because

most of the variables of the managers (status, salaries, job
securities, and power) and the owners (profit, capital growth,
output, public esteem) are positively and strongly correlated with
a single variable viz the size of the firm.

THE BEHAVIORAL MODEL OF CYERT AND MARCH

• The real business world is full of uncertainties.

• Accurate and adequate data are not available. Even if
available, managers have little time and ability to process
them and they work under certain constraints.
• Under such conditions, firma find it difficult to operate
under profit maximization hypothesis.
• Firms cannot maximize sales, growth or anything else. They
can earn only “satisfactory profit”, “satisfactory growth” etc.
This kind of behavior is termed as “satisfaction behavior”.
• Apart from dealing with the uncertain business world,
managers have to satisfy a variety of group of people –
stakeholders of the firm who have conflicting interest in the
firm.
• It is important for the firm to satisfy all of them in one way
or the other by sacrificing some of its interests.
• To reconcile between the conflicting interests and goals or
objectives, managers form an “aspiration level of the firm”
with the following goals:
  Production goal
 Sales and market share goal
 Profit goal
 Inventory goal

• All the above said goals and aspirations are set on the basis
of the past experience of the manager’s and their assessment
of the future market conditions. These aspirations are
modified and revised on the basis of achievements and
changing business conditions.

Williamson’s Model of Managerial Discretion