Chapter 3: The neoclassical theory of the firm

Pages Contents
48-79According to many economists, most notably among them Mas-Collel et al. (1995), Kreps (1990), Malinvaud (1985), Varian (1984) and Intriligator (1971), the ultimate objective of the business firm is to maximise profit subject to given information. Some economists maintain that the pursuit of profit maximisation is not realistic due to complexity and objectives other than profit. As Intriligator et al. (1996, p.275) point-out though, non-profit maximisation may be more true in the short-run than in the long-run: "The basic assumption of profit maximization has been repeatedly challenged. For example, Baumol (1967) suggests sales (or growth of sales) maximization, Williamson (1964) suggests managerial utility maximization, and Simon (1959) suggests replacing profit maximization by profit satisficing. Nevertheless, profit maximization is still the most widely used basic assumption for the firm, and these alternative goals frequently imply profit maximization - at least in the long-run."

Although these challenges have generated significant insights for the firm's short-run objectives, this chapter focuses on the 'black box' conceptual framework of the shortand long-run profit maximising neoclassical firm. In this framework, what enter the 'box' are information from input markets, information from output markets and governmental regulations regarding both; what exits it are outputs and services for profit. The firm's market share and profit performance provide useful feedback information that modifies the contents of the 'box' (see Figure 1). The contents of the box are considered the firm's private information that the firm depends upon for survival. In other words, the 'box' contains the firm's 'secret recipe' on how to transfer inputs into outputs; this 'secret recipe' is the firm's 'competitive advantage'. Decisions with respect to 'buying' or 'making' inputs, 'governance structure', stake holder 'incentive structures' as well as 'strategy' and 'evolution' are not concerns of the neoclassical theory.
1 The skeletal features of the neoclassical monopoly firm and the principle of profit maximisation
2 A formal model of the neoclassical theory of the monopoly firm
3 The firm in various market structures
3.1 Competitive advantage, market segmentation,
contestability and relevant competitors
3.2 The perfectly competitive firm
3.2.1 The perfectly competitive firm in the short-run
3.2.2 The perfectly competitive firm in the long-run
3.3 The monopolistically competitive firm
3.3.1 Monopolistic competition in the short-run
3.3.2 Monopolistic competition in the long-run
3.4 The Hotelling-type (spatially differentiated) firm
3.4.1 The spatial firm
3.4.2 The spatially differentiated industry in the short-run
3.4.3 Entry and the industry in the long-run
3.4.4 Efficient distance
3.5 Intra-industry trade theory
3.5.1 Industry structure
3.5.2 Two industries and two countries
4 Summary

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