Oligopoly Pricing and Profits Tax

Abstract

The pricing behaviour of entrepreneurs has been a subject of long discussion among economists, and yet remains unresolved. Pricing policy based on the profit maximization hypothesis has been criticised for a long time now for its apparent lack of realism. Although it was cot unexpected, the survey result by Hall and Hitch in 1939 showed that businessmen do not equate marginal cost to marginal revenue in order to maximize profits, but that they practiced full cost pricing, by equating price to the full cost, in which some measure of normal profit is calculated. Since then there have been many different assumptions on the behaviour of businessmen and, consequently, on how they price their products. Some advanced a theory that businessmen do not maximize short-run profits but long-run one. Others advanced a theory that businessmen equate price to the situation where some measure of rate of profit is obtained. In 1958 William Baumol advanced a theory of oligopolists pricing behaviour based on the assumption that businessmen maximize total sales rather than their profits. In doing so they are subject to some minimum level of profit constraint. This is, in a sense, relevant to the long-run profit maximization theorem, because survival appears to be the most important aspect of business life. This note aims not to castigate any particular hypothesis but attempts to show, in a theoretical perspective, how the controversy surrounding the incidence of profits tax (although there is some difference, I shall use profits tax and corporation income tax interchangeably) can be approached and, to a certain extent, tackled by using a simple economic model based on the sales maximization hypothesis.