Both models belong to the ‘managerialist school’ of thought, which accepts as an axiom that managers have discretion in determining the goals of the firm.
Given this discretion, the managers deviate from the goal of profit maximisation (which maximises the utility of owners) and pursue policies, which maximise their own utility.
In Baumol’s model managers are interested only in their own utility. In Marris’s model under conditions of steady growth managers can attain contemporaneously the maximisation of their own utility and of the utility of owners.
In both models the growth of demand for the product of the firm is maximised (subject to some constraints). Baumol measures growth of demand in terms of the change in sales revenue, while Marris measures growth of demand in terms of the diversification rate, that is, the number of new products introduced by the firm per period of time.
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In Baumol’s model the rate of growth of capital is of interest to the managers implicitly: in order to maximise sales revenue the firm must have the necessary equipment, the acquisition of which will be financed mainly from internal sources (retained profits). However, in Baumol’s model the growth of capital is not a goal per se. In Marris’s model the growth of capital is an explicit goal of the firm, aiming at the maximisation of the utility of owners.
In both models profit is endogenously determined. Both Baumol and Marris assume that retained profits are the main source for financing growth (of sales or of the firm in general). Thus, from the solution of their models, they determine not only the optimal rate of growth, but also the level of profit required to finance this growth. In both models exogenous demands for a minimum profit level (for dividends) can be incorporated without affecting the basic mechanics of the optimal solution. It is interesting to examine whether profit and growth are competing goals in these two models at their equilibrium solution.
In Baumol’s dynamic multi period analysis, growth and profits are always competing goals in equilibrium. Recall that the tangency solution in Baumol’s model occurs always on the negatively sloping part of the growth curve: in equilibrium, the g* that maximises the present value of the stream of sales revenue is lower than the maximum rate of growth, which corresponds to the peak level of profit (highest point of the growth function g = f (Π, R)).
In Marris’s model of steady balanced growth, profits and growth are non-competing goals so long as the financial policy (reflected in a) is kept constant (is treated as a parameter). However, in the real world managers do not treat a as a constant. In fact the financial ratios are important policy instruments at the disposal of managers. If managers are growth-seekers, they will favour a financial policy which increases a and growth, at the expense of profits. Recall that a is positively related to growth, but inversely related to profits.
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Thus in the modern ‘managerial capitalism’ a conflict of goals between managers (seeking high growth) and owners-shareholders (seeking higher dividends) may often be observed, unless one assumes that owners do prefer growth to profits. Of course there is a limit to the desire of managers for growth, set by their desire for job security: beyond a certain stage growth and security are competing goals. We will next compare the instrumental variables and their use in each of the two models.
Price:
Both models assume a given price structure, which is arrived at in some way not explicitly discussed. Baumol’s model assumes a known downward-sloping demand curve, from which total revenue is presumably derived. Marris states that price determination is not his main concern. He implies that the price structure will emerge either after a period of economic warfare (price war, advertising war, and/or product-change war), or by collusion in the form of trade associations or price leadership.
Thus in both models price is a parameter rather than a policy variable. The problem of oligopolistic interdependence is not satisfactorily dealt with in non-collusive markets. It seems that these models are applicable to large firms which have considerable monopoly power so as to afford to ignore their competitors’ reactions, or that the price is given historically, or determined collusively.
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In both models average-cost pricing practices are implicitly or explicitly assumed, as a device for the ‘orderly’ co-ordination of the market.
The level of output:
The level of output is an important policy variable in both models. Baumol treats firms as ‘output-makers’ rather than ‘price-makers’. The level of output is determined by the optimal revenue value (R*), and by advertising, given the market price. In Marris’s model the level of output is not explicitly determined. From his model the level of diversification (d) is determined. It is not explained how from d the firm will reach decisions about the optimal output levels (product-mix).
Advertising and R&D expenditures:
The advertising expenses play a prominent role in Baumol’s model. Their level is determined directly from the solution of his model. Baumol does not examine the implications of R & D expenses. In Marris’s model advertising is not treated explicitly. Its effects are reflected in the profit margin m. Since, however, m absorbs both the effects of A and R&D expenditures, the level of each one of these activities is not uniquely determined.
Financial policy:
Financial policy is explicitly treated in Marris’s model, in which it plays a crucial role. It is explicitly shown how manipulation of the financial instruments can affect the rate of growth and the profits of the firm. Baumol does not deal explicitly with the financial policy of the firm.
However, financial policy considerations are implicit in his model, when he discusses the minimum profit constraint for internal and external purposes. The predictions of both models regarding changes in demand, costs and taxes are similar as will be seen from the following section.