Friday, 25 November 2022

Coase on profit maximisation

One important, and at times controversial, assumption used in most theories of the firm, including that of Coase, but not discussed by Coase in his 1937 article, is that of profit maximisation. Coase learned from Plant that firms maximise profits but in his general approach to it, he appears to have been one which involved taking something of a bet each way. He seems to have thought that while in practice it is unlikely that profit maximisation would be achieved, it was still a useful elemental assumption for the theory of the firm.

In terms of actual business practice Coase wrote:
"[i]t would be Utopian to imagine that a businessman, except by luck, could manage to attain this position [MR=MC and the avoidable costs of the total output less than the total receipts] of maximum profit" (Coase 1981: 102)
and
"[t]his being so, it seems to me that any claim that modern cost accounting (at any rate in the form in which it is to be found in the textbooks) enables unprofitable lines to be discovered and eliminated is misleading. It is only possible to discover whether or not a particular activity is profitable by comparing the avoidable costs with the receipts. And this, as I understand it, is a task which modern cost-accounting methods do not enable one to perform" (Coase 1981: 113).
But he does also seem to have seen it as a useful tool for economic investigation:
"[w]ell, all this suggests that economists are satisfied. Now the fact is that they are satisfied. They are very pleased. To go to a meeting of the American Economic Association is to see thousands of self-satisfied economists. Now there is a reason why this is so. They have found economics useful and are quite happy therefore to go on using it. Now it’s true: it is useful. The concepts which have been developed for handling various problems are useful for handling a wide range of problems. Opportunity costs, supply and demand schedules, marginal costs, marginal revenues, maximization of profits – they’re all very useful concepts that you can use, and not simply for economic problems but for others as well" (Coase 2002: 4).
and
"[n]ow take a person in a firm situation. A man who buys something for 10 dollars and sells it for 8 dollars doesn't last very long. There's an immediate punishment that comes in within the economic system if you don't try to maximise profits and so on. So, I'm very happy with the assumption that people make, that firms make profits. And you can study what firms do and of course, it fits very nicely. They drop the lines that make losses. They expand the lines that make profits and so on. So, I make this difference between people acting in the productive system and people acting as consumers" (Coase in Becker 1995).
When discussing the nature of opportunity costs, Coase writes,
"[t]his particular concept of costs would seem to be the only one which is of use in the solution of business problems, since it concentrates attention on the alternative courses of action which are open to the businessman. Costs will only be covered if he chooses, out of the various courses of action which seem open to him, that one which maximizes his profits. To cover costs and to maximize profits are essentially two ways of expressing the same phenomenon. In practice it is probably better to regard the cost of doing anything as the highest alternative receipts that might have been obtained rather than vaguely as all the alternatives that are open" (Coase 1981: 108).
In a comment on Heflebower (1955) - which critically examined one attack on the standard neoclassical model including profit maximisation, that of full cost pricing - Coase wrote that he wasn't yet ready to give up on the standard marginal analysis:
"I am not willing on the basis of the arguments brought forward so far to abandon ordinary marginal analysis (taking account of demand) as a first approximation. It is clearly not the whole story and there is need for much more research on business behavior. But we should not be disappointed if a good deal of economic theory turns out to be usable after our investigations are completed" (Coase 1955: 394).

Refs.: 

  • Becker, Gary S. (1995). 'Gary Becker Discussions: Consumer Behavior'. Video of discussion between Gary Becker and Ronald Coase on the question of, Is the economic theory of utility a useful way of understanding consumer behavior? Available at https://www.freetochoosenetwork.org/ideachannel/ic_program.php?itemId=65
  • Coase, Ronald Harry (1937). `The Nature of the Firm', Economica, n.s. 4 no. 16 November: 386-405.
  • Coase, Ronald Harry (1955). 'Comment' (on Heflebower (1955)). In Universities-National Bureau Committee for Economic Research, Business Concentration and Price Policy (pp. 392-4), Princeton: Princeton University Press.
  • Coase, Ronald Harry (1981). 'Business organization and the accountant'. In J.M. Buchanan and G.F. Thirlby (eds.), L.S.E. Essays on Cost (pp. 95-132), New York: New York University Press.
  • Coase, Ronald Harry (2002). 'Why Economics Will Change: Remarks at the University of Missouri, Columbia, Missouri, April 4, 2002', International Society for New Institutional Economics Newsletter, 4(1) Summer: 1, 4-7.

Friday, 21 January 2022