Shouldn’t CrookedTimber be the site that covers the heterodoxy? Daniel Davies picks up the slack:
The anomaly I’m talking about is that neoclassical economics, in
both macro and micro forms, nearly invariably works on the basis of
models in which there are no profits.Since in general, companies do earn profits, I think this is a pretty big problem.
Do read his caveats.
I usually answer such questions by referring to the ordinary humdrum of my suburban life. It took my three days to buy the new Paul McCartney CD, and yes I do love his solo work, or at least some of it. And can you guess why it took me so long? The CD is available only in Starbucks, but until today each Starbucks was situated so that my exit would have necessitated a left turn across four lanes of crowded traffic (and, most importantly, without a traffic light). I love "Maybe I’m Amazed" as much as the next guy, but this boy just ain’t up for those sorts of indignities.
The higher the value of time, the more likely these competitive barriers will arise. So the standard monopoly model explains much more of the economy than most market-oriented economists like to admit. That said, I am less sold on Davies’s worry that this has nihilistic consequences for mainstream economics. Tariffs are still usually bad; let’s not forget that behavioral imperfections plague politics as well.
Hmm, my understanding of neoclassical economics is that is assumes the *marginal* company makes no profits – I’m not sure I get what the problem is.
You first have to understand that the definition of Economic profits and Accounting profits are not the same. People must make Accounting profits or they would not be in business. A firm can continue to earn Accounting profits while Economic profits are driven to zero in a competitive market. Economic profits include the opportunity cost of being profitable in any other industry. So when a firm could make the same accounting profit in one industry vs. another the firm is indifferent as to which industry they serve because economic profits are zero.
That’s an easy question. Unlike neoclassical “firms”, real businesses typically own some of the factors of production which they use; hence they receive the income due to those factors. Most commonly, this includes land rent, the yield of capital goods and the entrepreneur’s wages of superintendence.
In the real world, corporations are always attempting to get in a situation where they can exploit monopoly power. Sometimes they succeed.
Very true. And of course, much of that attempting to get in a situation where they can exploit monopoly power is advancing technology and innovation (and supply chains and organization et al.) Not all of it, to be sure, though government intervention has its own problems.
He’s certainly right that an assumption that perfect competition is the norm is flawed. At the same time, it’s flawed to think that an economy always in perfect competition is ideal over the long run either, even if it may seem like the best static instantaneous situation.
In the long run, there are no profits. Truly profitable companies make their profits by refusing to operate in the long run.
Instead they operate in the short runs between market formation and market saturation for their products and services. They redeploy assets to better situated short runs when their older offerings get close to or into the long run.
Profits come to innovators and value creators who keep innovating and value creating.
[Tariffs are still usually bad]
Alex, this result can’t be derived in an economy with a positive rate of profit; Ian Steedman proved this one in a series of papers discussed on Rob Vienneau’s blog.
dsquared, entrepreneurial profits are paid to the entrepreneur as wages of superintendence. In the long run, these are regulated by the labor market just like ordinary wages. When economists say that “businesses earn no profits”, they mean that all of their earnings must be accounted for by wages, interest or rent (including monopoly rent).
Also, don’t increasing-returns-to-scale production functions, such as those with externalities, allow for nonzero profits? I recall Romer’s endogenous growth models as being an example of that sort of thing.
There are no economic profits for the same reason most people can’t be better than average — it’s true by DEFINITION!
-Mercy
To address the original question which was: Why are there no profits in economic theory?
There are! However many of the contributors to this discussion seem to be stuck in the static neoclassical, perfectly competitive world where production inputs are land, labor & capital, production functions are linear homogeneous, & markets work perfectly & adjust instantaneously.
Of course such a world does not exist except in the models of abstract theory.
For profit to exist, all that is needed is an entreprenuerial input which has a positive opportunity cost. (There is of course a difficulty in defining & measuring the “entrepreneurial input!)
Positive & negative economic profit (not = OC of the entrepreneurial input) will exist during periods of market adjustment after some disturbance in the market. Monopoly power confers economic profit on those who possess such power, But positive & negative economic profit easily arises in a world where markets are subject to risk & uncertainty.
Some of the contributors are advised to read Frank Knight’s “Risk, Uncertainty & Profit” 1921,
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