Page 324 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-19: Behavioural and Managerial Theories of the Firm

Model with Fixed Costs—The sales maximization firm of Baumol is more real than profit maximization Notes
firm because it is affected by changes in fixed costs, which is really found in industrial firms. Neo-classic
profit maximization theory indicates that the production does not affect by fixed cost in short run. For
example, there is no effect on production and pricing if there is a lumpsum tax in this type of firm. But
Baumol says that if the fixed cost increases in short run due to lumpsum tax then the sales maximization
firm will high their product price and low their production. It is described in Fig. 19.6 where TP is total
profit curve of firm. MP is minimum profit constraint line which indicates that the firm should get OM
profit by selling OQ production.
1
Fig. 19.6

T
L
Profit M P

O Q Q Q
2 1
TP TP
1
Output

Suppose the government fix taxes are equal to LT by which its profit curve goes from TP to TP and firm
1
will lower their production from OQ to OQ . Firm will increase the price of product and transfer the
1 2
taxes to consumers. But due to lumpsum tax, the profit maximization production OQ does not change
even the fixed cost increases.
On the other hand, after adding a specific tax like sales tax, the profit curve will slope downward left,
as shown in Fig. 19.7. On the given profit constraint line MP, the sales maximization firm will slow
their production from OQ to OQ . It will increase the price and transfer the taxes to consumer. The
2 3
profit maximization firm will also lower their production from OQ to OQ and will increase the product
1
pricing. But the production loss of sales maximization firm will high than profit maximization firm,
Q Q > QQ .
1 2 1
Fig. 19.7

Profit M P

O Q QQ 3 Q 2
1
TP TP
Output 1

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