BUSS 517 Managerial Economics Tutor: Prof. Howard Davies Lecture 3 16 th September, 2002
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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!!!