The Emergence of the Theory of the Firm: From Adam Smith to Alfred Marshall

214 Pages·1978·20.01 MB·English

by  Philip L. Williams (auth.)

THE EMERGENCE OF THE THEORY OF THE FIRM
From Adam Smith to Alfred Marshall
THE EMERGENCE OF
THE THEORY OF
THE FIRM
From Adam Smith to Alfred Marshall
PHILIP L. WILLIAMS
© Philip L. Williams 1978
Softcover reprint of the hardcover 1st edition 1978
All rights reserved. No part of this publication may be
reproduced or transmitted, in any form or by any means,
without permission
First published 1978 by
THE MACMILLAN PRESS LTD
London and Basingstoke
Associated companies in Delhi
Dublin Hong Kong Johannesburg Lagos
Melbourne New York Singapore Tokyo
British Library Cataloguing in Publication Data
Williams, Philip L
The emergence of the theory of the firm
1. Corporations 2. Managerial economics
I. Title
338.7'01 002731
ISBN 978-1-349-03791-9 ISBN 978-1-349-03789-6 (eBook)
DOI 10.1007/978-1-349-03789-6
This book is sold subject
to the standard conditions
of the Net Book Agreement
Contents
Acknowledgements vii
I METHOD AND ORGANISATION 1
2 ADAM SMITH 11
I. The Motivation of the Firm 12
2. Costs and Cost Functions 19
3. Equilibrium and Stability under Competition 24
4. Monopoly 35
3 J. S. MILL 40
I. The Motivation of the Firm 41
2. Costs and Cost Functions 48
3. Value and Equilibrium 54
4 ALFRED MARSHALL 70
I. The Influence of Cournot 70
2. The Motivation of the Firm 76
3. Costs and Rents 81
4. Cost Functions and Supply Functions 87
5. Free Competition 102
6. Equilibrium and Stability under Competition 108
7. Monopoly 121
8. Bilateral Monopoly 130
9. Duopoly 136
5 MARSHALL AND AFTER 144
I. The Motivation of the Firm 145
2. Cost Functions and Supply Functions 151
v
vi Contents
3. Competition and the Size of Firms 155
4. Equilibrium and Stability under Monopoly 159
6 SOME REFLECTIONS 166
Endnotes 171
Index 202
Acknowledgements
The present study was originally prepared for submission to the
University of London as a PhD thesis. Throughout the period in which it
was written, I received assistance from two supervisors both of whom
were extraordinarily accessible and helpful. Professor Basil Y amey of the
London School of Economics welcomed me to the School and has been
my constant adviser, critic and friend. Professor Mark Blaug of The
University of London Institute of Education suggested the subject
matter of the thesis and then agreed to help with supervision. He has
tried desperately to give some shape to my indulgent musings. Later,
Professor Terence Hutchison, acting as external examiner, offered many
thoughtful suggestions.
While Professor Maureen Brunt and Mr. Courtney Wright of
Monash University first stimulated my interest in the theory of the firm,
it was not until I attended lectures by Lord Robbins at the LSE that I
began to understand how fascinating and valuable pre-Samuelsonian
economics can be. The seeds sown at Monash were fed by Lord
Robbins. Professors Blaug and Yamey acted as gardeners-sometimes
tending and encouraging, sometimes trying to discipline a wild and
unruly bush.
While these people deserve my lasting gratitude, my warmest thanks
are to my wife, Elizabeth, who has supported me in body and soul these
past three happy years.
Philip L. Williams
vii
1 Method and Organisation
This study analyses the way in which the theory of the firm's production
and selling decisions emerges from the eighteenth century until the death
of Marshall in 1924. By the time of Marshall's death the broad outlines
of present debates in the field had been drawn. The penultimate chapter
substantiates this proposition and reviews the evidence to determine
whether we can distinguish good theory from bad.
This introductory chapter aims to outline the methodological ap
proach which has been adopted in the studies proper. It explains the
basis of the value judgments taken; and it gives reasons why alterna
tive methodologies have not been followed. Those readers who are
interested in the studies, but less interested in methodological issues,
may prefer to begin reading at Chapter 2.
The study focusses on the choices firms make within the enironment
of a market system. Adam Smith produced one of the most lucid
explanations of how individual decisions mesh together in that pattern
of unconscious co-ordination which we call the market system. Operat
ing within that system, firms can be defined as units for the conscious co
ordination of resources. I Or, using D. H. Robertson's metaphors, they
are ' . . . islands of conscious power in this ocean of unconscious co
operation, like lumps of butter coagulating in a pail of buttermilk. '2
The determinants of the decisions of firms constitute the theory of the
firm. Such determinants may include the past decisions made by firms,
their internal structure, the personalities influencing policy within the
firm, the policies of close competitors and the framework of law
provided by government.
A study of the historical development of the complete theory of the
firm would be redundant. It would be redundant because there already
exist standard historical treatments of the firm's decisions in factor
markets. 3 So the present study relates only to the literature of those
decisions of the firm which relate directly to product markets-the
pricing and production decisions.
Because the firm is one of the least aggregated units recognised in
economic theory, hypotheses as to firm behaviour are embedded in that
1
2 The Emergence of the Theory of the Firm
economic theory which moves on higher levels of aggregation. Indeed,
von Hayek suggests that practitioners of the social sciences reason from
their experiences of how individuals operate (methodological in
dividualism). For this reason he characterises the method of the social
sciences as compositive (from Menger) or synthetic.4
Keynes appears to be one leading economist who eschewed the path
of methodological individualism.s Although he may have derived his
macro-economic propositions from observations of the behaviour of
disaggregated units, he did not argue for his propositions from an
analysis of disaggregated behaviour. But social science concerns the
interactions among the behaviour of indiviquals. So hidden behind
Keynes' functions of consumption and of the demand for money there
are propositions as to the behaviour of individuals. The inadequacy of
the General Theory in synthesising individual behaviour has necessitated
much effort in the post-Keynesian period devoted to elaborating the
micro-foundations of macro-theory.6
Because social science concerns the interactions among the behaviour
of individuals, the theory of the firm is (along with consumption theory)
one of the basic building blocks of the theory of markets. The primacy of
this theory makes it imperative for economists to understand the precise
nature of the debates between theoreticians and to try to assess the
relative merits of the various hypotheses.
Problem Shifts
Lakatos has pleaded for an 'internal' retelling of the history of science.
In arguing for the importance of internal history as compared with
external history he argues two propositions. In the first place, he argues
that the selection of topics for research is determined primarily by the
nature of the research programme (that is, the selection is internally
determined). Any research programme will consist of a hard core
(propositions which are not tested directly), a protective belt of auxiliary
hypotheses (which bear the brunt of testing and are adjusted or replaced
so as to defend the hard core), and a positive heuristic. • ... the positive
heuristic consists of a partially articulated set of suggestions or limits on
how to change, develop the "refutable variants" of the research
programme, how to modify, sophisticate, the "refutable" protective
belt. '7
One issue discussed in this study is the extent to which the history of
the theory of the firm is internally directed in this sense: the extent to
which the work of J. S. Mill, Senior and Marshall was suggested by the
Method and Organisation 3
model of Adam Smith, and the extent to which it was directed by factors
external to that model.
Chief among the external influences is public concern with the
problems of economic policy. This stimulus presents to economists
problems which may not be suggested directly by their current research
programme. s Adam Smith's outrage at government grants of monopoly
marked the culmination of a long line of earlier public debate which led
to a developing analysis. The re-kindling of this moral fire (particularly
in the United States) towards the end of the nineteenth century led to the
production of valuable case studies and to the improved analysis of price
discrimination and of joint costs.
The study gives some support to von Hayek's generalisation: 'It is
probably true that economic analysis has never been the product of
detached intellectual curiosity about the why of social phenomena, but
of an intense urge to reconstruct a world which gives rise to profound
dissatisfaction.'9 Not only does political debate suggest problems for
economists to solve, but also political debate imposes on scientists
standards of clarity and of truthlikeness. If an economist suggests that
political decisions should be based on predictions which turn out to be
wrong, the adviser will then be confronted (often in public) with the
wrongness of the predictions. lOAn illustration of the salutary effect of
political debate can be found in those economists who have undertaken
industry studies or given government specific advice on monopoly
policy. These have been much less ready to accept the doubtful
proposition that the number of firms is the most significant determinant
of monopoly power, than have the pure theorists.
Rational reconstruction
In the previous section it was noted that Lakatos argues for the primacy
of internally-directed problem selection. The second meaning he gives to
his plea for an internal account of history is that the historian should tell
the logical development of a story with the benefit of hindsight.
Important developments in the story will be those developments which,
with hindsight, can be seen to have been good. Developments in the
story which were bad, but of contemporary influence, should be treated
much more cursorily. Lakatos terms this approach the rational
reconstruction of history. He suggests: 'One way to indicate discrep
ancies between history and its rational reconstruction is to relate the
internal history in the text, and indicate in the footnotes how actual
history "misbehaved" in the light of its rational reconstruction.'ll