Austrian Microeconomics, Lecture 5 with Peter Klein - Mises Academy
Peter G. Klein | Mises Academy 20121 | Profit, Loss, and the EntrepreneurPeter G. KleinUniversity of MissouriAugust 16, 2012Austrian MicroeconomicsProfit, Loss, and the Entrepreneur
2 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012The evenly rotating economy► Recap: imaginary constructs in causal‐realist analysis► The imaginary construction of the evenly rotating economy (ERE) Passage of time “Action‐like” behavior No uncertainty► Purpose of the ERE Distinguishing profit from interest Isolating the function of entrepreneurship
3 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012The entrepreneurial function► Entrepreneurship: deployment of resources (in the present) in anticipation of (uncertain) future receipts. Implies property ownership May or may not imply imagination, creativity, alertness, leadership, etc.► Profit (loss): residual accruing to business owner after factors of production have been paid. In the ERE, all factor prices would equal their DMRPs no profit or loss► Laborers: earn wages► Landowners: earn rents► Capitalists: earn interest Profit and loss can thus only exist under conditions of uncertainty. Note on profit measurement, profit rates, etc.
4 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Uncertainty versus risk► Frank Knight (1921) on risk and uncertainty Risk: possible outcomes and probabilities are known Uncertainty: probability distribution is unknown► Richard (and Ludwig) von Mises on probability Class probability: event is part of a class of similar, repeatable events► Games of chance► Insurance Case probability: event constitutes a unique case► Understanding
5 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012What profit is not► Interest Interest: reward for foregoing consumption Profit: reward for successfully bearing uncertainty► Accounting income Accounting income includes profit, interest, and the entrepreneur’s implicit wage Economic concept of profit as a functional category, not a line item on the income statement► An automatic “return to capital”► A markup over production costs
6 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Entrepreneurship and resource heterogeneity► Austrian capital theory: heterogeneous, subjectively perceived resources► Lachmann (1956) on heterogeneity: “We are living in a world of unexpected change; hence capital combinations . . . will be ever changing, will be dissolved and reformed. In this activity, we find the real function of the entrepreneur.”► Note: given resource heterogeneity, profits and losses can only be calculated in a money terms.Ludwig Lachmann
7 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012The capitalist and the entrepreneur► The business firm: intersection of the capitalist and entrepreneur functions► Insights from Austrian economics Capital resources are heterogeneous Production takes time Entrepreneurs perform economic calculation Market competition selects for entrepreneurial skill
8 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Social functions of profits and losses► Provides feedback to entrepreneurs in short‐ and long‐run planningEstablishes a selection process for entrepreneurship, placing productive resources under the custody of those who can best use them to satisfy consumer wants.► Note: no such thing as “normal profits,” “excessive profits,” etc.
9 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Mises’s entrepreneur‐promoter► A special class of entrepreneur Economics “also calls entrepreneurs those who are especially eager to profit from adjusting production to the expected changes in conditions, those who have more initiative, more venturesomeness, and a quicker eye than the crowd, the pushing and promoting pioneers of economic improvement” (Mises, 1949, p. 255). Mises’s suggested term for these: promoter► Characteristics of the promoter Owns and invests financial and/or physical capital Is particularly alert to profit opportunities Exhibits creativity and leadership A more loosely defined, historically contingent concept than the pure, functional entrepreneur
10 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Entrepreneurs and managers► Original and derived judgment Original judgment – can only be exercised by resource owners. Derived judgment – exercised by subordinates who are delegated specified decision rights, acting as “proxy entrepreneurs.”► Economics of organization: art of managing derived judgment
11 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Alternative perspectives on the entrepreneurial function► Israel Kirzner: entrepreneurship as alertness to opportunities Similar to Mises’s promoter, but without capital Entrepreneurship (necessarily?) “pierces the fog”of uncertainty” Focuses not on profit and loss, but on equilibration► Joseph Schumpeter: entrepreneurship as the introduction of new products, processes, markets An “Austrian” addition to Walrasian general equilibrium Sees the entrepreneur as a disequilibrating force (“creative destruction”)► Mises: closer to Knight’s view of entrepreneurship as judgmental decision‐making under uncertainty
12 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Alternative concepts of entrepreneurship► Occupational concepts Entrepreneur = self‐employed individual Labor economics literature on occupational choice Psychological studies of the entrepreneur’s characteristics► Structural concepts Unit of analysis: the firm or industry Entrepreneurial firm = new or small firm IO literature on industry evolution ► Note: little relationship to functional approaches
13 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012Implications for the theory of the firm► Neoclassical view: firm as production function► Austrian view: firm as ownership of assets The firm is the capitalist‐entrepreneur (or a group of capitalist‐entrepreneurs) plus the alienable assets he owns. Ownership conveys authority Firms can own many, or no, production processes (functions).
14 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012The theory of the firm► Why do firms exist? Transaction costs of market exchange (Coase 1937) Entrepreneurial judgment is non‐contractible (Knight, 1921)► What determines the boundary of the firm? Internal and external transaction costs Entrepreneurial talent Need for economic calculation (Rothbard)► How should the firm be organized? Costs and benefits of delegation (Foss, Foss, and Klein, 2007)
15 | Profit, Loss, and the Entrepreneur Peter G. Klein | Mises Academy 2012The limits to the firm► Incremental limits: indivisibility in the entrepreneurial judgment► Ultimate limit: need for external markets for all internally transferred factors The vertical stages of production Divisional profit and loss Need for market‐based transfer prices ► Calculational chaos As external markets disappear, “islands of noncalculable chaos swell to the proportions of masses and continents. As the area of incalculability increases, the degrees of irrationality, misallocation, loss, impoverishment, etc., become greater” (p. 548).► Relationship to socialist calculation debate