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What Are the Main Achievements of Marginalism?

We have now seen the basic features of the marginalist model of the firm as a whole and can make an interim assessment of its value.

The first positive element is its generality. It can analyze competition between producers of un-differentiated products (price-takers), monopolists, and competitive producers of differentiated products (price-makers facing competition). We see its analysis of oligopoly 'competition between the few' - and also we shall see those rival models of the firm cannot match its breadth of coverage.

The second positive element is its compatibility with other areas of marginalist theory. Along with other areas not included in this book they constitute a complete model of microeconomic relationships.

This generality and compatibility lead to the third asset applicability. Marginalist theory of the firm has an impressive list of areas in which it has been applied to forecast the behavior of firms when faced with problems such as cost increases, taxation changes, and government controls over prices and dividends.

Explain Major Criticisms of Marginalism

Marginalism has also been widely criticized, and we deal with some of the results of this criticism in this and subsequent. In some sense, the other models of the firm as a whole are the result of gaps in the marginalist model.

First, there is the objection that many firms are not mainly interested in profit, but in sales (whether in units or in value). This 'sales maximisation' objective is discussed later.

A second line of criticism has centered on the pricing policies which should be and/or are followed by firms. Research has often shown firms operating other than equating MC and MR!

The assumption about decision-taking has been criticized by those who stress the role of professional managers, and the effect of different management structures on decision-taking.

Strategic interdependence was not really incorporated into marginalist theory until comparatively late, and oligopoly has remained an area of weakness.

Lastly, we can argue that firms themselves do not usually build marginalist models of their operations to aid them in decision-making.

Having produced arguments for and against the marginalist model, let us now look at a recent rival, the sales-maximisation model.

Give an outline of the Sales Maximization Model

The most detailed outline of the sales(revenue) maximisation model is attributable to Baumol (1959), and this outline relates a simple version of it to the marginal analysis we have already used.

The initial impetus for the theory arose from the observation of American firms that appeared to be attempting mainly to increase their turnover (total revenue) while not neglecting to make enough profit to satisfy shareholders' desire for dividends and provide for future investment. Thus they were maximising sales subject to a satisfactory rate of profit.

Let’s first decide whether they were price-takers or price-makers. Assuming, first, price-takers, we could make use of Figure 5.4 below.

Fig. 5.4 Costs and revenue for price-takers

Fig. 5.8 Sales maximization by a price-taker

We have assumed that normal profit will be 'satisfactory' to the firm; if not, we could raise the AC curve by the requisite amount. We can now look at the price-takers position by using Figure 5.6 to construct Figure 5.9.

Fig. 5.6 Costs and revenue for price-makers

Fig. 5.9 Sales maximisation by a price-maker

Here, we see that the price-maker may find that sales (revenue) are at a maximum before above-normal profits are exhausted. At output Qsm marginal revenue is 0, thus outputs beyond Qsm will reduce total revenue, but at this output AR is still above AC, meaning that the firm is still earning above-normal profit. (Normal profit is included in the AC curve.) The output which would have been chosen by a profit-maximizing firm is included for comparison, showing that sales-maximisers tend to produce more at lower prices. (QPM is less than and Ppm is higher than PSM-) sm Thus the price-maker seems to be able to make an above-normal profit, as in the case of the profit-maximising price-maker. However, this depends on the position of the cost curves, as it did in the profit-maximising case. Thus in Figure 5.9 the firm 'runs out' of revenue it 'runs out' of above-normal profit, but the opposite might occur if costs were higher. Having two criteria (maximum revenue and satisfactory profit) means that one may easily 'bite' in one situation and one in another. So the sales (revenue) maximisation model does produce the simple decision criterion of profit- maximisation; firms will sometimes produce where AC AR and sometimes where MR=0.

Finally, we can add that under very high costs or very low prices-sales-maximisation may turn out to be the same as profit-maximisation. For instance, looking back at Figure 5.5, we can see that revenue is maximised at the profit-maximising output if the firm wishes to earn normal profit.

What Is the Significance of The Sales-Maximization Model?

We can identify two major contributions that this model makes, and the first is in introducing realistic assumptions. It attempts to relate the objectives of the firm in the model to those found in real-world firms. Managers are keen to increase their salaries and improve the competitive position of the firm, and both benefit from higher sales. Moreover most firms have to take into account the views of their shareholders and thus have to maintain satisfactory profits to retain and attract investors. So the model seems more reasonable than one which suggests profits are always maximised regardless of the effect on the firm's size or future prospects.

The second contribution is to offer a model of a firm with more than one objective. This again is realistic. Firms are not single-minded and do have different aims which receive different emphases at different times. However multiple objectives do introduce problems as we saw in the case of price-makers who were sales maximisers. They needed an 'algorithmic' approach, stopping expanding out- put whenever either of the conditions was about to become unacceptable.

This approach is followed up in the 'behavioral theories' considered, where the alternative objectives are said to be satisfied rather than maximised. However there are also theories in which multiple objectives are jointly maximised as in Williamson's 'managerial model'. Thus the sales-maximisation model leads us naturally into a brief study of 'managerial' and 'behavioral' models.