The history of the theory of the firm in one diagram

 

The theory of the firm and economic thought

To me, it appears there is a lack of engagement with the theory of the firm by historians of economic thought. Evidence for this lack of interest can be found in books on the history of economic thought. Students would meet little, if anything, on the theory of the firm in introductory texts. For example, Sandmo (2011) devotes none of its almost 500 pages to the theory of the firm, while Heibroner (1999), throughout its seven editions, discusses firms but does not discuss the theory of the firm. Backhouse (2002), another well-regarded introduction to the history of economic thought, does better in terms of coverage of the theory of the firm than either Sandmo (2011) or Heilbroner (1999) insofar as Backhouse devotes, roughly one page out of 369 to the history of the post-1970 developments in the theory of the firm.

The lack of coverage could just be a level thing since some graduate-level texts do better in terms of the discussion of the theory of the firm, see, for example, Blaug (1997: 355-7; 373-5; 395-6; 435-9.) Or is it a time thing, from an earlier era, Whittaker (1940) has a 40-page chapter on production.

But these are exceptions that prove the rule. Lack of enthusiasm for the firm or production does appear to be a problem of long-standing. In 1893 when Edwin Cannan published the first of three editions of his A History of the Theories of Production and Distributions from 1776 to 1848 he commented that “I have been able to obtain surprisingly little assistance from previous writers” (Cannan 1893: v).

Since then, sadly, little appears to have changed. There is still little assistance from the literature for those who are interested in the history of thought to do with production or the firm. In fact, in the more than one hundred years since Cannan wrote, there seems to have been only three additional books (in English at least) published that directly deal with the topic of the history of thought to do with either the theory of production or the theory of the firm: George Stigler published a revised version of his PhD thesis as Production and Distribution Theories: The Formative Period in 1941; in 1978 Philip L. Williams published his PhD thesis as The Emergence of the Theory of the Firm: From Adam Smith to Alfred Marshall and Paul Walker published A Brief Prehistory of the Theory of the Firm in 2018.

So why so little interest? Do historians of economic thought really think that production is so uninteresting and worthless a topic that they just ignore it? Or do they (and economists more generally) just think that the production in the economy is so unimportant that it need not be studied?

Refs.:

• Backhouse, Roger E. (2002. The Ordinary Business of Life: A History of Economics from the Ancient World to the Twenty-First Century, Princeton: Princeton University Press.
• Blaug, Mark (1997). Economic Theory in Retrospect, 5th edn., Cambridge: Cambridge University Press.
• Cannan, Edwin (1917). A History of the Theories of Production and Distribution in English Political Economy from 1776 to 1848, 3rd edn., London: P. S. King & Son.
• Heilbroner, Robert L. (1999). The Worldly Philosophers—The Lives, Times, and Ideas of the Great Economic Thinkers, 7th edn., New York: Simon & Schuster.
• Sandmo, Agnar (2011). Economics Evolving-A History of Economic Thought, Princeton: Princeton University Press.
• Stigler, George J. (1941). Production and Distribution Theories: The Formative Period, New York: The Macmillan Company.
• Walker, Paul (2018). A Brief Prehistory of the Theory of the Firm, London: Routledge.
• Whittaker, Edmund (1940). A History of Economic Ideas, New York: Longmans, Green and Co.
• Williams, Philip L. (1978). The Emergence of the Theory of the Firm: From Adam Smith to Alfred Marshall, London: The Macmillan Press.;

Derivation of the word "firm".

An interesting detail. Spulber (2008: 5, footnote 8) gives the origin of the word 'firm' as "[t]he word "firm" derives from the Latin word "firmare" referring to a signature that confirmed an agreement by designating the name of the business". According to Cresswell (2021), "[f]irm meaning 'not yielding to pressure' comes from the Latin firmus, also the root of farm [ME], which originally meant a tax or rent. Firm meaning 'a company or business' has the same root, but the immediate origin is different. The Latin word has also given rise to Italian firma 'confirmed by signature', and in the late 16th century this was adopted into English to mean the name under which business was transacted by an organization [M18th], as in 'trading under the firm of "Grant & Co"'. Finally, in the 18th century, firm became the term for a company''. 

Refs.:

• Cresswell, Julia (ed.) (2021). Oxford Dictionary of Word Origins, 3rd edn., Oxford: Oxford University Press.
• Spulber, Daniel F. (2009). The Theory of the Firm: Microeconomics with Endogenous Entrepreneurs, Firms, Markets, and Organizations, Cambridge: Cambridge University Press.

Coase and profit maximisation

One assumption not discussed much in the mainstream theory of the firm is that of profit maximisation. Most theories of the firm take it as a given, a non-controversial notion to base their theory on. Ronald Coase's view isn't so clear cut.

In one case he seemed to have been that in practice profit maximisation was unlikely to be achieved by any firm:

"[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 also seemed 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. These'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" (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).

So it appears that while Coase thought that businessmen could not enact profit maximisation in practice, it was still a useful simplification for theoretical purposes.

For a short overview of the attacks on the neoclassical model, including those concentrating on profit maximisation, during the 1940-1970 period see Walker (2021: chapter 6).

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?
• 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.
• Heflebower, Richard B. (1955). 'Full Costs, Cost Changes, and Prices'. In Universities-National Bureau, Business Concentration and Price Policy (pp. 359-92), Princeton: Princeton University Press
• Walker, Paul (2021). Foundations of Organisational Economics: Histories and Theories of the Firm and Production, London: Routledge.

The relationship between economics and business?

Given an email discussion I was having with a friend (another economist) recently, I was reminded of something I wrote back in 2012. It seems my view of economics is out of step with other views of the subject. I see it as a social science with a close relationship to moral and political philosophy, political science, psychology etc. But this it seems is a minority view. Many people, economists included, seem to see the subject as simply being part of business, its sole role is to train better businessmen (whatever "better" may mean in this context).

Of course, I would ask, What use is general equilibrium theory or the theory of the firm or time-series econometrics or experimental economics or ..... to a businessman? Does your local dairy owner really need to know about Granger causality or the second fundamental theorem of welfare economics to run a successful business? I would say not, but it seems I'm wrong. Others believe these to be vitally important for the success of the enterprise.

Now I would argue that a basic knowledge of economics is valuable and useful for all people be they businessmen, school teachers, truck drivers or whatever. What I don't see is why businessmen need more economic knowledge than other people. ,p>Oh well, like on so many things, it looks like I'm wrong yet again :-(

What would Adam "Moral Philosopher" Smith say?

I should add that I was not the first person to think economics is of little use to businessmen. A. C. Pigou got there well before me, in 1922 in fact:

"[ . . . ] it is not the business of economists to teach woollen manufacturers to make and sell wool, or brewers how to make and sell beer, or any other business men how to do their job. If that was what we were out for, we should, I imagine, immediately quit our desks and get somebody - doubtless at a heavy premium, for we should be thoroughly inefficient - to take us into his woollen mill or his brewery".

Lionel Robbins followed up in 1935 by arguing that running a business is beyond the competence of economists,

"[t]he technical arts of production are simply to be grouped among the given factors influencing the relative scarcity of different economic goods. The technique of cotton manufacture [ . . . ] is no part of the subject-matter of Economics [ . . . ]".

Ronald Coase notes that when he went to the LSE to study for the Bachelor of Commerce, specialising in the Industry Group,

"It will have been noticed that during my two years at LSE I studied a great variety of subjects, devoting therefore very little time to each and inevitably doing no systematic reading. I took no course in economics [...]" Obviously, in Coase's day economics was not seen as vital to business.

Ulrich Witt notes that early in the history of economics in Germany economic theory was separated from business economics,

"There, economic theory (Volkswirtschaftslehre) and business economics (Betriebswirtschaftslehre) were institutionally segregated as early as at the turn of the century to a degree still unknown today in the Anglo Saxon world. As Lachmann once conjectured, Austrian writers therefore considered the organizational form of entrepreneurial activities to be a topic best left to their business economics fellows."

May be my view is just old fashioned.

Latest Blogwatch column

 My Blogwatch column from the latest issue (Issue 70, April 2021) of the NZAE magazine Asymmetric Information.

Published!!

My latest book is finally published!! The publisher's page for the book is here.

Foundations of Organisational Economics: Histories and Theories of the Firm and Production delves into a range of key topics to do with the history of the mainstream approach to the theory of production and the theory of the firm. This includes the frameworks used to analyse production, the division of labour and its application to the firm and the development of the neoclassical model of production. The first topic explored is the change from a normative approach to a largely positive approach to the analysis of the theory of production, which occurred around the seventeenth century. The next topic is an examination of the relationship (or the lack of a relationship) between the division of labour and the theory of the firm. In the fourth chapter, the focus is on the development of the proto-neoclassical approach to production. Here, the development of the theories of monopoly, oligopoly and perfect competition are discussed, as well as the theory of input utilisation. Chapter 5 looks at Marshall’s idea of the representative firm, which was the main early neoclassical approach to the theory of industry-level production. The penultimate chapter considers the criticisms made of the neoclassical model between 1940 and 1970. This work is an illuminating reference for students and researchers of the history of economic thought, industrial organisation, microeconomic theory and organisational studies.

Table of Contents 1 Introduction 2 Normative versus positive analysis in the history of the theory of production 3 The division of labour and the theory of the firm 4 Proto-neoclassicals and the theory of production Appendix: a very brief history of perfect competition 5 The representative firm 6 The neoclassical model under fire 1940–1970 7 Conclusion