103 – ECONOMIC

ANALYSIS FOR Prof.Dr.Harsha Thorve

BUSINESS
DECISIONS
UNIT 1
1. Managerial Economics: Concept of Economy,
Economics, Microeconomics, Macroeconomics. Nature
and Scope of Managerial Economics, Managerial
Economics and decision-making. Concept of Firm,
Market, Objectives of Firm: Profit Maximization Model,
Economist Theory of the Firm, Cyert and March’s
Behavior Theory, Marris’ Growth Maximisation Model,
Baumol’s Static and Dynamic Models, Williamson’s
Managerial Discretionary Theory.
UNIT 2
2. Utility & Demand Analysis: Utility – Meaning, Utility
analysis, Measurement of utility, Law of diminishing
marginal utility, Indifference curve, Consumer’s equilibrium
- Budget line and Consumer surplus. Demand - Concept of
Demand, Types of Demand, Determinants of Demand, Law
of Demand, Elasticity of Demand, Exceptions to Law of
Demand. Uses of the concept of elasticity. Forecasting:
Introduction, Meaning and Forecasting, Level of Demand
Forecasting, Criteria for Good Demand Forecasting,
Methods of Demand Forecasting, Survey Methods,
Statistical Methods, Qualitative Methods, Demand
Forecasting for a New Products.
UNIT 3
3. Supply & Market Equilibrium: Introduction, Meaning of
Supply and Law of Supply, Exceptions to the Law of
Supply, Changes or Shifts in Supply. Elasticity of supply,
Factors Determining Elasticity of Supply, Practical
Importance, Market Equilibrium and Changes in Market
Equilibrium. Production Analysis: Introduction, Meaning
of Production and Production Function, Cost of
Production. Cost Analysis: Private costs and Social Costs,
Accounting Costs and Economic costs, Short run and Long
Run costs, Economies of scale, Cost-Output Relationship -
Cost Function, Cost-Output Relationships in the Short Run,
and Cost-Output Relationships in the Long Run. (8+1)
UNIT 4
Revenue Analysis and Pricing Policies:
Introduction, Revenue: Meaning and Types, Relationship between Revenues
and Price Elasticity of Demand, Pricing Policies, Objectives of Pricing
Policies, Cost plus pricing. Marginal cost pricing. Cyclical pricing.
Penetration Pricing. Price Leadership, Price Skimming. Transfer pricing.
Price Determination under Perfect Competition- Introduction, Market and
Market Structure, Perfect Competition, Price-Output Determination under
Perfect Competition, Short-run Industry Equilibrium under Perfect
Competition, Short-run Firm Equilibrium under Perfect Competition, Long-
run Industry Equilibrium under Perfect Competition, Long-run Firm
Equilibrium under Perfect Competition. Pricing Under Imperfect
Competition- Introduction, Monopoly, Price Discrimination under
Monopoly, Bilateral Monopoly, Monopolistic Competition, Oligopoly,
Collusive Oligopoly and Price Leadership, Pricing Power, Duopoly, Industry
Analysis. Profit Policy: Break Even analysis. Profit Forecasting. Need for
Government Intervention in Markets. Price Controls. Support Price.
Preventions and Control of Monopolies. System of Dual Price.
UNIT 5

5. Consumption Function and Investment

Function: Introduction, Consumption Function,
Investment Function, Marginal efficiency of
capital and business expectations, Multiplier,
Accelerator. Business Cycle: Introduction,
Meaning and Features, Theories of Business
Cycles, Measures to Control Business Cycles,
Business Cycles and Business Decisions.
BOOKS
Managerial Economics, Peterson, Lewis, Sudhir Jain,
Pearson, Prentice Hall
2. Managerial Economics, D. Salvatore, McGraw Hill,
New Delhi.
3. Managerial Economics, Pearson and Lewis, Prentice
Hall, New Delhi
4. Managerial Economics, G.S. Gupta, T M H, New
Delhi.
5. Managerial Economics, Mote, Paul and Gupta, T M H,
New Delhi.
EVALUATION-

Internal 50
University Exam 50
Total 100
EVALUATION

Attendance 20
FIVE to SIX 30 (5 Marks each)
activities (presentation , quiz, test
including , assignments, internal
internal exam exam
Total 50
 CHAPTER 1
MANAGERIAL
ECONOMICS
SOME IMP CONCEPTS
ECONOMY
What comes to your mind naturally???
CONCEPT OF ECONOMY
CONCEPT OF ECONOMY
 CONCEPT OF ECONOMY
 An economy is the large set of inter-
related production, distribution and
consumption activities that aid in
determining how scarce resources are
allocated.

which is also referred to as an

economic system.
 CONCEPT OF ECONOMY
 Producers – Tata Motors, Cipla, Bank of
Maharashtra, Samsung ….

Consumers- You and me…..

Distribution
WHAT DO YOU (SOCIETY) NEED TO LIVE A
NORMAL LIFE?

PRODUCTS AND SERVICES

???????
WHAT DO YOU (SOCIETY) NEED ?
PRODUCTS AND SERVICES
food, clothing, shelter,
transport facilities like roads and railways, to
reach college,
Laptop/ mobile/ internet for online learning
postal services and
various other services like that of doctors.
And so on……………..----
WHAT DO YOU (SOCIETY) HAVE ?
RESOURCES
YOU- Money of your parents
FARMER- may own a plot of land, some grains, farming
implements, maybe a pair of bullocks
DOCTOR- SKILLS
TEACHER- has the skills required to impart education to
the students.
BUSINESSMAN - INDUSTRY

YOU- Money of your parents --- use your

resources to fulfil what you need
YOU HAVE LIMITED
RESOURCES--MONEY-
1000
You want
Branded clothes-250
/movies/-250
college fees/-250
food at restaurant/-250
trip to lonawala-250
=1250
 AMOL FROM PUNE WANTS TO
VISIT LADAKH THIS MONTH
SALAR CLOTH, ENTERTAINMENT, RENT, FOOD
Y
1LAKH 25000 25000 25000 25000
PM

This tour require 25000

What will u do?
If you want to visit Ladakh???
 AMOL FROM PUNE WANTS TO
VISIT LADAKH THIS MONTH
SALAR CLOTH, ENTERTAINMENT, RENT, FOOD
Y
1LAKH 25000 25000 25000 25000
PM

This tour require 25000

This means he has to forgone

something to visit Ladakh

This is problem of choice/ what will he choose????

 AMOL FROM PUNE WANTS TO
VISIT LADAKH THIS MONTH
SALAR CLOTH, ENTERTAINMENT, RENT, FOOD
Y
1LAKH 25000 25000 25000 25000
PM

This tour require 25000 and let say

someone from family had an minor
accident this also requires 25000

What will he choose????

This is problem of choice/ what will he choose

Resources are limited and wants are unlimited

I may want lot of things but do I

have resources for that

no individual in society, to begin

with, has all the things he/she
needs
This holds true for company

Every medical co wants to produce vaccine for

coronavirus
But they do not have capacity / resources

Country –roads /airport/ metro

Economics is Study of
Choices???

Resources are limited

and wants are unlimited
TYPES OF ECONOMICS
The study of choices by individuals (like how someone
decides to budget their paycheck each month) is
called microeconomics.

The study of governments, industries, central banking,

and the boom and bust of the business cycle is called
macroeconomics.
WHAT IS ECONOMIC
ANALYSIS
A systematic approach to determining the
optimum use of scarce resources, involving
comparison of two or more alternatives in achieving a
specific objective under the given assumptions and
constraints.
 CONCEPT OF
ECONOMICS
Towards the end of the eighteenth century Adam Smith, the
celebrated English Economist and the father of Economics,
termed Economics as the ‘Science of Wealth’.
According to him, “Economics is a science that enquires into
the nature and causes of the wealth of nations”.
Alfred Marshall defined Economics by saying, ‘Economics is a
study mankind in the ordinary business of life’.
Lionel Robins, the modern economist, ‘Economics is a
science which studies human behavior as relationship
between ends and scarce means which have
alternatives uses’.
FACTORS OF
PRODUCTION
CIRCULAR FLOW OF
MONEY
CENTRAL PROBLEMS OF
AN ECONOMY
Production, Distribution and Consumption of
goods and services are among the basic
economic activities of life.

In the course of these basic economic

activities, every society has to face
scarcity of resources and it is the
scarcity of resources that gives rise to
the problem of choice.
 SCARCITY
Scare VS Free

Diamond

Water GANGAJAL / Home in the

Picture
Air

Scare-Have to give something to get these

Free- Infinite- No scarifies are required
 ECONOMY OR
SOCIETY’S PROBLEMS
What is produced and in what
quantities?

How are these goods produced?

For whom are these goods

produced?
 AUTOMOBILE SECTOR
IN INDIA
Per annum basis
What is produced and in what quantities?- Car
-100 –Price- 5L
How are these goods produced?-
Manufacturing IN INDIA
For whom are these goods produced?- People
with income 10L p.a.

Let us say there are 100 people living in India.

20 can afford car (has the required income-
10L p.a.)
WHAT MAXIMUM A
ECONOMY CAN
PRODUCE?
Car, TV, Washing Machine, Software, schools, college,
mobile ad so on

Land, Labor, Capital- Limited

COMPOSITION OF
ECONOMY
The Centrally Planned Economy
In a centrally planned economy, the government or the central
authority plans all the important activities in the economy. All
important decisions regarding production, exchange and
consumption of goods and services are made by the
government.
Cuba, North Korea, and the former Soviet Union are
examples of countries that have command economies,
while China maintained a command economy for
decades before transitioning to a mixed economy that
features both communistic and capitalistic elements.
COMPOSITION OF
ECONOMY
Market economy
In contrast to a centrally planned economy, in a market
economy, all economic activities are organized through the
market. A market, as studied in economics, is an institution
which organizes the free interaction of individuals pursuing
their respective economic activities.

Hong cong, Singapore, Newzealand

COMPOSITION OF
ECONOMY
Mixed Economy:
In reality, all economies are mixed economies where some
important decisions are taken by the government and the
economic activities are by and large conducted through the
market.
India , US almost all
ECONOMICS

Origin ---Greek word

Oiken and nomos means household
management
CONCEPT OF
MACROECONOMICS
 Macroeconomics is the branch of economics
that deals with the structure, performance,
behavior, and decision-making of the whole, or
aggregate, economy.
 The two main areas of macroeconomic research are
long-term economic growth and shorter-term business
cycles.
 Macroeconomics in its modern form is often defined as
starting with John Maynard Keynes and his theories
about market behavior and governmental policies in
the 1930s; several schools of thought have developed
since.
 In contrast to macroeconomics, microeconomics is
more focused on the influences on and choices made
CONCEPT OF
MICROECONOMICS
 Microeconomics studies the decisions of
individuals and firms to allocate resources of
production, exchange, and consumption.
 Microeconomics deals with prices and production in
single markets and the interaction between different
markets, but leaves the study of economy-wide
aggregates to macroeconomics.
 Micro economists use mathematics as a language to
formulate theories and observational studies to test
their theories against the real world performance of
markets.
DIFFERENCE

Point of Microeconomics Macroeconomics

difference
Definition

Example

Deals with

Vision

Scope

Popularity
DIFFERENCE

Point of Microeconomics Macroeconomics

difference
Definition

Example Income of National income

Individual
Deals with Individual product, National income,
firm, household national output
Vision Microscopic Telescopic

Scope Limited Broad

Popularity Alfred Marshal J.M. Keynes

SUMMARY
CONCEPTS OF
MANAGERIAL
ECONOMICS
 Managerial Economics may be defined as the study of
economic theories, logic and methodology which
are generally applied to seek solution to the
practical problems of business.
Managerial Economics is thus constituted of that part
of economic knowledge or economic theories which is
used as a tool of analyzing business problems for
rational business decisions.
Managerial Economics is often called as Business
Economics or Economic for Firms.
DEFINITION OF
MANAGERIAL
ECONOMICS
 “Managerial Economics is economics applied in
decision making. It is a special branch of economics
bridging the gap between abstract theory and
managerial practice.” – Haynes, Mote and Paul.
“Business Economics consists of the use of economic
modes of thought to analyse business situations.”
- McNair and Meriam
“Business Economics (Managerial Economics) is the
integration of economic theory with business practice
for the purpose of facilitating decision making and
forward planning by management.” - Spencer
and Seegelman
“Managerial economics is concerned with application
of economic concepts and economic analysis to the
NATURE OF
MANAGERIAL
ECONOMICS
 The primary function of management executive in a
business organisation is decision making and
forward planning.
Decision making and forward planning go hand in hand
with each other. Decision making means the process of
selecting one action from two or more alternative
courses of action. Forward planning means establishing
plans for the future to carry out the decision so taken.
The problem of choice arises because resources
at the disposal of a business unit (land, labour,
capital, and managerial capacity) are limited and
the firm has to make the most profitable use of
these resources.
SCOPE OF MANAGERIAL
ECONOMICS
The scope of managerial economics is not yet clearly
laid out because it is a developing science.
Even then the following fields may be said to generally
fall under Managerial Economics: from above case we
learned
1. Demand Analysis and Forecasting
2. Cost and Production Analysis
3. Pricing Decisions, Policies and Practices
4. Profit Management
5. Capital Management
MANAGERIAL ECONOMICS AND
DECISION-MAKING
MANAGERIAL
ECONOMICS AND
DECISION-MAKING
Defining Problem-

Course of Action- (how will u solve it)

Evaluating alternative: what options

you have

Observing results:
CASE 1
YOU are driving a car for imp interview and
car malfunctions

Defining the problem- I have a flat

tyre
OBJECTIVE- REPLACE
THE TYRE
If you have a kit you can do it
If not
IDENTIFYING
ALTERNATIVES- FIND
TYRE REPLACING
CENTERS
( Near one )or At a Distance
IDENTIFYING ALTERNATIVES-
NEAR ONE----CLOSE BUT HAS MORE COST
AT DISTANCE--- IS FAR BUT IT IS CHEAP
MAKING CHOICE- WILL
GO TO NEAR ONE AS
INTERVIEW IS IMP
CASE STUDY--2
In year 2008, Godrej Consumer
Products reported worse-than-expected
fourth-quarter earnings, underscoring
the persisting weak demand in Asia's
third-largest economy.
From last few years consumers were
neglecting products of the company.
Despite Brand name people were
turning away from companies’ product.
What will you do to get the customers
back?
Using decision making tool answer the
MANAGERIAL
ECONOMICS AND
DECISION-MAKING
Defining Problem-

Course of Action- (how will u solve it)

Evaluating alternative: what options

you have

Observing results:
WHAT GODREJ DID

Defining Problem-Despite Brand name people were

turning away from co product
Course of Action-Introduce Better Technology, more
products, rebrand to appeal the youth
Evaluating alternative: Finding brand ambassador, new
adds etc. (RITIK ROSHAN, NEW LOGO)
Observing results: Godrej is top FMCG co in India in
next 2-3 years
CASE 3
A film song was recorded in a studio.
(Today)
One of the employee on the set leaked
the song on the you tube as a pirated
version. ( to earn the money). (next day)

As this will ruin the song and the film

both what will you do?
MANAGERIAL
ECONOMICS AND
DECISION-MAKING
Defining Problem-

Course of Action- (how will u solve it)

Evaluating alternative: what options

you have

Observing results:
CASE ON DECISION
MAKING
MANAGERIAL
ECONOMICS AND
DECISION-MAKING
Defining Problem-

Course of Action- (how will u solve it)

Evaluating alternative: what options

you have

Observing results:
CONCEPT OF FIRM
Firm is a business organisation that buys or hires
factors of production in order to produce goods and
services that can be sold at a profit.
Objective of firm:-
1. The standard economic assumption underlying the
analysis of firms is profit maximization. Firms are
assumed to make decisions that will increase profit.
Generally speaking, profit maximization is the
process of obtaining the highest possible level of
economic profit through the production and sales of
goods and services.
2. sales maximization
3. pursuit of personal welfare, and
TYPES OF FIRM- DEFINE EACH
AND GIVE 5 EXAMPLES OF EACH
THE CYERT AND MARCH THEORY OF FIRM

Cyert and March proposed that real firms aim at satisfying

rather than maximizing their results
The behavioral theory of firm was developed by Cyert and
March, focuses on the decision making process of the large
multi product firm under uncertainty in an imperfect market.
They deal with the large corporate managerial business in
which ownership is separated.
Their theory was originated from the concern about the
organizational problem with the internal structure of such firms
that creates the need to investigate the effect on the decision
making process in these large organizations.
The internal organizational actors may well explain the
difference in the reactions of firms to the same external stimuli,
that to the same changes in their economic environment
THE CYERT AND
MARCH THEORY OF
FIRM
The assumptions underlying the behavioral theories about
the complex nature of the firm introduces an element of
realism into the theory of the firm. The firm is not treated as
a single-goal, single decision unit, as in the traditional
theory, but as a multi goal, multi decision organization
coalition.
The firm is as a coalition of different groups which are
connected with its activity; in various ways, managers,
workers, shareholders, customers, suppliers, bankers, tax
inspectors and so on. Each group has its own set of goals or
demands.
The behavioral theory recognizes explicitly that there exists
a basic dichotomy in the firm, there are individual members
of the coalition firm and there is the organization coalition
known as ‘the firm’. The consequence of the dichotomy is a
conflict of goals; individuals may have different goals to
those of the organization firm.
THE CYERT AND
MARCH THEORY OF
FIRM
Cyert and March argue that the goals of the firm depends on the
demand of the members of the coalition, while the demand of these
members are determined by various factors such as aspiration of
the members, their success in the past in occupying their demands,
the expectations, the achievements of other groups in the same or
other firms, the information available to them.
The demands of the various groups of the coalition firm change
continuously over time. Given the resources of the firm in any one
period, not all demands, which confront the top management can
be satisfied. Hence, there is a regular bargaining process between
the various members of the coalition firm and inevitable conflict.
The top management has several tasks; to get the goals of the firm
which are often in conflict with the demands of the various groups,
to resolve the conflict between the various groups, to reconcile as
far as possible the conflict in goals of the firm and of its individual
groups.
THE GOALS OF THE FIRM ARE SET BY
THE TOP MANAGEMENT, WHICH THE
MAIN FIVE GOALS OF THE FIRM ARE

Production Goal: The production goal originates from the

production department. The main goal of the production manager
is the smooth running of the production process. Production
should be distributed evenly over time, irrespective of possible
seasonal fluctuations of demand, so as to avoid excess capacity
and lay off of workers at some periods and over working the plant
and resorting to rush recruitment of workers at other times with
the consequence of higher, costs due to excess capacity and
dismissal payments or too frequent breakdowns of machinery
and waste of raw materials in period of rush production.
Inventory Goal: The inventory goal originates mainly from
the inventory department if such a department exists, or from
the sales and production department. The sales department
wants an adequate stock of output for the customers, while the
production department needs adequate stocks of raw materials
and other items necessary for a smooth flow of
the output process.
THE GOALS OF THE FIRM ARE SET
BY THE TOP MANAGEMENT, WHICH
THE MAIN FIVE GOALS OF THE FIRM
ARE
Sales Goal: The sales goal and the share of the market goal
originate from the sales department. The same department
will also normally set the ‘sales strategy’ that is decided on
the advertising campaigns, the market research programs,
and so on.
Profit Goal: The profit goals is set by the management so
as to satisfy the demand of share holders and the
expectations of bankers and other finance institutions; and
also to create funds with which they can accomplish their
own goals and projects, or satisfy the other goals of the firm.
Share of the market goal: While making decisions, the
firms are guided by these goals. All goals must be satisfied
but there is an implicit order of priority among them. The
conflict among different goals may crop up.
THE GOALS OF THE FIRM ARE SET
BY THE TOP MANAGEMENT, WHICH
THE MAIN FIVE GOALS OF THE FIRM
ARE
The goals of the firm are ultimately decided by the top management
through continuous bargaining between the groups of the coalition. In
the process of goal formation, the top management attempts to satisfy
as many as possible of the demands with which the various members of
the coalitions confront it. The goals of the firm such as the goals of the
individual members or particular groups of the coalition take the form
of aspiration levels rather than strict maximizing constraints.
The firm in the behavioral theories seeks to satisfy, i.e., to attain a
‘satisfactory’ overall performance as defined by the set aspiration goals,
rather than maximize profits, sales or other magnitudes.
The firm is as satisfying organization rather than a maximizing
entrepreneur. The top management, responsible for the coordination of
the activities of the various members of the firm, wishes to attain a
‘satisfactory’ level of production, to attain a share of the market, to earn
a ‘satisfactory’ level of profit, to divert a ‘satisfactory’ percentage of
their total receipts to research and development or to advertising,
to acquire a ‘satisfactory’ public image and so on.
But it is not clear in the behavioral theories what is a satisfactory and
what an unsatisfactory attainment is.
CRITICISMS OF THE CYERT AND
MARCH THEORY

The behavioral theory relates to a duopoly firm and fails as the

theory of market structures. It does not explain the
interdependence and interaction of firms, nor the way in which
the interrelationship of firms leads to equilibrium of output and
price at the industry level. Thus, the conditions for the attainment
of a stable equilibrium in the industry are not determined.
The theory does not consider either the conditions of entry,
effects on the behavior of existing firms of and the threat of
potential entry by firms.
The behavioral theory explains the short-run behavior of firms
and ignores their long-run behavior. It cannot explain the dynamic
aspects of inventions and innovations which are related to the
long-run.
The behavior theory is based on the simulations approach which
is a predictive technique. It is simply the products of behavior of
the firm but does not explain it.
MARRIS’ GROWTH
MAXIMIZATION MODEL
Working on the principle of segregation of
managers from owners, Marris proposed that
owners (shareholders) aim at profits and market
share, whereas managers aim at better salary,
job security and growth. These two sets of goals
can be achieved by maximising balanced growth of the
firm (G), which is dependent on the growth rate of
demand for the firm's products (gD) and growth rate of
capital supply to the firm (gC). Hence growth rate of
the firm is balanced when the demand for its product
and the capital supply to the firm grow at the same
rate.
FINANCIAL CONSTRAINT
This relates to the prudence needed in managing
financial resources. Marris suggested that a prudent
financial policy will be based on at least three financial
ratios, which in turn set the limit for the growth of the
firm. In order to prove their discretion managers will
normally create a tradeoff and prefer a moderate debt
ratio, moderate liquidity ratio and moderate retained
profit ratio.
(a) Debt ratio (DR): This is the ratio between borrowed
capital and total assets of the firm.High value of this
ratio may cause insolvency; hence a low value of this
ratio is usually preferred by managers to avoid
insolvency. However, a low value of DR, may create a
constraint to the growth of the firm in terms of
dependence on high cost capital, i.e., equity.
(b) Liquidity ratio (LR): This is the ratio between
liquid assets and total assets and is an indicator
of coverage provided by current assets to current
liabilities. According to Marris, a manager would
try to operate in a region where there is
sufficient liquidity and safety and hence would
prefer a high LR. But this would imply low
yielding assets, since liquid assets either do not
earn at all (like cash and inventory), or earn low
returns (like short term securities)
(c) Retention ratio (RR): This is the ratio between
retained profits and total profits. In other words,
it is the inverse of dividend payout ratio, i.e., the
retained profits are that portion of net profit
which is not distributed among shareholders. A
high retention ratio is good for growth, as
retained profits provide internal source of funds.
FORMAL PRESENTATION
OF THE MODEL
In Marris’s model the optimization goal of the firm is
maximization of the balanced rate of growth (g) which
internally depends on two factors: the rate of growth of
demand for the firm’s products (gD), and the rate of growth of
capital supply (gC). Thus g = gD = gC
The firm seeks to pursue this balanced growth objective,
subject to two major constraints: managerial and financial. The
managerial constraint is set by the skill and efficiency of
available manager’s team. The financial constraint is set by the
desire of managers to attain the maximization of their own
utility function and their owner’s utility function.
Marris argues that since growth is an objective acceptable to
both the owners and managers therefore there is no need to
distinguish between rate of growth of demand (which
maximizes utility of managers ) and rate of growth of capital
supply (which maximizes utility of owners) since in equilibrium
these two are equal. Thus we can write two utility functions as
U0 = f1 (gC) Um = f2(gD,s)
Where C-capital supply; D-demand,s-job security
constraint
U=utility Function
BAUMOL'S THEORY OF SALES REVENUE MAXIMISATION

Prof. Baumol, in his book 'Business behavior, Value and

Growth' has propounded a theory of Sales
Maximization. Main aim of a firm is to maximise sales.
By sales he meant total revenue earned by the sale of
goods. That is why this goal is also referred to as Sales
Maximization Goal.
According to this theory, once profits reach acceptable
levels, the goal of the firms become maximisation of
sales revenue rather than maximisation of profits.
In the words of Baumoul, 'The sales maximisation goal
says that managers of firms seek to maximise their
sales revenue subject to the constraint of earning a
satisfactory profits.
BAUMOL'S THEORY OF
SALES REVENUE
MAXIMISATION
Baumol raised serious questions on the validity of
profit maximisation as an objective of the firm. He
stressed that in competitive markets, firms would
rather aim at maximising revenue, through
maximisation of sales.
According to him, sales volumes, and not profit
volumes, determine market leadership in competition.
He further stressed that in large organisations,
management is separate from owners.
Hence there would always be a dichotomy of
managers' goals and owners' goals. Manager's salary
and other benefits are largely linked with sales
volumes, rather than profits.
BAUMOL'S THEORY OF
SALES REVENUE
MAXIMISATION
Baumol hypothesised that managers often attach their
personal prestige to the company's revenue or sales;
therefore they would rather attempt to maximise the
firm's total revenue, instead of profits.
Moreover, sales volumes are better indicator of firm's
position in the market, and growing sales strengthen
the competitive spirit of the firm. Since operations of
the firm are in the hands of managers, and managers'
performance is measured in terms of achieving sales
targets, therefore it follows that management is more
interested in maximising sales, with a constraint of
minimum profit.
Hence the objective is not to maximise profit, but to
maximise sales revenue, along with which, firms need
to maintain a minimum level of profit to keep
BAUMOL'S THEORY OF
SALES REVENUE
MAXIMISATION
i. More Realistic: Goal of maximisation of sales is a
more realistic goal- In fact, firms accord more
importance to the goal of sales maximisation than
profit maximisation. It is so because success of a firm
is generally judged from its total sales
ii. More Practical: Revenue maximisation thesis of
Baumol is more practical. It is so because goal of
revenue (Sales) maximisation leads to more production
which, in turn, leads to fall in price. As a result,
consumers' welfare is promoted. They also endorse
this goal of the firms.
iii. More Availability of Loans: At the time of sanctioning
loan to a firm, financial institutions mainly consider its
sales. Prospects of loans are bright for such firms as
have large total sales.
BAUMOL'S THEORY OF
SALES REVENUE
MAXIMISATION
iv. Strong Position in the Market: Maximum sales of a
firm symbolize its strong position in the market. Sales
of a firm will be large only in that situation when
consumers like its production, firm has more
competitive power and has been expanding. All these
features are indicative of the progress of the firm.
v. More Advantageous to the Managers: It is more to
the advantage of the managers that the firm should
aim at sates maximisation. This way their credibility
enhances in the market. Maximum sales is a reflection
of the competence of the managers It has a favorable
effect on their wages. Firm is in a position to offer
higher wages to the employees
WILLIAMSON’S MODEL OF
MANAGERIAL DISCRETION
O.E. Williamson presented his model in the article, ‘Managerial
Discretion and Business Behavior’ published in American Economic
Review (1963). According to him managers have the discretion of
following policies which further their utility maximization objective,
rather than that of owners. But discretion of managers is limited by
the desire of owners to earn a minimum level of profits. This acts as
a constraint on the profit maximizing behavior of the managers.
Managers utility function comprises the variables as salary, job
security, power ,status, position etc
WILLIAMSON’S MODEL OF
MANAGERIAL DISCRETION
According to Williamson, managers are concerned with the goodwill
of the firm only to the extent that it favors their own personal
motives and ambitions. He argues that the most important motive of
managers are desires for salary, security, dominance and professional
excellence.
These can be gained by incurring additional expenditure on staff,
managerial emoluments and discretionary investment. Williamson
argues that managers have discretion in pursuing policies which
maximize their own utility rather than seeking the maximization of
profits which maximize the utility of most shareholders (i.e., the
owners of the company).
WILLIAMSON’S MODEL OF
MANAGERIAL DISCRETION
Um = ƒ(S, M, ID)
where Um = managerial utility, S = monetary
expenditure on staff including managerial salary, M =
Managerial slack, absorbed as a cost, and ID = amount
of discretionary investment.
Apart from salary directly, managerial power and
status in the firm also depend on number of staff
working under him. This being directly related to salary
is clubbed with it in the Um function.
Management slack concerns non essential expenditure
on lavishly furnished offices, luxurious company car
and the like. Discretionary investment is the amount of
funds the managers can use according to their will.
Maximization of the above utility function is subject to
CASE STUDY 1
Case Study 2