Historical development of the neoclassical
Separation of ownership from control
Managerial and behavioral theories of the firm
Transaction Cost theory; Property rights theory
Resource based and knowledge based theory
The Neoclassical Theory
Wealth of Nations Adam Smith (1776)
– Pin factory on production costs
– Value is related to production cost
Augustic Cournot was one of the first economist to attept a formal
mathmematical analysis of the behavior of the monopolists and
duopolists. Value depends ultimately on demand
Utility concapt by Stanley and Jevons (1871)
Alfred Marshall (1890, 1892) was the one who drew the link between
costs of production and market demand
John Bates Clark The Theory of Perfect Competitin (1899)
Frank Knight (1921) lists a number of conditions required for a
market to conform to the model of PC
Joan Robinson and Edwin Chamberlein (1930)
Critique of the NC Model
Based on oudated view of competition
1. Organizational goals
Max. of profits or ???
2. Rationality ??
3. Perfect information ??
4. Decision making ??
The emphasis of the neoclassical theories is that
they miss dynamics
The entrepreneur is the personification of the
firm, plays an unimportant rolein the long run.
Price competition is the only form of rivalry
Schumpeter (1942) and the Austrian school give
the enterpreneur a central role within a more
dynamic model of competition
Separaton of Ownership from
– Increasing organizational compleqity meant
that it was impossible for the large firms to be
managed solely by the owner
Teams of managers
– Impractical for the enterpreneur to finance
solely by personal resources
Presence of capital markets
Baumol’s Theory of Sales Revenue
Maximize sales revenue subject to
minimum profit constraint
Why sales revenue and not profits??
– Sales are good general indicatof of
– Executive power, influence, status tend to be
linked to the sales performance
– Lenders tend to rely on sales data
Figure 3.1 Baumol’s sales revenue maximization model
Multiperiod version: Sales revenue depends on
current sales revenue, annual rate of growth on
sales revenue and ciscount rate.
Figure 3.1 shows that short run profit
maximization implies that sales revenue is lower
than it could be
By increasing output beyond its short run profiy
max. Level, the firm achieves an increase in
current sales revenue at the expense of
reduction in g
Marris’s Theory of Growth
Baumol (1962); Marris (1964) and Williamson (1963)
suggest that managers may pursue a strategy of
maximum growth of the firm
Strategy of max. Growth of firm :Max. Growth at the
expense of firms’ future profit streams.
Managers strive for growth rather than profit max.
Growth of demand => advertising expenditures; further
price reductions; extensive advertisements
May be harmful due to:
– Managerial constraint on growth
– Financial constraint on growth
Figure 3.2 Marris’s growth maximization model
As the rate of growth of demand is increased,
profitability is increased as well until a certain
point. Then managerial constraints on growth
tend to take place.
The maximum growth of capital function shows
the relationship between the firm’s rate of profit
and the maximum ate at which the firm is able to
increase its capital
This model suggests several testable hypothesis
one of which is: “owner controlled firms achieve
lower growth and higher profits”.
Williamson’s Theory of Managerial
Baumol’s model view that managers’ interests are tied to
a single variable: sales revenue.
Williamson (1963) argue that several variables should be
in the manager’s utility functrion
U= Utility function
S= Expenditure on staff (which leads to a higher prestige
on behalf of the manager)
M= Expenditure on managerial banefits (company car,
fringe benefits, ..)
ProfitD= Net profit (after tax and expenditure over and
above the minimum level of profit required
Figure 3.3 Williamson’s managerial utility maximization model
The Behavioral Theory of the Frm
Cyert and March (1964)
Defines the firm in terms of its
organizational structure and decision
Boundaries of the firm are loosely defined
Bounded rationality (Simon (1959))
Due to observance of actual behavior
Newer theory on why firms exist
Feature that are common to all firms:
– Specialization and exchange
– Coordination and cooperation
– Efficiency in production
Why markets and why firms?
Coordination creates a saving in TC
Search on the most effective organization
Figure 3.4 Unitary or U-form organizational structure
Figure 3.5 Multidivisional or M-form organizational structure
Figure 3.6 The science of choice and the science of contract
Source: Adapted from Williamson (2002), p. 181.
Figure 3.7 Modes of governance and the degree of asset specificity
Source: Adapted from Williamson (2002), p. 173.
NOTE FOR THE TERM PAPER
You will be responsible for writing a research paper on an industry of your
This research paper will most likely be between 15 - 25 pages, although it
will not be graded on length.
Conditions to be met include, but are not limited to, established major
industries with available firm-level performance and industry-wide data.
It must also be an industry that has an interesting regulatory and/or
The paper must have a bibliography.
For example, you may choose to have the following headings for the paper:
– History of the industry
– Market Structure
– Conduct (Pricing Policies/Foreign Markets/Other Behavior/Antitrust issues)
– Conclusion: If appropriate, your conclusion could include some policy
suggestions or implications for this industry. Any graphs or tables may be
included in the body of the paper or in the appendix, whatever you prefer.
Suggested List of possible industries to study: (This list is not exhaustive.
There are many other possibilities.)
Agriculture, Airlines, Aluminum, Automobiles, Beer, Casino Gaming, Cement,
Cereals (ready to eat breakfast cereals), Chemicals, Cigarettes and/or Tobacco,
College Sports, Crude Oil, Electric equipment/products, Grain Farming, Health
Care, Motion Picture Entertainment, Petroleum Refining and Marketing,
Pharmaceuticals, Rayon and Other synthetic fibers, Semiconductors, Soft
drinks, Steel, Telecommunications
Grading Criteria for Paper:
10 points: Grammar/Spelling
10 points: Presentation/Use of tables and figures
10 points: Innovativeness/Uniqueness/Imagination/Inclusion of some
interesting policy issues
15 points: Organization/Logical Flow/Introduction and Conclusion
15 points: Bibliography/ Use of Outside Sources and Timeliness of Data
40 points: Content/Completeness (Do you include the relevant topics of:
History, Market Structure, Conduct (Pricing Policies/Foreign Markets/Other
Behavior/Antitrust issues), Performance, and Conclusion. Are there any
apparent "holes" in the content or arguments of the paper?