BUSS 517

Managerial Economics
Tutor: Prof. Howard Davies

Lecture 3 16th September, 2002

Group B1
Group Member: But Yuk Chun, Nicole Chan Tse Ping, Tony Mai Kim Man, Carmen Tam Kam Chiu, Gary 02729318G 02703002G 02425083G 02433452G

Topic:
Demonstrate the comparative static properties of the Baumol models and identify those characteristics which the Baumol and Williamson model have in common with the profit-maximizing model

Outlines of the presentation

1. To describe the Baumol Model
2. To explain the Profit Constraint 3. To demonstrate the Comparative Static Properties of

the Baumol Model

4. To describe the Williamson Model (1963) 5. To identify the common characteristics which the Baumol Model, Williamson Model and the profitmaximizing model have

What is Baumol Model (1958)?

Maximisation of sales revenue (in terms of

the salaries of managers, their status and

other rewards) in short run in an oligopoly

market, subject to a minimum level of profit

constraint.

Baumols Revenue-maximizing Model

$
B E Revenue Maximization
Total cost

Total revenue

A
Profits

Output

Basic version of the model, using total revenue, total cost, and profit curves.

The firm will produce at the level of output A where the sales revenue is maximised, giving total revenue B and profit C
It implies a higher level of output, and therefore a lower price, than the equivalent profit-maximiser, which would produce output D and earn revenue E.

Why the model needs to be amended to include a Profit Constraint?

Because maximising revenue may imply making losses to the shareholders To allow a sufficient payment of dividends in order to keep shareholders quiescent and prevent them from voting for a new board of directors. To enhance a positive influence on the market value of the shares in order to avoid a take-over bid by another firm.

Revenue-maximization subject to different minimum profit constraint

Amended version of the model, subject to profit constraint assumed by the firm

$
R max

Total cost

Total revenue

P max

PC1 PC2 PC3

Q3

Q2

Q1

Profits

Output

R max = Maximizing revenue

P max = Maximizing Profit

Comparative Static Properties

Price
Demand + Demand Fixed Cost + Fixed Cost + (profit constraint does not bite) Fixed Cost Fixed Cost (profit constraint does not bite) Variable Cost + Variable Cost + (profit constraint does not bite)

Output
? ? ? ? ? ? ? ? ? ? ? ? ? ? ? ?

Variable Cost
Variable Cost (profit constraint does not bite)

?
?

?
?

Comparative static
Increase in Demand: Q0 to Q1

Total cost

Revenue max

Total Revenue 1

Total Revenue 0

PC 0

Output
Q0 Q1
Profits 0 Profits 1

Comparative static
Decrease in Demand: Q0 to Q1

Revenue max

Total cost

Total Revenue 0

Total Revenue 1

PC 0

Output
Q1 Q0
Profits 1 Profits 0

Comparative static
Increase in fixed cost: no movement of Q0
Total cost 1 Total cost 0

Revenue max

Total revenue

PC1 0 Q0
Profits 1 Profits 0

Output

Comparative static
Increase in fixed cost under profit constraint: Q0 to Q1
Total cost 1

Revenue max

Total cost 0

Total revenue

PC

Output
0 Q1 Q0
Profits 1 Profits 0

Comparative static
Decrease in fixed cost: no movement of Q0
Total cost 0 Total cost 1

Revenue max

Total revenue

PC1 0 Q0
Profits 0 Profits 1

Output

Comparative static
Decrease in fixed cost under profit constraint: Q0 to Q1
Total cost 0 Total cost 1

Revenue max

Total revenue

PC

Output
0 Q0 Q1
Profits 0 Profits 1

Comparative static
Increase in variable cost: Q0 to Q1
Total cost 1

Revenue max

Total cost 0

Total revenue

PC1

Q1

Q0
Profits 1

Profits 0

Output

Comparative static
Increase in variable cost: no movement of Q0
Total cost 1

Revenue max

Total cost 0

Total revenue

PC1 0 Q0
Profits 1 Profits 0

Output

Comparative static
Decrease in variable cost: Q0 to Q1
Total cost 0

Revenue max
Total cost 1

Total revenue

PC1

Q0

Q1
Profits 0

Profits 1

Output

Comparative static
Decrease in variable cost: no movement of Q0
Total cost 0

Revenue max

Total cost 1

Total revenue

PC1 0 Q0
Profits 1

Output

Profits 0

Comparative Static Properties

Price
Demand + Demand Fixed Cost + Fixed Cost + (profit constraint does not bite) Fixed Cost Fixed Cost (profit constraint does not bite) Variable Cost + Variable Cost + (profit constraint does not bite) Variable Cost Variable Cost (profit constraint does not bite)

Output
+ No change + No change No change + No change

+ + No change No change + No change No change

What is Williamson Model (1963)?

Maximisation of managerial utility, which means that the managers get satisfaction from using some of the firms available profits for unnecessary expenditure on items from which they personally benefit, in the firm
U = f(S,M,D) where U = Managerial utility S = Staff expenditures, over and above those needed to run the firms operations M = Managerial discretionary pay and expenditures D = Discretionary after-tax profits over and above the minimum required to satisfy the shareholders

Common Characteristics shared by Baumol Model, Williamson Model and Profit-Maximising Model
Maximising the firm seeks for a maximum value to meet its objectives and achieve the best possible performance
Profit-maximising: profit Baumol Model: sales revenue Williamson Model: managerial utility

Holistic the firm has own objectives and takes decisions and actions as a single entity Deterministic full knowledge of market opportunities and demand condition and costs is assumed

Thank you for your kind attention and participation!!!!

Goodbye! Welcome Group B2!!!