The static model of the theory of the firm continues to be taught in economics courses in spite of its dubious relevance to how real world firms actually operate. This detracts from student interest in economics. This article explores a strategy for remedying that.
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“Economists are at long last emerging from the stage in which price competition was all they saw. In capitalist reality . . . it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization . . . competition which . . . strikes . . . existing firms . . . at their foundations and their very lives. This kind of competition is . . . much more effective than the other . . . and [is] . . . the powerful lever that in the long run expands output.” (Schumpeter, 1962 , p. 84)
This in spite of the fact that the limited number of variables in the standard neoclassical model are dramatically inadequate to describe real world competition. Real world firms almost always produce more than one product, engage in product differentiation and ongoing innovation. The claim of the irrelevance of the simplifying assumptions of the “as-if” methodology appears difficult to sustain, to say the least, particularly when it is used, as discussed in the text, to determine the degree of monopoly power (and similar examples), where a more accurate set of assumptions would suggest a more innocuous and economically congenial explanation.
Economists teaching in business schools find themselves teaching the neoclassical cannon to students who are simultaneously studying strategic management, organization theory, dynamic marketing models and so on. It is no surprise therefore that many students find their economics courses of little relevance to the business world that is their concern.
It is important to remember that profit depends crucially on the presence of uncertainty. The absence of uncertainty, as in the neoclassical world, would imply that sales revenue was known with certainly and all other earnings (wages, rents, and interest) could and would be contracted for and there would be no residual to be taken as profit.
For details see Lewin and Cachanosky (2020a) chapters 8 and 9.
Or more accurately, and more revealingly in our formulation, the firm’s objective is not to maximize current profits, but rather to maximize the value of the present value of the flow of profits over the relevant time horizon – in other words to maximize the estimated capital-value of the firm.
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Lewin, P. How should an Austrian economist teach the theory of the firm? Do the equi-marginal conditions still apply?. Rev Austrian Econ (2021). https://doi.org/10.1007/s11138-020-00540-7
- Austrian economics
- The firm