BUSS 517

Managerial Economics

Tutor: Prof. Howard Davies
Lecture 3
16
th
September, 2002

Group 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 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
Profits
A

B

Baumols 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
Profits
Q
1
R
max
Revenue-maximization subject to different
minimum profit constraint
Q
3
$

Output

PC
1
PC
2
PC
3
Q
2
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 Properties
Price 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: Q
0
to Q
1
Profits
1
Q
0
Q
1
0

Total cost

Total Revenue
0
Profits
0
Comparative static
Revenue
max $

Output

PC

Total Revenue
1
Decrease in Demand: Q
0
to Q
1
Profits
1
Q
0
Q
1
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC
1
Total cost
1
Increase in fixed cost: no movement of Q
0

Profits
1
Q
0
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC

Total cost
1
Increase in fixed cost under profit constraint:
Q
0
to Q
1
Profits
1
Q
0
Q
1
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC
1
Total cost
1
Decrease in fixed cost: no movement of Q
0

Profits
1
Q
0
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC

Total cost
1
Decrease in fixed cost under profit constraint:
Q
0
to Q
1
Profits
1
Q
1
Q
0
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC
1
Total cost
1
Increase in variable cost: Q
0
to Q
1
Profits
1
Q
0
Q
1
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC
1
Total cost
1
Profits
1
Q
0
0

Increase in variable cost: no movement of Q
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC
1
Total cost
1
Decrease in variable cost: Q
0
to Q
1
Profits
1
Q
0
Q
1
0

Total cost
0
Total revenue
Profits
0
Comparative static
Revenue
max
$

Output

PC
1
Total cost
1
Profits
1
Q
0
0

Decrease in variable cost: no movement of Q
0

Comparative Static Properties
Price 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 firms 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 firms
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!!!