Profit

Now consider the proprietor of the firm. Nothing has yet been said about the proprietor except that she provides the nonhuman means of production. At this level of abstraction the proprietor in effect is identified with a given set of nonhuman means of production, that is, capital goods, tracts of land, and stores of raw and semifinished materials. Thus, let proprietor a E S, and a' another potential proprietor, and consider the deviation D = (S{a}) U {a'}. To say that a' is a potential proprietor is to say that a' is appropriately linked to the other members of S as a is. In this we assume that the rational successor R = s(Q,D) is the naive successor;2 that is, we abstract from any reorganization of N/D. Suppose then a supplies nonhuman means of production {a*1, a*2, a*3, . . .} and a' would supply a different set {a'1, a'2, a'3, . . .}. We extend the production function, equation (A11.1b) in the appendix to Chapter 11, as

With

This will yield, for the same total effort, a greater Q and thus a greater total consumers’ surplus than is attainable for coalition S; so that V(R, D) > V(Q S). Since, however,

coalition structure Q is dominated via D and consequently Q is unstable.

To relate this to a capitalist economy will require some interpretation! Of course, it is incomplete to identify the proprietor with a bundle of capital goods. The proprietor will have determined, by an earlier, noncooperative decision, what nonhuman inputs to procure. What we have learned is that, if the proprietor has not procured the set of nonhuman inputs that generates maximum value for the coalition, then the coalition may be unstable. If for some reason the proprietor is unable to procure this optimal set of nonhuman inputs - because, for one example, of liquidity constraint and a consequent inability to raise the necessary finance or, for a second example, because land is entailed and cannot be bought and sold - then it may be profitable, and efficiency probably would be increased, if the firm were sold to a different proprietor.

In this discussion of the proprietor, we have so far ignored transaction costs, but the transition of proprietors will probably often entail very large transaction costs. For the model in this part of the book, transaction costs are the costs of search and matching to establish new information-sharing links, and what we have assumed is that the potential new proprietor is already appropriately linked to the coalition. If the “potential new proprietor” is the same person equipped with a different set of capital goods, this will be no difficulty. In the case of finding a new buyer for an undercapitalized firm, transaction costs could be quite large and a crucial consideration.

(There is also the complication that the proprietor might be a central agent, that is, c or f in Figure 12.1. In that case, however, the proprietor would not be a pure supplier of nonhuman inputs as assumed, but would also supply “human capital” in the form of links - goodwill - and thus is also an employee with an idiosyncratic productivity ka that depends on that human capital. In small firms this will be the usual situation. However, to maintain the analytical distinction between the proprietor and employees, which is borrowed from neoclassical economics, the following convention is adopted: the central agent, who maintains information-sharing linkages among the members of the coalition, is an employee, the “human resources director,” and is analytically distinct from the proprietor. In any case our examples of linkage are highly simplified, and the distinct “central agent” is herself a fiction of simplification.)

Now, suppose again that a E S, and D = (S{a}) < {a'}, where a' is a potential proprietor appropriately linked to the members of S other than a. However, suppose instead that a*k = a'k, that is, both supply the same set of nonhuman inputs. Then, by reasoning parallel to that associated with equations (12.13)-(12.15),

Since

in a stable coalition, the (economic or net) profit accruing to the proprietor is zero. In particular, suppose the money value of {a*j, a*2, a*3, . . .} is K, the alternative rate of return is r; then П = rK. This corresponds to the familiar neoclassical proposition that in a fully competitive situation, the rate of “economic profit” is zero.

Here again we have ignored transaction costs and simply assumed that an alternative proprietor with the same suite of nonhuman inputs is freely linked to the coalition. This seems a reasonable construction of a “fully competitive situation.” Still, to illustrate the importance of this assumption, suppose the proprietor, a, is engaged in an innovation in the Austrian framework described by Schumpeter (1934/1961, pp. 65-6): a “new combination” of higher order goods. Then there is no other potential proprietor, linked or unlinked, who would bring a'k = a*k to production. Suppose {a'k} are the higher-order goods (nonhuman means of production) used within Schumpeter’s (1934/1961, Chapter 1) circular flow. As they are routine, we may suppose without much hesitation that there will be an appropriately linked potential new proprietor who would supply {a'k} for deviation D. Thus

We see that, as Schumpeter argued, economic profit may be associated with innovations. (However, they will also depend on the proprietor’s bargaining power.)

Two further remarks are needed. First, in practice, an innovator may need to create new links and establish a new coalition. This, too, is a “new combination” of higher-order goods (since labor is also a higher- order good) and the formation of a new coalition to use methods that are already well established is no less entrepreneurial, in the Austrian sense, than “the Deerfoot Sausage” (Schumpeter, 1947, p. 141). But this goes beyond the function we have conventionally associated with a pure proprietor, as, indeed, entrepreneurial activity often will. Second, we cannot concede to Schumpeter that only innovation generates economic profit. Informational imperfections also may do it. We may have V(R, D) < V(^, S) simply because no well-financed alternative proprietors are appropriately linked to the employees and customers of the firm. Indeed, innovation is simply a particular case of market imperfection, in which the market imperfection arises from “the creative response” (Schumpeter, 1947).

 
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