Abstract
The essence of the market is the interaction between firms, which produce, and households, which buy the products of the firms and sell labor and other factors of production to the firms.
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- 1.
We use the term risk here in its everyday sense, denoting the inherent uncertainty of the future; this uncertainty can be reduced by calculating probabilities, but it can never be completely eliminated.
- 2.
Note a related argument by Hans von Mangoldt’s (1824–1868) concerning the source of entrepreneurial profit or enterprise profit. Mangold is one of the few economists who were looking for an explanation of profit, rather than interest. Just like Adam Smith, he views profit as a compensation for risk. He states that according to “the nature of the enterprise, the entrepreneur bears the risks of production, i.e. he sells the products of his firm on his own account, while having personal responsibility for replacing the [real] capital used in production as well as for the payment of wages to his workers. Whatever surplus remains to him from this is the compensation for the sacrifice he has made, is therefore entrepreneurial profit” (von Mangoldt 1871, p. 35).
Note: This citation and all other non-English citations are translated by the author.
- 3.
Adam Smith argued on the basis of an agricultural enterprise organized around the use of capital, requiring draught animals and agricultural equipment that had to be bought from the leaseholder—the farmer—who made the capital available. He writes: “In the price of corn, for example, one part pays the rent of the landlord, another pays the wages or maintenance of the laborers and laboring cattle employed in producing it, and the third pays the profit of the farmer. These three parts seem either immediately or ultimately to make up the whole price of corn. A fourth part, it may perhaps be thought, is necessary for replacing the stock of the farmer, or for compensating the wear and tear of his laboring cattle, and other instruments of husbandry. But it must be considered that the price of any instrument of husbandry, such as a laboring horse, is itself made up of the same three parts; the rent of the land upon which he is reared, the labor of tending and rearing him, and the profits of the farmer who advances both the rent of this land, and the wages of this labor. Though the price of corn, therefore, may pay the price as well as the maintenance of the horse, the whole price still resolves itself either immediately or ultimately into the same three parts of rent, labor, and profit” (WN I.vi.11).
- 4.
Marx’s formulation is valid quite independently of whether his interpretation of surplus money as surplus value is valid. (For Marx’s theory of surplus value, see p. 58 below.) It can be supposed that Marx drew on A. R. J. Turgot’s (1727–1781) account of the “continuous advancing and return of capital.” For Turgot capital is “useful and fruitful circulation that stimulates all labor in society” and “which maintains the movement and life of the body politic” (Turgot 1981, p. 201).
- 5.
See also Johannes Schmidt (1998, 162 ff.).
- 6.
The relation of an enterprise to its cash balance differs considerably from that of a household. See the comment of Josef Ackermann (1977, p. 103): “To avoid problems of liquidity firms will throughout the production period retain a part of the cash that result from their transactions. … Firms do not therefore collect all their money together so as to spend it during the following period. Instead, bills are also settled with money that has just been paid in. The problem of cash holdings, or of liquidity, is limited therefore to the clearing of net positions.” The level of cash holdings is a matter of experience and judgment.
- 7.
The following account is simplified for the purpose of our example, which is a normal textbook procedure. I am indebted to Albert Gebhardt for the presentation of the three case-studies in accounting (see also pp. 32 and pp. 41).
- 8.
If we assume that firms and households behave as “homines oeconomici”—firms maximizing profit, households maximizing utility—this should not be read too rigorously. Both have some scope to orient their decisions on production and consumption to some other end, such as ethical or ecological criteria. But firms have less free play than households, since profit is determined monetarily both on the costs and the revenue side. For households this is only true on the costs side. See for a discussion of the significance of free play in firms and households Peter Ulrich (1997) as well as Helge Peukert (2005) on ethical aspects and Thomas Dyllick, Frank Belz, and Uwe Scheidewind (1997) and Volker Stahlmann (1994, 201 ff.) on environmental aspects. The different forms of the “homo oeconomicus” are discussed by Gebhard Kirchgässner (1997, 2000).
- 9.
Here we base our account of the classical theory on the work of Bertram Schefold (1981a, b) and Ernst Helmstädter (1981). We are not so much concerned here with issues of Adam Smith interpretation, but wish rather to develop the simplest possible representation of the market process involving the temporal path of the market process.
- 10.
The classical conception of the market price which is supposed to cover at least the minimum “normal” profit is dealt with by Spahn in his “Macroeconomics.” In his words, “The decision to start production is bound up with the expectation that the usual market return on equity and borrowed capital can be made through the prices at which the goods are sold in the market. The minimum profit is included in the calculation of the product price” (Spahn 1999, p. 31).
- 11.
This identification of “natural price” with the “reproduction price” is taken from Heinz D. Kurz and Neri Salvadori: “The prices of reproduction … were conceived as expressing the persistent, non-accidental and non-temporary forces governing the economic system, and were thus distinguished from ‘actual’ or ‘market’ prices, which reflected all kinds of influences, many of an accidental and temporary nature” (Kurz and Salvadori 1995, 1 f.).
- 12.
This process can be clarified mathematically by a difference equation model. See Ernst Helmstädter (1981, 100 ff.).
- 13.
See on this Wolfgang Stolper: “Equilibrium theory describes processes of adaptation. But this is only one part of the capitalist economy. There is no explanation of why equilibrium is repeatedly disturbed by the logic of the system itself. Contrary to the assumptions of equilibrium theory, production functions change under endogenous impulses. Entrepreneurs actively search for new opportunities for profit if the older sources are eroded” (Stolper 1994, 20 f.).
- 14.
Adam Smith also dealt with expansionary strategies, although not in the context of the explanation of the market process but in the context of the explanation of the division of labor and his advantages, underlining the significance of competition. George B. Richardson states: “Smith offers us in effect both a theory of equilibrium and a theory of economic evolution and in each of it competition has a key role to play” (Richardson 1975, p. 351). Andrea Lavezzi adds: “We argue that the process of growth envisaged by Smith has essentially the nature of a disequilibrium process supported by competition” (Lavezzi 2003, p. 87).
- 15.
From this perspective, it becomes clear that the entrepreneur plays a central role in ongoing market process and is not restricted to innovation as a special case, as Joseph Schumpeter claimed. Although he emphasized the role of entrepreneur like no other modern writer, he failed to see that the role of the entrepreneur has more significance than he allowed to it. This failure originated from his allegiance to the Walrasian model of general equilibrium, in which the entrepreneur has no real function, as Walras himself recognized. Schumpeter consequently defines the entrepreneur as a personality who “realises new combinations, opens up new markets for it, and enters into direct conflict with competitors” (Schumpeter 1926, p. 174). But, if the entrepreneur runs the firm “statically” without further innovation, then “he ceases to be an entrepreneur. The character of the entrepreneur is related to the creation of the new” (Schumpeter 1926, p. 174). Hence, it is in his view also correct “that the entrepreneur,” and for Schumpeter, this means also the firm as such, “receives nothing in a static situation” (Schumpeter 1926, p. 175), which means that the normal profit is zero. Schumpeter explains this by the fact that “the combination of factors of production in that situation is already determined, they are a legacy, and so there is nothing for the entrepreneur to do apart from routine matters, which means by extension that he receives nothing for this routine activity” (Schumpeter 1926, p. 175). The identification of the ongoing process of production and sales with a routine process prevents Schumpeter from seeing that the entrepreneur has to take permanently decisions on a daily basis relating to sales that involve a perpetual risk. He has therefore constantly to defend himself against such risks.
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Binswanger, H.C. (2013). Capital and the Firm: The Firm as the Engine of the Market Process. In: The Growth Spiral. Springer, Berlin, Heidelberg. https://doi.org/10.1007/978-3-642-31881-8_3
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