BUSS 517

Managerial Economics

Tutor: Prof. Howard Davies

Lecture 316th September, 2002

Group B1Group B1

Group Member:

• But Yuk Chun, Nicole 02729318G

• Chan Tse Ping, Tony 02703002G

• Mai Kim Man, Carmen 02425083G

• Tam Kam Chiu, Gary 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 presentationOutlines 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 profit-

maximizing 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.

Total cost

Total revenue

ProfitsA

B

Baumol’s Revenue-maximizing ModelBaumol’s Revenue-maximizing Model

D

C

$

Output

Revenue Maximization

E

0

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.

Total cost

Total revenue

ProfitsQ1

R max

Revenue-maximization subject to different minimum profit constraint

Q3

$

Output

PC1

PC2

PC3

Q2

P max

R max = Maximizing revenue P max = Maximizing Profit

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

0

‘Comparative Static’ PropertiesPrice Output

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”)? ?

Total cost

Total Revenue 0

Profits 0

Comparative static

Revenue max

$

Output

PC

Total Revenue 1

Increase in Demand: Q0 to Q1

Profits 1Q0 Q1

0

Total cost

Total Revenue 0

Profits 0

Comparative static

Revenue max$

Output

PC

Total Revenue 1

Decrease in Demand: Q0 to Q1

Profits 1

Q0Q10

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max

$

Output

PC1

Total cost 1

Increase in fixed cost: no movement of Q0

Profits 1

Q0

0

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max$

Output

PC

Total cost 1

Increase in fixed cost under profit constraint: Q0 to Q1

Profits 1

Q0Q1

0

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max

$

Output

PC1

Total cost 1

Decrease in fixed cost: no movement of Q0

Profits 1

Q0

0

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max$

Output

PC

Total cost 1

Decrease in fixed cost under profit constraint: Q0 to Q1

Profits 1Q1Q0

0

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max

$

Output

PC1

Total cost 1

Increase in variable cost: Q0 to Q1

Profits 1

Q0Q1

0

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max$

Output

PC1

Total cost 1

Profits 1

Q0

0

Increase in variable cost: no movement of Q0

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max

$

Output

PC1

Total cost 1

Decrease in variable cost: Q0 to Q1

Profits 1

Q0 Q10

Total cost 0

Total revenue

Profits 0

Comparative static

Revenue max$

Output

PC1

Total cost 1

Profits 1Q0

0

Decrease in variable cost: no movement of Q0

‘Comparative Static’ PropertiesPrice Output

Demand + + +

Demand – - -

Fixed Cost + + -

Fixed Cost +(profit constraint does not “bite”)

No change No change

Fixed Cost – - +

Fixed Cost –(profit constraint does not “bite”)

No change No change

Variable Cost + + -

Variable Cost +

(profit constraint does not “bite”)No change No change

Variable Cost – - +

Variable Cost –

(profit constraint does not “bite”)No change No change

What is Williamson Model (1963)?

• U = Managerial utility

• S = Staff expenditures, over and above those needed to run the firm’s operations

• M = Managerial discretionary pay and expenditures

• D = Discretionary after-tax profits over and above the minimum required to satisfy the shareholders

U = f(S,M,D) where

Maximisation of managerial utility, which means that the

managers get satisfaction from using some of the firm’s

available profits for unnecessary expenditure on items from

which they personally benefit, in the firm

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!!!