2022 Semester Exam Solution on Marginalist Theories from the Northwestern University
Exam Question: explain major marginalist theories and how their contributors distinctively argued
The Managerial Revolution
- That economic power is increasingly concentrated in the hands of a few large manufacturing companies;
- That their assets are controlled by professional managers who do not own large proportions of their shares;
- That they do not have to raise much money from the capital market and thus do not have to be profit-orientated; and
- That managers tend to develop a 'corporate conscience' which leads them away from the less acceptable aspects of profit maximization.
The concentration of economic power
Separation of ownership and control
Average holdings of the four top managers after the chief executive
Insulation from market pressure
- Staff, the more subordinates the manager has, the greater his feelings of security, status, power, prestige, and likelihood of esteem by professional colleagues.
- Emoluments - managers are particularly concerned about 'perquisites', above a normal salary for their job.
- Discretionary profits - managers like to make slightly more profit in their area than is strictly necessary or budgeted.
Achievements and failures
- 'the theory of information feedback characteristics how stimulus and response can be modelled:
- knowledge of the decision-making systems used by the firms being modelled;
- simulating the behaviour of the firm over time rather than producing an analytical optimizing model;
- and using computers to run the simulation models produced.
Fig. 7.1 Lags in ordering and supplying
Fig. 7.2 Graphs of lags in a supply chain
- changing production or dispatching plans; and
- Transport time. The effect of the lags produces late and exaggerated responses to the customers' change in demand, as shown in Figure 7.2.
Thus Forrester argues that simulation is often the only way to model complex business situations. In this, he unconsciously echoes the feelings of many economists dissatisfied with simple analytical theories. The classical economists often argued (as in the Cournot model in Chapter 8) that more firms meant more competition. At the same time, neoclassical models also postulated a relationship between an 'industry' structure and firms' behaviour. Triffin (1940) was one of the economists who argued most strongly that it was impossible to determine what firms would do from an industry's structure. For him, each firm had to be examined individually to determine how it would behave. Forrester is saying the same, and for him, there is no 'theory of the firm' but rather a model which can be built for each firm. (We return to this theme in Chapter 9, where we consider the models firms build for their use.)
Cohen, Cyert, March and Simon
The best-known behavioural theories are associated with the above group of authors. We examine the best-known version of their approach, as contained in Cyert and March's (1963) book.
The basic model is, like Forrester's, deterministic and dynamic. It sees the firm as a coalition of different departments and central management. The departments perhaps function as production, transport, marketing and purchasing, or different selling units such as in a department store. Are where performance is monitored, controlled and achieved. They have a great say in setting their aspirations or budgets and bargain with the central management and other departments. The central management runs the mechanisms which ensure that:
- The firm's goals are adjusted and reviewed:
- Crucial problems are identified;
- Departments' needs and demands are reconciled: and
- The structure and organization are changed when necessary.
Fig. 7.3 Behavioural theory: adjustment of aspirations
The 'behavioural' firm carries out several distinctive activities. One is adjusting its 'aspirations' to what can be achieved, as shown in Figure 7.3. Generally, they appear to lag behind the performance, so the firm will consistently underachieve its aspiration when performance falls. When performance improves, it will tend to run ahead of aspiration or budgeted targets. If performance stabilizes, aspiration will tend to be higher than present performance.
Another crucial innovation in the theory is the assumption that some of the firm's goals will be satisfied. The firm will be content with a 'satisfactory' performance rather than the best. This is a similar approach to the 'sales revenue maximizing subject to a satisfactory rate of profit' model, which we met in Chapter 5, but different from the managerial utility function of Williamson, which involved maximizing each variable so long as it did not reduce another objective. The behavioural firm 'does not bother about some of its objectives once a satisfactory performance is achieved. It concentrates on unsatisfactory performance and rewards overachieving departments with organizational slack. This reward, allowing a rather easier time to those who achieve, is called a side payment and is often in the form of 'perks' or 'emoluments', as Williamson called them. So, in summary, the behavioural firm adjusts its aspirations dynamically and satisfies them rather than maximizes them.
The achievements of behavioural theories were clearly stated in the early 1960s by Clarkson and Simon (1960) and Cohen and Cyert (1961). They fall into three categories:
- The incorporation of more detail and complexity into a model than had hitherto been possible;
- The incorporation of realistic assumptions about the behaviour of managers in different departments of a firm;
- Allowing models would not be possible if the model builder tried to obey the normal rules of mathematical model-building. Thus a behavioural model need not have the same number of equations as variables, and some of the statements in the model will not be equations but algorithms describing the behaviour of different departments if certain conditions exist.
Behavioural models are also truly dynamic because they involve heuristic processes (moving towards a solution, 'learning' to accept new aspirations, and changing emphasis on different goals over time).
Criticisms and failures
After the early enthusiasm of the pioneers, we have seen little published material on behavioural models of firms. Naylor and Vernon (1969) sum up the probable reasons very well;
- Adequate data is difficult to obtain, and confidentiality problems may have prevented economists from obtaining the cooperation of suitable firms.
- Firms which have constructed their models may have become reticent to reveal them to the public for competitive reasons. (We return to this problem in Chapter 9.)
- Behavioural models do not lie within the competence of any academic discipline, although economics and behavioural science are its main inputs. Thus inter-disciplinary teams are needed to create such models, and they are difficult to assemble outside industry and government.
We also know little about what would be suitable criteria for saying whether a particular model was good. This experimental design problem is considered by Naylor and Vernon, as cited in the further reading.
The last reason for the slow take-off of behavioural theories may be the resurgence of marginalism. Many economists agree with Machlup (1967) that marginalist models may be adequate for the situations they wish to investigate.
Thus managerial and behavioural theories provide us with detailed models of the process of decision-making by professional managers. In this respect, they appear to complement rather than compete with the simpler and more aggregated, maximizing theories of Chapter 5.