Wednesday, 18 September 2013

To be or not to be. That is the question for the firm

Over at the always interesting Organizations and Markets blog Nicolai Foss writes,
Fritz Machlup famously argued that economists should not care about the specificities (e.g., internal organization) of individual firms, as this was unlikely to bring substantial additional insight in the market outcomes that were the real objects of interests for economists.
Machlup was defending the neoclassical (or marginalist as it was called then) theory against the attack of the behavioural and managerial theories.He argued that the behavioural and managerial theorists who were attacking the neoclassical model were doing so erroneously since they were working at a different level of analysis relative to that of the neoclassical model. The behavioural and managerial theories are aimed at the level of the individual firm whereas the neoclassical model concerns the industry level and thus, Machlup argued, the former are not genuine theoretical rivals to the latter.

Machlup argued that there was confusion as the role of the firm in price theory,
My charge that there is widespread confusion regarding the purposes of the “theory of the firm” as used in traditional price theory refers to this: The model of the firm in that theory is not, as so many writers believe, designed to serve to explain and predict the behavior of real firms; instead, it is designed to explain and predict changes in observed prices (quoted, paid, received) as effects of particular changes in conditions (wage rates, interest rates, import duties, excise taxes, technology, etc.). In this causal connection the firm is only a theoretical link, a mental construct helping to explain how one gets from the cause to the effect. This is altogether different from explaining the behavior of a firm. As the philosopher of science warns, we ought not to confuse the explanans with the explanandum.
Foss goes on to say,
Thus, for the purposes of price theory, firms within an industry could essentially be taken to be homogenous.
I'm not sure the problem here is that firms are homogenous, its more that firms don't exist in the neoclassical model. To quote Foss,
With perfect and costless contracting, it is hard to see room for anything resembling firms (even one-person firms), since consumers could contract directly with owners of factor services and wouldn’t need the services of the intermediaries known as firms
Or his his co-blogger Peter Klein,
In neoclassical economic theory, the firm as such does not exist at all. The “firm” is a production function or production possibilities set, a means of transforming inputs into outputs. Given the available technology, a vector of input prices, and a demand schedule, the firm maximizes money profits subject to the constraint that its production plans must be technologically feasible. That is all there is to it. The firm is modeled as a single actor, facing a series of relatively uncomplicated decisions: what level of output to produce, how much of each factor to hire, and so on. These “decisions,” of course, are not really decisions at all; they are trivial mathematical calculations, implicit in the underlying data. In the long run, the firm may also choose an optimal size and output mix, but even these are determined by the characteristics of the production function (economies of scale, scope, and sequence). In short: the firm is a set of cost curves, and the “theory of the firm” is a calculus problem.
I guess firms in the neoclassical model are homogeneous in their non-existence.

The upshot of dealing with a zero transaction cost world, as standard price theory does, is that one of its most important concepts doesn't really exist. Not that this stops anyone talking and analysing firms using neoclassical price theory.

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