A Marshallian Theory of the Firm I: Introduction (Microeconomics)

Firms in Discrete Time and Geographic Space

At the start of the preceding set of posts on the Walrasian/Paretian firm, I advanced the proposition that the Neoclassical tradition encompasses multiple distinct theorizations of the firm.  Each such approach, moreover, advances a somewhat distinct lineage of influences from Classical and pre-Classical economics, with their own epistemological presumptions regarding introspective/theoretic deduction and empirical validation as means for ascertaining truth, and their own particular means for dealing with ontological spatio-temporal complexities in the workings of an economic system and its component parts.
           We have so far investigated a Walrasian/Paretian theorization of the firm, to which I attributed the characterization of a "pure" Neoclassical theory.  Its purity reflects both the degree to which certain ontological tendencies latent within all Neoclassical economic thought could be taken to extremes and to the extent that Walrasian/Paretian general equilibrium economics represents a radical break with earlier dominant paradigms in economic theory, most notably Classical Ricardian orthodoxy.  The forthcoming theory represented in this set of posts will reverse course on both of these thresholds of purity.
           Expressly, Marshallian economics, as originally formulated from the writings of the Nineteenth century English economist Alfred Marshall and more formally elaborated by subsequent theorists, constitutes, in some degree, a compromise between Classical Ricardian thought and Neoclassical, marginalist/utility-centric innovations developed by other British (Jevons, Edgeworth) and continental (Walras, Menger) theorists.  At its foundations, Marshallian theory resonates an overarching epistemological empiricism, advancing its postulates as guideline hypotheses for rigorous empirical investigation of real economic practices.  It is, in this respect, less abstract and epistemologically grounded in rationalist introspective deduction of theoretic principles than either the Walrasian/Paretian or Austrian schools, and, consequently, it is relatively more receptive to statistical/econometric analyses.  In its greater commitment to investigate the real and theorize from its empirical findings, Marshallian theory rejects the timeless and spaceless ontological frames embodied in Walrasian/Paretian general equilibrium theorization, developing instead a complex interweaving of divergent temporal frames and engaging with the particular ways in which real economic processes both utilize and reshape/reconfigure geographic space.
           With respect to time, Marshallian firms operate under heterogeneous, overlapping temporal periods based on relative variability of particular factors in particular industries.  At shorter time frames, few factors are treated as variable in achieving profit maximizing outcomes.  At relatively longer time frames, more factors become variable.  At the longest time frames, all or nearly all factors can be treated as variable, at which point the profit maximization/cost minimization process attains a degree of convergence with that of a Walrasian/Paretian and can be patterned through the tools of Walrasian/Paretian production analysis (e.g. isoquant and isocost curves).  On the other hand, if the overarching structure of Walrasian/Paretian production analysis remains grounded in the negotiation of exchange processes between households (i.e. tâtonnement), then the articulation of profit maximization/cost minimization for Marshallian firms across multiple overlapping time frames operates under starkly different principles, grounded in entrepreneurial decision-making/risk-taking and periodic, discrete readjustment in response to changes in market conditions and technological dynamics.  Thus, in the acknowledgement that firms operate within multiple, overlapping real time frames, Marshallian theory necessarily accounts for the creation of an entrepreneurial space within which the actions of the firm and its managerial decisions, at least potentially, attain a complex, open, non-mechanical character.
           With regard to space, Marshallian theory expressly accounts for divergent locational patterns in the particular industries, responding to diverse situational advantages in procurement of raw materials, capital, or skilled labor, and/or proximity to complementary producers or contracting consumers across a broader logistical/supply chain.  Alfred Marshall's own writings on production theory and industrial organization explicitly reserve an important role for locational decisions by firms.  As such, Marshallian theory reinforces the point that the spatial/geographic organization of an economy may confer external economies on individual firms or entire industries and that such patterns are, in turn, shaped by the locational decisions of firms/entrepreneurs.
           This document will seek to initially outline the manner in which the Marshallian theory of the firm deals with sources of ontological complexity in space and time.  We will first develop a set of baseline assumptions regarding the Marshallian partial equilibrium approach to markets.  We will then articulate Marshallian production analysis under the standard Neoclassical assumption that the firm and its entrepreneur are rational profit maximizing agents in production.  This analysis will explicitly account for differences between temporal periods in production and investment, demonstrating, in this regard, the conceptual relevance of differences between the short and long run for Marshallian firms in different industries and differently structured markets.  The final section of our theoretic elaboration will articulate one standardized conceptualization of Marshallian production analysis developed by the American Marshallian theorist Jacob Viner, asserting both the theoretic relevance of this conceptualization to the broader Neoclassical understanding of the firm in multiple, discrete production periods and the innate and serious problems arising from this formulation relative to other Neoclassical and Classical conceptions of the firm.  Beyond our theoretic elaboration, I will engage in a critique of the assumptions and conclusions of our Marshallian theory of the firm, again proceeding from a perfomative epistemological framework to both inquire what the theory has to tell us about economic reality and how such an approach simultaneously reshapes the reality that it seeks to highlight.

Partial Equilibrium Economics: A Set of Baseline Assumptions 

So far we have examined the firm as a construction of Walrasian/Paretian general equilibrium theory.  This construction demanded strict adherence to a set of baseline assumptions, including perfect competition (many firms competing in every output market and many industries competing against each other within factor markets), perfect information (perfect distribution of information on production technologies, availability of factor resources, and household demand for commodities), and instantaneous adjustment by firms to changes in output market demand and factor market supply by households.  The combination of these various assumptions structured the operation of a general equilibrium system within which continuous negotiation between households (tâtonnement) generates a single vector of output and factor market prices reducing excess demand across all markets to zero.  In this document, we will develop a very different conception of market dynamics, against which firms both enjoy a substantially greater degree of flexibility in determining how much output will be supplied and how much of each factor will be demanded and experience a substantially greater level of risk and uncertain regarding their capacity to negotiate the dynamics of imperfectly integrated, temporally and spatially structured market systems.  Moreover, in the same manner that our Walrasian/Paretian theory of the firm both assumed and implicitly/explicitly defined a particular theoretic construction of the household as the autonomous other to our captive, intermediary production agent, our Marshallian theory of the firm will redefine the household in reference to our new set of assumptions about markets and the operations of firms.  Such a redefinition will not purely contradict the assumptions presented in the Walrasian/Paretian theory of the firm, but it will seek to emphasize the complex positionalities of both households and firms when we cease to operate under the rigorous set of restrictions governing Walrasian/Paretian general equilibrium theory.
                  Summarizing, in part, the set of assumptions governing our Marshallian partial equilibrium theory of markets and firms, with a particular emphasis on the manner in which these assumptions differ with those of Walrasian/Paretian economics, we can argue:
1.  Market systems contain ranges of output and factor markets that are never perfectly integrated.  Emphatically, we are not dealing with a general equilibrium system in which all prices are simultaneously determined in order to realize market clearing/zero excess demand across all markets.  Rather, a market system is a composite of individual markets with divergent spatial and temporal dimensions in which market clearing, excess supply, and excess demand are all potential outcomes in any specified context.  If, in this regard, the outcomes of any particular set of market processes may be inferred to shape all other market processes, then the manner in which such market processes are interconnected can never be assumed to take a pre-determined form and to realize a pre-determined conclusion.  Market systems are complex and bear complex interconnections between individual constitutive market processes.  If such systems are not perfectly integrated, then it stands to reason that we cannot undertake analysis of a market economy as if pricing signals will precisely and instantaneously be communicated between markets.  The best that we can do is to analyze the organization and dynamics of one market and theorize the effects of changes affecting multiple markets by means of specific, imperfect communications channels.  Hence, partial equilibrium economics, in the Marshallian mold, limits its analytical lens to equilibria in single markets or groups of markets with well articulated linkages and specified pathways through which multiple market effects can be readily transmitted.
2.  Markets are spatio-temporally defined and vary in accordance with the scale of operations of producing and consuming agents.  A market is simply a context of exchange between two sets of agents, producers/suppliers and consumers/demanders.  The ontological (space/time) dimensions of exchange vary widely between individual market processes.  A market might be defined as a series of fixed sites of retail exchange of a largely homogeneous product over some vaguely defined period in which prices and quantities exchanged, across all sites of exchange, remain relatively constant.  A different form of market might exist across a series of Internet websites, where, again, relatively homogeneous products are exchanged.  A still different form of market might exist where purchasers of a particular set of services might contract the production of a range of heterogeneous products with a provider, across a number of diverse locations and instances in time, by various means of communications, and through various contractual specificities, that might have been purchased from a wide range of other product and/or service providers.  The act of exchange and the at least potential confluence of a range of competing agents on both the production and consumption sides of the market constitutes the universally binding characteristic between the ontologically divergent conditions of existence of a market.  
             On the other hand, the connections between diverse contexts of market exchange tend to inscribe individual markets with extreme ontological complexities.  That is to say, an individual market may be characterized by multiple, divergent types of exchange relations between agents (e.g. retail transactions in privileges exchange spaces, online transactions, etc.) unified by the relative homogeneity of the goods or services exchanged.  Such complexities raise a question on the definition of boundaries to a given market.  When can we properly argue that we have traversed a boundary from one market to another, especially if the goods or services being exchanged look essentially the same?  In certain respects, I would argue that Marshallian theory tends to resolve this question by appealing to how competition between agents on both sides of the market tends to promote the fluctuation and/or stability of given pricing patterns.  When the prices of particular, relatively homogeneous goods or services tend realize a uniform equilibrium rate of exchange between sellers and buyers at a given moment in time, encompassing a defined set of divergent exchange contexts, then we are dealing with a single market, and we can specify its spatio-temporal dimensions even if they are wildly discontinuous across geographic space.  
3.  Interrelations between markets arise because of linkages within and between logistical/supply chains and because of complementarities between consumption goods and services.  Assuming, along the lines of assumption 1, that individual markets exist as separable entities, we must simultaneously recognize that changes in one market may impact a wide range of other markets by varying degrees.  Such interrelations between markets reflect, in part, the utilization of particular goods and services within logistical/supply chains connecting production processes to culminate in the production of a particular set of marketable goods or services.  In this manner, an increase in the price of particular forms of skilled labor driven by changes in training expenditures will manifest a cascading effect of price increases across industries utilizing such skilled laborers intensively, reflecting, in part, the extent to which each utilizes the subject form of skilled labor.  In turn, such price increases will induce other downstream price increases, ultimately realized in the prices of retail goods and services.  Transitioning to the opposite side of retail markets, price increases in particular product markets may induce substitutions and reductions in demand for complementary goods and services within household consumption portfolios.  Recognizing such interconnections between otherwise separable markets acknowledges the reality that no market outcome ever occurs in a vacuum.  Our rejection of the sort of perfect integration of relative prices evident in a general equilibrium system does not invalidate this reality.  Rather, it forces us to specify the particular channels through which a change in one market resonates in certain other markets but not others.    
4.  Individual markets contain discrete assemblages of producing and consuming agents, each operating with divergent capacities to exert market power.  As a generality, every market contains producing agents and consuming agents.  To establish some measure of continuity with our Walrasian/Paretian theory of the firm, at least certain factor markets may contain household units/individuals acting as producers/suppliers of a given factor of production.  In most cases, these households will supply basic labor (or labor combined with human capital) and/or land.  In our present theory of the firm, we will, at least to some degree, continue to understand capital, in an Austrian vein, as increased "roundaboutness," but we will simultaneously shift to the assumption that firms/entrepreneurs are the primary investors in capital, outside of human capital investments.  Proceeding from this set of assumptions regarding the production factors, certain factor markets engage household against firms/entrepreneurs while others constitute markets purely internalized to the structure of the firm, where firms/entrepreneurs manage a portfolio of factor resources either contracted over the long term or, otherwise, owned by the firm/entrepreneur.
            In output markets, delineating lines are normally somewhat clearer.  Households often constitute the consumption-side agents.  Otherwise, goods and services constitute intermediate products/factors for the production of other goods and services on a logistical/supply chain.  In either case, we are dealing with the competitive utilization of outputs, satisfying the needs of households or other firms/entrepreneurs at successive stages of a supply chain.  Likewise, suppliers are likely to face price competition in the sale of their goods or services.  Evaluated in these respects, provided that there adequate means of communication uniting each context in which a given quantity of a given product is offered at a given price, the equilibrium price at which subject goods and services exchange should depend on the degree of competition between participants on both the producer and consumer sides of the market.  In the event, to the extent that one side of the market is sufficiently constrained quantitatively relative to the other side, prices will diverge from the aggregate reserve price of agents on the non-constrained side.  Emphatically, we will encounter a circumstance of short-side power, where agents on the relatively quantitatively constrained side can command a price.  Under such circumstances, we will argue that the operative market price may exceed (under a quantity constrained supply-side) or settle below (under a quantity constrained demand-side) the price that would obtain under perfect competition on both sides of the market.  Alternatively, institutional constraints on the capacity of agents to accumulate particular information on production processes/technologies or market conditions may enable certain agents to a market transaction to act as first movers in procuring the factor resources and/or goods and services of other agents, enabling them to command prices diverging from those that would obtain under perfect competition where price negotiations occur under symmetrical distributions of information.       
5.  The capacities of individual agents to exert market power are structured, to a significant degree, by the presence of institutional barriers to entry on the production and/or consumption side of the market.  The primary barrier to entry that I mean to emphasize at the present time involves constraints in efficient scales of operation to agents on the producer side of markets.  In our evaluation of Walrasian/Paretian firms, we assumed that firms would operate under constant returns to scale/constant average costs, and, as such, general equilibrium systems would be characterized by a complete absence of increasing returns to scale/decreasing average costs among firms.  In the present circumstance, I intend to dispense with this conditionality.  The absence of any restrictions on increasing/decreasing returns to scale in a partial equilibrium market system implies that certain markets may be characterized by the presence of large scale producers with significant cost advantages in relation to smaller competitors.  Such large scale producers may reap excess returns per unit of output to the extent that they allow operative production costs of smaller producers to determine market prices.  In any case, scale economies in either production or utilization/consumption constitute an important source of institutional barriers to entry into particular markets on either the supply or demand side.  Beyond differences in the scale of operations, legal barriers may arise from the injunction of property rights to particular technologies.  In our elaboration of the Walrasian/Paretian firm, we argued that such barriers, arising from, say, patent franchising, would deprive firms of any capacity to derive cost advantages under perfect competition.  In this document, we will slacken this assumption to argue that a strategic space may arise for the utilization of patented technologies to reduce costs for particular firms and, as such, to place competitive pressures on firms utilizing less efficient technologies.  In general, we will assume that any legal and/or economic/technological constraint on the capacity of production and/or consumption-side agents to participate on an equal footing with other agents to market processes may cause prices and quantities produced/consumed in a market to diverge from those that might obtain in a competitive equilibrium, and that such circumstances are at least as likely within real markets as a perfectly competitive case.
6.  Information on production technologies and on household demand for final goods and services and supply of production factors is imperfectly distributed across market agents on the production and consumption sides, contributing further to the imperfection of price competition.  Informational imperfections constitute one particular barrier to entry constraining perfect competition.  In assuming at the outset an imperfect distribution of information among agents to a market system, we have driven a powerful wedge between our imagery of a Walrasian/Paretian general equilibrium economy and the empirically-driven portrait of market systems conveyed in Marshallian economics.  In general, deficiencies in the distribution of information available to households and/or firms/entrepreneurs are critical in preventing markets from realizing Pareto-optimal outcomes in the distribution of factor resources and final goods and services.  In a more fundamental sense, the ontological definition of a market is framed by the particular informational deficiencies experienced by participating agents to the market.  That is to say, for example, the geographic boundaries faced by suppliers are framed by the capacity of consuming agents to collect information on sourcing to secure the particular needs realized from exchange in the market.  Spatially isolated markets arise because information on exchanged goods and services is not globally accessible to consuming agents.  To the extent that progressive integration of spatially isolated markets reduces prices for consumers, global market integration exists as a potential limit on cost minimization, and global market integration necessarily demands globally perfect distributions of information on market conditions.
7.  In the limit, as barriers to entry diminish on the production and/or consumption side of a market and relevant economic information becomes more equally distributed, markets can be characterized as perfectly competitive.  This assumption exists as a conclusion from assumptions 5 and 6.  In this respect, it posits a set of conditions under which we might, at least, approximate a Walrasian/Paretian general equilibrium economy, in the sense that market outcomes will be strictly driven by negotiations between relative equals (many consuming agents and many producing agents, each with perfect information on available opportunities and cost structures in production).  Further, to the extent that the transmission of information accelerates, we might approximate instantaneous readjustment to changes in supply and demand side conditions.  On the other hand, in this document, we will continuously assume that such transmissions are beyond the capacity of actually functioning market systems.  Insofar as we assume perfect competition, we will, therefore, restrict our assumptions to singular markets or finite sets of closely interrelated markets.  Under these conditions, individual agents, on both the consumption and production side, will operate as price takers, incapable of meaningfully impact market prices through their own behavior.
8.  Changes in the supply and demand schedules for final goods and services and for factors of production are localized and spread discontinuously across markets.  Following from our previous assumptions, any changes in the demands of consuming agents and the technological capacities of producers will arise on a strictly local scale, transforming market outcomes through a prolonged cascading dynamic, through which competing firms and consumers unevenly collect information and adjust to discrete transformations in consumer demand and production capacity.  To the extent that Marshallian theory commits to a rigorous empiricist epistemology, it requires conceptual vehicles to convey information from particular market sites to other sites.  For Walrasian/Paretian theory, relative prices constitute adequate means for the transmission of information on technological change and fluctuations in household consumption preferences and/or factor supplies.  For Marshallian theory, this is not sufficient.  We need to account for the particular sources through which information on market conditions transmit across all markets.  In general, how do individual consumers collect information on offer prices from suppliers?  If there are readily available technological mechanisms through which consumers can collect sets of prices from suppliers, then, under an assumption of rigorous price competition, consumers should flock to the lowest price supplier for relatively homogeneous goods or services.  If this happens, then other suppliers, who may begin to accumulate inventories of unwanted products, will realize that market conditions have changed in relation to normal conditions and will adjust their prices accordingly to liquidate accumulated stocks.  By this reasoning, the easier it is for consumers to accumulate information on prices from competing suppliers, the more nearly we will approximate perfect price competition between suppliers and, hence, a single market price for relatively homogeneous goods or services.
9.  Market equilibrium prices tend to be transitory and localized, but, over longer temporal periods, prices may settle into a normal range, determined by patterns of consumer demand, production technologies, and availability of production factors to production agents.  Following from assumptions 7 and 8, individual equilibria in markets characterized by relatively competitive conditions arise from the cumulative impact of myriad exchange processes in which the relatively unrestricted flow of information to agents on both sides of the market will tend to result in progressive uniformity of prices across all exchanges, promoting the liquidation of all supplied stocks of goods and services.  Proceeding from an assumption of relatively competitive conditions over longer periods of time, we may assume that prices settle into a normal range or to a normal price level.
           As a consistent feature in Marshallian market analysis, this assumption deserves more consideration.  The idea of a normal price most succinctly reflects the lingering connection of Marshallian theory to Classical Ricardian and even Smithean thought.  Marshall's concept of the normal price is virtually equivalent to Adam Smith's conception of the "natural" price and David Ricardo's conception of "exchangeable value," and it even, in a certain sense, parallels Karl Marx's conception of the "price of production" (i.e. an average price incorporating a normal rate of profit for the entrepreneur).  As a practical matter, the normal price for a particular good or service defines the price of the product that obtains over some extended period of time, abstracted from purely short term causes of divergence whose influences can be otherwise isolated.  The idea that prices assume a long term level is not unique to either Classical economics or Marshallian Neoclassical theory.  Walras even assumes, in his theorization of product exhaustion and the zero-profit condition for competitive firms, that prices will settle to some long run average level where entrepreneurs can neither gain nor lose in their capacities as entrepreneurs.  For Marshall, however, as for Smith, Ricardo, and Marx, this normal price was taken to be largely equivalent to the cost of production faced by firms for producing the good or service in question (see Alfred Marshall, Principles of Economics, Book V, Chapter 5, at: http://www.econlib.org/library/Marshall/marP32.html#Bk.V,Ch.V).  Acknowledging that production costs, at least potentially, hold a special primacy as a regulator of long run market pricing, we have to subsequently recognize Marshall's contention that the long run is not only indefinite in duration but widely varied across industries and across firms at different scales of production in individual industries.  In this regard, any assertion that a given market price is abnormal in relation to the long run price of a good or service needs to be rigorously situated in reference to the particular processes that promote a stable or unstable long run price axis.
             The key point is that, production costs may constitute one very important influence on long run pricing, but if short run prices vary wildly around a common axis based on perpetually changing short run conditions, then the normal price level or range may prove largely irrelevant to a broader analysis of markets.  I am going to argue, however, especially over the course of our critique of the Marshallian theory of the firm, that the mere notion that market prices take on relatively stable long run values holds relevance for agents on both sides of a market, as do the particular interpretations that we advance to explain the stability or instability of such values.  
10.  All market agents are strictly rational, as profit/utility maximizers, but the rationality of their actions is strictly bounded by their lack of perfect information regarding contemporaneous production technologies and market conditions and future outcomes of contemporaneous investments.   To the extent that Marshallian theory seeks to advance an empiricist account on the workings of markets and market agents on the production and consumption sides, it both recognizes the reality of ontological complexity and negotiates complexity by recognizing the capacity of individual agents to reframe their images of economic reality through the repetitive accumulation of new information.  In this manner, we will advance the proposition that individual agents, on both the consumption and production sides of markets, approach the market rationally, where rationality implies, in conformity with the larger Neoclassical tradition, self-interested maximizing behavior.  Thus, Marshallian theory, with Walrasian/Paretian general equilibrium theory, regards the firm as a profit maximizing/cost minimizing entity.  Unlike Walrasian/Paretian theory, however, the Marshallian theory of the firm advanced here will hold that individual firms/entrepreneurs are incapable of executing objective maximal behavior because firms lack perfect information.  Rather, the Marshallian firm (as profit maximizer) and the Marshallian consumer (as utility maximizer) negotiate the imperfection of their market engagements through a framework of bounded rationality.  That is, Marshallian agents accumulate new information, update their comprehensions of reality, and repeatedly adapt their behavior against new referential frames.
            At the outset of our analysis, we have to conclude that, in a world of individuals who approach the complexities of market exchange through repeated behavioral readjustment in response to new information, every disproportionality in informational distributions is likely to result in exploitable differentiations of market power.  Acknowledging this point, we need to differentiate between a theory of market interactions in which distributions of information are largely proportional among all participating agents, and a theory of strategic interaction where informational distributions are disproportional and, hence, certain agents are capable of exercising power in a given context derived from their access to privileged information.  The latter theories will be further explored as we develop an understanding of strategic interaction through various game theoretic formulations.  In this document, we will largely assume proportionality in the distribution of information and, where we diverge from such an assumption, we will specify particular mechanisms through which disproportionalities may become institutionally durable (e.g. patent rights to production technologies and consumption goods and services).

The Marshallian Entrepreneur

In the previous set of posts, I took great pains to reinforce the argument that the Walrasian/Paretian firm is a ship without a captain.  It is a collaboration among autonomous, utility-maximizing households structured and mechanistically driven entirely by a mathematical formula and, hence, that formula, the production function, becomes the primary defining signature of the firm based on what Walrasian/Paretian firms do.  In Marshallian theory, we will, of necessity, deal with production functions that describe the technical combinations of production factors utilized by Marshallian firms to produce outputs, but they will not rigorously define the firm because, ultimately, the Marshallian firm is a vehicle of repetitive readjustment by a human driver.  The Marshallian production function exists as both an outcome of partial and disproportional accumulations of information and as a tool with which entrepreneurial agents seek to maximize profits subject to both their financing constraints and their own lack of perfect information, a lack simultaneously manifesting the power and peril of entrepreneurial activity.  In this manner, the signature of the Marshallian firm is not the technical formula that describes its manipulation of production factors to generate outputs, but the entrepreneur who both orchestrates production, under the tentative limitations established by the production function, and bears the risk of production and exchange over differentially extended temporal durations and across potentially broad ranges of geographic space through which investments in the production and exchange of goods and services may yield either gains or losses for the firm.
               This imagery of the firm as an entrepreneurial project defines, in large part, the critical departure of Marshallian theory from the Walrasian/Paretian firm, reinforcing, in particular, a differentiation of informational and associational/ethical assumptions.  In the Walrasian/Paretian firm, we do not need an entrepreneur because households, as consumers and owners of the production factors, universally possess perfect information on production technologies and market conditions.  Moreover, any change in technology or market conditions will instantaneously be communicated between households facilitating continuous, instantaneous readjustment across all markets.  For Marshallian firms, information on contemporaneous production technologies and market conditions is imperfect distributed, and, as such, individuals possess unequal quantities of information governing the exchange/utilization of production factors in their possession and availability/demand for final goods and services.  Certain individuals possess advantages driven by their access to privileged information, capable of conferring contemporaneous advantages in achieving rational/self-maximal behavior.  On the other hand, uncertainty about future outcomes and the discontinuous potential for readjustment in response to changes in technologies and market conditions generates a void in the contemporaneous decision sets of individuals.  Under circumstances where contemporaneous decisions will carry consequences for an undefined temporal duration into the future, every decision to commit factor resources and/or invest savings into a process of production whose outputs face an uncertain future in market contexts as yet non-existent produces risks structurally absent from a Walrasian/Paretian general equilibrium economy.
               Additionally, the informational differences between Walrasian/Paretian and Marshallian conceptions of the firm shape the associational/ethical consequences of the firm as a collective project.  At numerous places in our development of the Walrasian/Paretian firm, we reiterated the conception of the firm as a cooperative project between the household owners of production factors.  In a broader sense, the cooperative project of the firm constitutes a single component of a seamlessly interconnected cooperative whole - a fully integrated market economy.  This imagery of the firm as a cooperative entity pervades the larger structure of the Walrasian/Paretian general equilibrium economy, within which the ultimate goal of production is conceived as the maximization of utility for all households through enhancement of consumption possibilities in cooperative production relative to individual/autarkic household production.
               Marshallian theory, to a certain degree, acknowledges the potential for production by individual/household units in the absence of collective assemblage of production factors from other households.  However, the firm, in general, continues to embody the conception that collective production may, under most circumstances, hold the potential for gains in output from cooperation.  On this note, to the extent that the Marshallian firm consolidates production factors from multiple households, it achieves cooperation without any pretense of an egalitarian principle in organization.  The entrepreneur, as the embodiment of the firm, organizes the factors of other households and advances, at least, the promise that a certain mutually agreed compensatory formula will strictly determine the compensation for each factor of production.  In this respect, the entrepreneur acts as a quintessential first mover.  Insofar as the firm consolidates factors from other households, the entrepreneur extends the contractual offer to integrate factors from outside households into the firm, determines the compensatory rates at which they will be paid and the schedule at which they will be compensated in relation to the broader production process and the exchange of final outputs, and bears the risk that the firm's outputs will not realize the desired price per unit in market exchange.  In return for organizing production and bearing the risks of uncertain future technological and/or market conditions, the entrepreneur demands a privileged rate of return for his/her entrepreneurial activity, per se.  We will define this rate of entrepreneurial compensation as normal profit.    
              In our critique of the Marshallian firm, we will interrogate the concept of normal profit in relation to other Neoclassical perspectives on entrepreneurship, entrepreneurial compensation, and profit rates, and in relation to Classical conceptions of profit, especially the Marxian perspective.  At the present time, however, I want to simply advance the idea that entrepreneurs earn a certain compensatory rate for their activities as entrepreneurs.  This compensation rate, moreover, is distinct from the compensatory rate for owners of capital, defined, as in Austrian and Walrasian/Paretian theories, as a rate of interest.  In this manner, we need to recognize that the entrepreneur, as a household owner of production factors, typically owns and advances units of capital into the production process.  In fact, we will make the assumption that the entrepreneur is an owner of capital seeking to earn a rate of interest on the capital in his/her possession.  We can, thus, explicitly apply the term capitalist to the Marshallian entrepreneur.  All capitalists seek a positive rate of interest on their accumulated savings.  In some cases, a capitalist can achieve such a rate of return by lending their capital to some other production agent/entrepreneur, enabling the latter to organize other factors of production, invest in the production of goods and services destined for market exchange, and bear the risk that future technological and/or market conditions will enable them to realize a desired price per unit for their outputs.  In other cases, the capitalist seeks to be an entrepreneur in their own right, organize factors, producing goods and services, and bearing all the risks that their outputs can find a market.
            In the former case, a financial lending capitalist obtains at least a nominal degree of insulation from risk to the extent that the contractual agreement between him/her and their entrepreneurial borrower stipulates a mandatory repayment rate with interest, regardless of market conditions.  In the latter case, the entrepreneurial capitalist not only incurs the challenge of organizing production but also foregoes any protection from fluctuations in market conditions that might undermine the entire project.  Consequently, in addition to the prevailing rate of interest on capital that our financial capitalist seeks as an inducement to lending their savings, our entrepreneurial capitalist seeks a rate of normal profit to compensate his/her organizational efforts and risk-taking.  As such, it might be fair to label normal profit as the manifestation of a risk premium to entrepreneurial activity, but, as we will subsequently argue, such risk premia may also accompany financial lending to the extent that certain capital market transactions incur greater quantities of risk and less insulation than others.  It may be the case that the entrepreneur realizes, through market exchange, revenues sufficient to reward the owners of capital (including him-/herself) with a normal rate of interest but not sufficient to provide for normal profit as entrepreneurial compensation.  To the extent that such circumstances tend to approximate product exhaustion in the absence of an entrepreneur for Walrasian/Paretian firms, we need to consider the potential effects of inadequate or non-existent normal profits over time under divergent conceptions of entrepreneurship and entrepreneurial compensation.  
             Acknowledging that, by assumption, the Marshallian entrepreneur is a capitalist, advancing implements of capital of varying durability into the firm's production processes, it may also be the case that the entrepreneur is a landowner and that the firm's production processes occur in fixed proprietary space.  Furthermore, in many cases, the entrepreneur may contribute labor services to the production processes undertaken by the firm.  As such, the total compensation due to the entrepreneur might simultaneously include wages on labor services, interest on capital, rents on land, and profit on entrepreneurial activity.  The key point here is that, while the entrepreneur may need to procure additional production factors from other households to enable production to take place, the Marshallian firm, as a site of productive activity orchestrated by the entrepreneur and incorporating his/her own proprietary production factors, takes on a permanent or semi-permanent existence not possible for the Walrasian/Paretian firm.  In important ways, this non-transitory character reinforces the capacity of the entrepreneur to act as a first-mover.  A firm that already exists as a tangible and permanent/semi-permanent project of collective production, with established proprietary physical space/infrastructure and durable capital, may possess the capacity and credibility to offer contractual compensatory rates to suppliers of other production factors.  It may, likewise, possess the capacity to repeat the process for successive iterations without having to renegotiate the terms of exchange.  That is to say, the tangible existence of the firm as an extension from the committed proprietary factors of the entrepreneur, the entrepreneur's direction, and the outcomes of production and exchange over successive periods may congeal a mass of production factors contributed by multiple households under the direction of the entrepreneur into a semi-permanent entity cemented by a repetitive set of mutually beneficial exchange relationships between the entrepreneur and other contributing households.
            To conclude, it might be fruitful to consider how we can inscribe the Marshallian theory of the entrepreneur against manifestations of the firm in real economies.  Marshallian theory approaches real economies in a profoundly empirical sense, and it prioritizes market-oriented firms, producing goods and services in the interest of maximizing profit.  To these ends, we cannot exclude sole proprietary businesses employing only the factors of production advanced by the entrepreneur.  The absence of employees in such a firm does not meaningfully make its entrepreneur less committed to the organization of production and exchange or less subject to risk.  By contrast, non-corporate partnerships may include multiple individuals sharing entrepreneurial responsibilities without substantive transformation of their roles vis-à-vis sole proprietary firms.  Adding additional owners of proprietary factors of production, operating from a basis of mutual equality of status, multiplies the individuals occupying entrepreneurial roles without redistributing those roles away from the proprietors.  Finally, non-corporate worker or producer cooperative firms, in which all members of the cooperative possess an ownership share in the firm, operate with a democratized institution of entrepreneurship, but this institution remains congruous with entrepreneurial activity in sole proprietary and non-corporate partner firms.  Even insofar as the person of the entrepreneur is multiplied across all members of the cooperative, to the extent that the cooperative, as a whole, organizes production and exchange and assumes risks from changes in technological and market conditions, the entrepreneur is as unitary as the entrepreneur in a sole proprietary firm and non-corporate partnerships.  
          On the opposite end of the scale, we would have to include large corporate firms, incorporating thousands of individual household and institutional/organizational shareholders, steered by a board of directors overseeing a range of executive officers.  We would, conversely, have to inquire into the identity of the entrepreneur as we expand the scale of the firm to include corporate institutions.  Specifically, would it be fair to label the corporation itself, as an artificial legal person, as an entrepreneur, or might we invest the board of directors or corporate executive officers with this label?  To the extent that we identify entrepreneurial activity primarily in the organization of production and exchange and in bearing risks from a shift in technological and/or market conditions, and not in mere ownership of capital or other factors of production committed to the production process, the legal institution of artificial personhood conferred on the corporation, as the embodiment of a set of vested property rights in particular factors of production and in outputs generated by their use, does not coincide with our conception of entrepreneurship.  Rather, the technical organization of production and exchange processes is undertaken most directly by the executive officers of the corporation and their hierarchy of supervisory personnel.  On the other hand, these executive officers constitute hired hands of the board of directors, representing the interests of all shareholders.  The executive officers may bear substantial legal fiduciary responsibilities to act in the best interests of shareholders to maximize profits, but the shareholders ultimately bear the risk that the corporation's outputs will not find a desired price in exchange.  In the end, the board of directors may most directly reflect our conception of the entrepreneur insofar as the board represents the interests of shareholders, but the board confers substantial parts of its responsibilities with regard to the day-to-day organization and operations of the corporation to its executive officers.  The corporation effectively redistributes the characteristics of entrepreneurship across diverse corporate roles, the division of which does not manifest itself within sole proprietary firms, non-corporate partnerships, cooperatives, or other forms of the firm.
             Summarizing the relevant arguments made in this section concerning the Marshallian firm and its entrepreneur, we can say:
1.  The Marshallian entrepreneur is a first-mover among agents of production, assembling production factors from other households to achieve cooperative gains in total output relative to individual/autarkic production.  
2.  The status of the entrepreneur as a first mover is shaped, in part, by his/her access to privileged information on production technologies and/or market conditions and, additionally, by his/her willingness to bear risks arising from incomplete information about contemporaneous and future conditions.
3.  In general, we will assume that the entrepreneur exists as an owner of capital and, hence, a capitalist, seeking positive rates of interest as compensation for the investment of capital.  However, as an entrepreneur, he/she foregoes the potential for returns from lending at mitigated levels of risk in favor of organizing production and bearing the risk that outputs will not find a market at their desired price per unit.  
4.  In addition to normal rates of interest on capital, the entrepreneur seeks, as compensation for the organization of production factors from outside households and for bearing the risk that goods and services will not find a market at a satisfactory price, a rate of normal profit.  
5.  Under the entrepreneur's direction and commitment of proprietary factors of production, the firm enjoys a semi-permanent/permanent existence, through which it can credibly engage household owners of other production factors in repetitive contracting without subsequent renegotiation of contractual terms.  
6.  Real sole proprietary firms, non-corporate partnerships, and cooperative firms manifest simple, undivided entrepreneurial roles by a single or plural entrepreneurs.  Corporate firms involve divided entrepreneurial roles, distributed between shareholders, boards of directors, and executive officers, all of whom occupy incomplete and institutionally reconfigured responsibilities for the organization of production and exchange and assumption of risk.   

A Pure Neoclassical Theory of the Firm XV: Summary (Microeconomics)

The account in this document has sought to achieve two ends: to present a theory of the firm in an integrated general equilibrium economy, abstracted from a broader theory incorporating household choice in factor supply and output demand; and to critique the various component parts and assumptions of such a theory.  The title of the document presupposes the idea that such an account constitutes a "pure" Neoclassical theory.  My application of the label meant to emphasize that the theory seeks to be firmly grounded in utility maximization, subordinating considerations on production costs and entrepreneurial direction central to the Classical (Ricardian or Marxian) tradition.  Along these lines, I further differentiated the theory from Marshallian approaches to the firms, which I will approach in the next document, because the concerns of the latter with space/geography, time frames, entrepreneurial strategizing, and the role of production cost in long run commodity pricing conflict with the assumptions of the theory presented here.  By contrast, I offered the initial position that the theory could be labeled Walrasian/Paretian (in regard to the usually conjoined schools of Neoclassical theory associated most closely with general equilibrium theory) and, potentially, Austrian (in regard to its rigorous foundations in utility maximization by autonomous household agents, the theoretically transitory character of the firm as an agent of production, and the reliance of free market mechanisms as the sole regulatory institution for the operation of firms).
          Over the course of our critique, however, we gradually undermined the conditions enabling us to apply the Austrian characterization, most critically because our theory of the firm lacks, for all intents and purposes, a capitalist entrepreneurial agent, imperative to any rigorous Austrian account of free market economies.  The Walrasian/Paretian firm, as we have conceptualized it here, is a transitory and cooperative enterprise, undertaken by household agents in possession of diverse production factors with the motive of enjoying gains from their cooperation, either through direct consumption of collectively produced goods and services or through exchange with other households producing alternative sets of goods and services.  In this manner, the notion of a proprietary return payable to an entrepreneur for the service of acting as an instigator for the production process disappears.  Consequently, it might be fair to label the Walrasian/Paretian firm, as we have here characterized it, as (quixotically) both market-oriented and non-capitalist/cooperative.  In a larger sense, the concept of capitalism, per se, appears largely absent in our account, except in those rare moments of our critique where the influence of Austrian theory creeps into view (e.g. our theorization of capital, influenced by the Austrian idea of "roundaboutness").  
          Our theorization established a set of theoretic tools.  Most notably, it developed an understanding of the forms and significance of production and cost functions in the mathematical determination of profit maximizing/cost minimizing factor combinations.  Production functions, in this manner, represent the embodiment of feasible technological combinations of production factors, producing determinate quantities of outputs.  Every possible combination of production factors, defined in accordance with varying degrees of factor heterogeneity, produces determinate quantities of a particular good or service under examination.  On the other hand, cost functions map the quantities of production factors available for rental by the firm under given factor market prices for each factor, again, in accordance with varying degrees of factor heterogeneity.           Approaching output markets through the insular window of a firm, under conditions of perfect competition across all output and factor markets, we established that the intersection of household utility maximization in consumption decisions and the technological constraints on production faced by all firms in a given market determines the output market price for an equilibrium quantity of a given good or service.  Pivoting off to the opposite side of production, we concluded that the intersection of household utility maximization in factor supply and technologically-driven demands for factors by firms determines the price for each factor of production utilized in particular production processes.
          To the extent that the firm continuously faces its output and factor markets as a pure price-taker, incapable by itself to impact the decisions of diverse, heterogeneous households to supply factors or demand goods and services (both as products of given internal, psychological predispositions in the household), its decisions on factor demand and output supply are strictly grounded on the technological contours of the production function.  On the other hand, we simplified matters by assuming a given functional form for our production function: our Walrasian/Paretian firm operates with a continuously differentiable linearly homogeneous production function, in which every set of positive factor market prices generates a unique factor market combination that will maximize profits/minimize costs for every scale of output.  At every profit maximizing factor combination, each production factor rented from households, moreover, will be compensated at a rate proportional to its productivity at the margin of employment, under a condition of diminishing marginal productivity for all production factors.  Under the particular conditions of our production function, such a compensatory rate will realize a condition of product exhaustion, where the sum of all factor payments will exactly exhaust the incomes generated by the firm.  Such a result is both mathematically necessary, under the particular functional forms utilized to describe production technology, and ethically expedient, to the extent that we firms do not generate incomes for non-productive agents.  Under the principle that each rented factor must strictly be paid its productivity at the margin of employment, the distribution of payments between factors, moreover, can be characterized as both efficient and fair, relative to the marginal productivity of each factor.  
           Extending beyond the limits of our firm, we argued that the interaction of perfect competition and perfect information, as assumptions in Walrasian/Paretian general equilibrium theory, ensured that all firms within a given market would operate with the most efficient available technologies and that, as such, each firm would exist as a representative firm within a given market, with a production function equivalent to that of every other firm.  Differences in scale between firms might exist, as a result of differences in the financial constraints faced by individual firms, but such differences would not be reflected in costs per unit of output because linearly homogeneous production functions are characterized by constant returns to scale at profit maximizing combinations.  If all industries within a general equilibrium economy, moreover, are characterized by firms facing constant returns to scale, then every industry, as a combination of individual firms, would approach factor and output markets with perfectly elastic demand and supply schedules, respectively, because, the profit maximizing factor ratios of all firms would be proportional for all scales of output.  We argued, in this manner, that, in a general equilibrium economy, firms exist as pure technological intermediaries, translating factor inputs into finished goods and services, ultimately exchanged between the autonomous household agents constituting firms and engaging in the exchange of their collectively produced outputs.
              In our critique, we argued that argumentation on the nature of firms within a general equilibrium economy ultimately reinforces the partisan preferences/prejudices of Walrasian/Paretian theories.  Emphatically, the reduction of the firm to a place as pure, captive intermediary between autonomous household agents reinforces a broader image of a general equilibrium economy as cooperative/competitive endeavor between households, each in possession of production factors and each possessing a set of preferences for consumption of goods and services.  In this manner, the firm represents a practical institution, through which free, autonomous household agents combine their production factors to undertaken cooperative production with the expectation that such processes enlarge the consumption possibilities for each household beyond what each is able to gain from individual/autarkic production of consumption goods and services.  Our reasoning here attempts to articulate one dimension of the larger negotiation of gains from exchange which Walras encapsulates in the French term tâtonnement meaning to jostle or grope one's way tentatively forward.  We argued that the concept of tâtonnement is pivotal to any understanding of general equilibrium economics - beyond any articulation of mathematical functions and assumptions on functional forms, we are left with the portrait of individual household agents coming together to bargain, auction, or otherwise negotiate the terms of mutually beneficial exchanges.  Our theory of the firm is entirely grounded on this imagery, even to the extent that it diverges from other theories of the firm in a Neo-Walrasian frame and, perhaps, constitutes a caricature of the very assumptions latent within Walrasian/Paretian general equilibrium thought.
              Pursuing, as relentlessly as possible, the consequences of Walrasian/Paretian theories of production on the structural role of the firm, we concluded that assumptions about the homogeneity of production factors, while simplifying to our overall presentation of the theory, create certain problems in translation of the theory into the contexts of real factor markets.  It remains difficult if not impossible to rigorously define abstract, homogeneous factor resources called labor, land, and capital, even if our capacity to calculate marginal productivities is absolutely predicated on our capacity to add discrete quantities of such homogeneous substances to the production processes of firms.  Our individual examinations of land, labor, and capital ultimately led to the conclusion that the real production factors rented out by households and utilized by firms are likely to be highly heterogeneous in nature (and may involve complex combinations of production factors, like basic labor and human capital, that exchange as a combined unit) and that our calculation of compensatory payments to such factors may more readily rely on imputation from given output market prices.  To the extent that we rely on output price imputation of factor prices, however, we may imperil the ethical corollaries of product exhaustion through marginal productivity factor pricing - our factor compensation rates become wholly disconnected from the mathematical determination of factor prices through differentiation of the production function, enabling market forces to skew compensatory rates as a result of, say, short-side market power, not evident if we relied strictly on the technological contours of our production function to determine the relative contribution of each production factor at its margin of employment.  Again, however, to the degree that we ground our theory of the firm on tâtonnement and we grant the possibility of some role for exogenous (governmental) mediation of market outcomes to ensure basic fairness between participating household agents, the potential for divergence from strict marginal productivity factor pricing may be mitigated.
               More critically, the Walrasian/Paretian theory of the firm suffers, in its engagement with the economic reality of firms that it means to theoretically simplify and explicate, from the absence of an entrepreneurial agent.  In this respect, we argued that neither Léon Walras nor Vilfredo Pareto, as the foundational theorists in general equilibrium economics, seriously grasped the potential necessity of entrepreneurial action, decision-making, and risk-taking in the face of uncertain outcomes to production or investment decisions.  Ultimately, the rationale for this absence of an entrepreneurial agent resides in the timeless and spaceless character of general equilibrium theory.  I have attempted to convey these deficiencies in the ontological construction of general equilibrium economics by asserting, among other things, the instantaneous character of adjustments to changes in individual preferences and/or production technologies as an outcome of continuous tâtonnement between households in continuous possession of perfect information.  In subsequent theories of the firm, we must further engage in the problem of information and the consequences of differential distributions of key information concerning production technologies, household preferences, and market opportunities on the organization of an economy.  Insofar as we have here collapsed every species of information problem and their respective consequences by imposing an assumption of perfect information, we likewise have no need for an active, autonomous, and entrepreneur/risk-taking production agent to negotiate contemporaneous information deficiencies and uncertain future outcomes, particular with respect to capital investments that take time to come to fruition.  In a Walrasian/Paretian economy, we can replace such an agent with a continuously differentiable, linearly homogeneous production function as the wholly captive, technologically-driven signature of the firm.
              Notwithstanding the obvious short-comings of Walrasian/Paretian thinking on the organization of production in a general equilibrium economy in relation to the institutions of real economies, I want to conclude this summary by pressing home the fundamental, partisan arguments that, at least in my view, underlie this theory of the firm.  By virtue of its single-minded, rationalist reduction of economics to exchange between autonomous, utility-maximizing agents across an integrated ensemble of output and factor markets, Walrasian/Paretian constructs, if inadvertently, an image of the firm in which the cooperative impulse of human agents overcomes the impulse for exploitation arising from differentials in market power.  The firm, as an outcome of the rigorous elaboration of general equilibrium thinking, ensures fairness for all cooperating households, expressed as a distribution of the gains from cooperation in rigorous conformity with marginal productivity factor pricing.  Moreover, it constitutes a single element in a broader economic structure, driven by tâtonnement, in which the balanced effects of cooperation and competition aim to achieve the greatest augmentation of social welfare by means of individual, self-interested, utility-maximizing behavior.  Such a structure not only exemplifies its rationalistic epistemological grounding, as an effort to arrive at the fundamental truth of market economics by means of abstract speculation and introspective deduction, but it unabashedly approximates a utopia in human interaction.
                In positing Walrasian/Paretian theory as a species of utopian thinking, we can obviously advance the criticism that it represents an unrealistic analysis and appraisal of the workings of a market economy and that, consequently, theories of the firm emerging from such a construction are of no value.  Conversely, to the extent that we view utopian projects as discursive interventions intended to transform the realities that they describe, the image of market economies grounded in cooperation/competition as a dual regulatory mechanism and the imagery of firms as pure, transitory cooperative projects, functioning to enhance the utility of participating households, presents one hopeful starting place in a broader project of enhancing economic democracy in place of exploitation.  Evaluating such a theory from a Marxian standpoint, it seems at least as possible to me to extract from Walrasian/Paretian theory a cooperatist/communistic project, articulating progressively participatory, real manifestations of tâtonnement in order to generate a fair, democratic, and, still, efficient distribution of incomes from the assemblage of production factors in collective production.  The key point, in this respect, remains epistemological.  Insofar as we view Walrasian/Paretian theory as an epistemologically realist, rationalist body of ideas about the workings of a market economy, we foreclose against the possibility of utilizing the theory and its conceptual elements as transformative/performative tools, shaping new efforts to validate non-capitalist, non-exploitative organizational forms.