Generally in business, there is a trade-off between selling many units at a low price and selling only a few units at a high price. There are different managerial models in a firm embodying different assumptions like the Profit Maximization Model which is a traditional model, the Marris Model, the Williamson Model and the Baumol Model.
This write-up will focus on understanding management preferences in terms of price, revenue and profit maximization, critically evaluate the management model of Baumol and review the extent to which the Baumol model provides a more useful insight into pricing and output decisions of modern management. In many respects, it shares the fundamental characteristics with the standard model, as it also an optimizing model in which a single product firm aims for a single objective, having perfect information about its cost and demand conditions.
Nevertheless, the details are different, as illustrated in below which sets out the basic version of the model, using total revenue, total cost and profit curves. [pic]
As can be seen above, the firm will choose to produce level of output giving total revenue and profit. Note that this implies a higher level of output, and therefore a lower price, then the equivalent profit maximizer, who would produce output A and earn revenue B.
A straight forward revenue maximizer will always produce more and charge less than a profit maximizing firm facing the same cost and demand conditions for the following reasons:
• for revenue maximization, maximum marginal revenue is 0 • for profit maximization, marginal revenue is equals to marginal cost • as marginal cost must be greater than 0, then for a profit maximizer marginal revenue must be greater than 0 • therefore marginal revenue for a profit-maximizer must be greater than marginal revenue for a revenue maximizer • as
