To criticize is relatively easy. To provide an alternative approach toward explaining some facts is much more difficult. Still, I hope that once again the readers will have the patience first to become acquainted with some of the traditional approaches toward the subject of state-owned enterprises and criticism of them. For only then can one understand the alternative viewpoint pursued here. But I must immediately admit that the facts presented in this chapter cannot carry the weight of my arguments, which also draw support from a number of studies dealing with a wide variety of subjects, among them the role of the state in particular [see Brenner (1983, 1985)].

There have been numerous studies written on the origins of state-owned enterprises, many of them with little, if any, appeal to the facts. What can one learn from such studies? Not much. Although some ideas may turn out to be just fine, in the absence of reliance on facts, one is quickly lost in, oy, again that pompous, technical vocabulary.

Before surveying some of the traditional approaches, a few facts about state-owned enterprises across countries and time will be presented. This evidence will serve to cast doubt on a number of approaches that have been proposed to deal with the subject of state-owned enterprises, to narrow down both the possible departure points and the contexts in which the subject may be illuminated, and lead toward the approach suggested here.

How to attract people's ears, eyes, and, eventually, their pockets? This is the question that preoccupies producers when considering advertising. Why, by what mechanism, advertising succeeds in achieving these outcomes is the question that many writers have raised. Both questions will be examined here from a somewhat new angle, which suggests that advertising can be viewed as one particular competitive strategy that, by reminding customers of a possibility (in numerous imaginative ways), lowers the full price of using a product.

Even those skeptical of advertising admit that it is necessary to use it in order to provide information on new products. But they make the accurate observation that most advertising is not of this type. Advertising is most intensive for products where many brands already exist and buyers are fickle (thus causing rapid shifts in shares of sales); but advertising does not have an impact on the sales of all brands taken together. Such repetitive advertising is mainly examined here.

The views presented in this chapter are simple: In contrast to the unique advertising that announces the introduction of novel products, thus informing the public of a new way to spend their money, the role of intensive, repetitive advertising is either to shift uncommitted customers from one brand to another or to prevent the already existing customers from forgetting an option.

The view presented here, as well as in Brenner (1983, 1985), examines the conditions under which people bet on new ideas (in any domain) and the likelihood of others to adopt or reject them. The questions raised are simple: Since betting on new ideas represents, by definition, abandoning customary behavior, what induces some people to act in this way, and what determines the rest of the society's reaction toward them?

As shown in the previous chapters, the pressure of competition and the threat of rivals induce some people to abandon their customary ways of thinking and inspire inventions and innovations. However, it would be misleading to jump to the conclusion that only competition (as defined in Chapter 3) and no other incentives can make the sparks fly. There are numerous other forms of threat that can shock people out of their customary behavior and provide incentives for an innovative one.

Introduction

With the aid of clear and explicit assumptions about the nature of the cost and demand conditions, one can expose the inner structure of the mechanism underlying the theories of duopoly proposed by Cournot in 1838, Bertrand (1883), and Edgeworth (1925). These theories have been the subject of continuous analysis by many economists over a long period of time and remain the starting point of all contributions to this subject. Despite this, their theories are ambiguous because they lack clear descriptions of the economic reality they purport to explain. The standard these theories ought to satisfy is this. It should be possible to state the rules for the situations they describe with enough clarity so that treated as a game, in the sense that poker is a game, the participants would know precisely what they can do under the various circumstances that can occur. The models I shall describe intend to meet this criterion.

The difference between Cournot's theory and the Bertrand–Edgeworth theories are the topic of the next section. Briefly, the Cournot model assumes the duopolists choose output and allow the demand conditions to determine the price at which the total output can be sold. The Bertrand–Edgeworth models allow the duopolists to choose their prices. Consequently, there is the question of what happens if a firm is unable to fill the demand forthcoming at this price or if the demand is below the firm's expectation.

Introduction

Edgeworth invented the method of analysis now known as the theory of the core in his study of exchange. This reminds us that neoclassical economic theory is the source of this approach and that the theory of the core owes its greatest achievements to refinements of the study of exchange. A coalition of traders in the current usage corresponds to a contract among them in Edgeworth's analysis. The process by which traders seek the best possible terms for themselves is called recontracting by Edgeworth. An allocation of the goods among the traders gives an equilibrium when none can get better terms. Not only does this mean that each leaves the market with a bundle of goods he does not regard as inferior to his initial one but also that he cannot obtain better terms from anyone. The theory attempts to answer the question of when there is an equilibrium and if there is one whether it is the only one. It is a major accomplishment of Edgeworth to answer these questions. Nor is this all. He found the range of possible equilibria in case there is only a finite number of traders and showed how the indeterminacy shrinks as the number of traders of each type increases. In the limit with an infinite number of traders of each type, only a single equilibrium might be compatible with the competitive process.

STABLE COALITIONS WHOSE RETURNS ARE CONVEX FUNCTIONS

Introduction

In many important economic applications the return to a coalition is given by a convex function. For this reason the theory given here has two purposes. First, it explains which coalitions can form and survive when the return to a coalition is a convex function of its size and composition. Second, it describes the nature of the imputation of the returns to the coalition.

The size and composition of a coalition are represented by a vector in the nonnegative orthant of Rn. Let t denote such a vector. Its ith coordinate shows how many members of type i belong to the coalition represented by the vector t. Since the coordinates of t are nonnegative numbers, ti measures the size of type i membership in t. Think of a very large number of participants so that one individual is a very small fraction of the total number like him. A subcoalition of t is a vector s with 0 ≤ s ≤ t. Such a subcoalition will secede from t if it can get more doing this than by remaining in the grand coalition. Let the function f(s) denote the return to a subcoalition s so that f(t) represents the return to the whole group. The latter can divide the total return among its members so that each one of the same type i gets xi and together all members of this type get xiti.

Introduction

The actions people take depend on what they believe is true. But what they believe is true, that is, their perceptions, may be only partly true or even wholly false. Even so, these perceptions of reality, not reality itself, affect their behavior. The effects of their actions do depend on reality and may in turn cause changes in their perceptions. People's knowledge is surely incomplete and partly wrong. Learning is the process of expanding and correcting the stock of knowledge. As there is learning so perceptions change. A theory of behavior that assumes there is a difference between what is true and what people believe to be true can make better predictions of what they will do than a theory assuming omniscience. As an illustration consider the problem of explaining which trade routes were used by merchants. By taking into account people's belief that the world was flat, we could make better predictions of the actual trade routes that were used until the beginning of the sixteenth century than by assuming that people knew the true shape of the earth. Only those who believe the earth is round would be willing to sail west in order to go to the Far East.

The better theory of behavior not only distinguishes between perception and reality but it also explains how and when people reduce the discrepancy between them. If an individual cannot change reality, then the theory must describe the conditions leading him to change his beliefs.

Preliminary versions of some parts of this book came out in various articles published between 1982 and 1985. This holds true for parts of Chapters 2, 7, and 8 (Telser 1984a, 1984b, and 1982a). The material in Chapter 3 is based on a paper presented at a conference at the Hoover Institution in September, 1984, which was published in the conference proceedings (Telser 1985). I presented Chapter 2 at another conference at the Hoover Institution in February, 1986. Chapter 6 is a substantial revision of Telser (1980). Part 1 of Chapter 4 draws on some ideas in Telser (1982b) and corrects some errors therein.

Propositions and lemmas are numbered sequentially in each chapter starting with 1, and by part in each chapter with more than one part. Corollaries are numbered sequentially starting with 1 by proposition or lemma. Equations are numbered sequentially starting with 1 by section.

Sheldon Kimmel has been my most attentive and faithful critic. He has read preliminary versions of almost everything in this book and has saved me from many errors and obscurities. Howard Marvel carefully read preliminary versions of Chapters 2 and 3. George Bittlingmayer and David Haddock read these and some other chapters and gave me many useful comments and suggestions. I am also grateful to Frank Easterbrook, David Galenson, John Hause, Roger Noll, and Daniel Spulber for their helpful comments on various parts of this book.

As mathematics penetrated economic analysis during the nineteenth century, a structural, static, rather than a behavioral, dynamic view of enterprises and of markets became widespread. This viewpoint reduced the entrepreneurs to the level of arithmeticians and eliminated all social and cultural context. The viewpoint presented here restores the balance and shows how to understand numerous facets of the behavior of enterprises by looking at the entrepreneurs and other decision makers behind them.

What is a “market”?

One of the cornerstones of economic analysis is the concept of “the market” within which demand and supply curves are drawn and the equilibrium price, to which a firm in a competitive industry adjusts itself, is calculated. The definition of the market involves two steps: The first is to identify the purchasers, and the second to identify the group of sellers who are or could potentially serve these purchasers. The output, that is, the product together with its good substitutes, defines the relevant market.

The problem of money capital, we have argued, needs to be integrated into the theory of the firm at as early a stage as possible. To employ the categories that the neoclassical theory inherited from Marshall, it needs to be incorporated before the beginning of the short-run, rather than after the end of the long-run, analysis. Otherwise, money capital has no analytically integrative significance for the theory of the firm at all.

Moreover, the notion of money capital, together with that of the money capital availability constraint, imports into the theory of the firm the realities of uncertainty and the lack of perfect expectation and foresight. The cost of money capital is very much an uncertainty concept. It takes up the questions of intertemporal valuation and the specification of risk-adjusted discount rates, or the rates of return required by the risk-averting suppliers of money capital at which future income streams should be reduced to their economic values. Behind the neoclassical development of these concepts lies a highly developed theory of the money capital or financial asset market. The cost of capital depends, in that body of analysis, on the prices of risky assets and the rates of return they provide when equilibrium conditions in the asset market are satisfied.

The apparatus we need in order to consider this equilibrium theory of prices and yields has been almost completely assembled in the preceding chapters. The theory is heavily indebted to the thought forms of the probability calculus.

The analytical issues of time and uncertainty have been relevant to many parts of our exposition. They throw an important light on many aspects of sequential decision making in the firm. In the traditional development of our subject, the assumptions that have been made in order to render the problems of time and uncertainty tractable have been related to the notion of equilibrium and equilibrium theorizing. In this chapter we shall reexamine a number of the interrelations that exist between these issues, and we shall bring into focus again a number of the questions that were raised in this connection in Chapter 1.

The theory of the firm has all too often been cast in a timeless, static, certainty, or certainty-equivalent mold. The capitulation of economics to the analytical priorities of general equilibrium theory has left the theory of the firm preoccupied with the description of equilibrium states of affairs. This has become paramount so far as our principal object in this book is concerned, namely the analysis of the firm's employment of money capital. Money capital costs have been conceptualized by the theory as definable by the rates of return that investors require on risky assets when equilibrium conditions are satisfied in the financial asset markets. We have suggested, on the other hand, ways of envisioning the money capital problem from the perspective of partial equilibrium and imperfect market theory.

The theory of the firm in a real-time, money-using economy must be grounded in the interdependent theories of production, capital investment, and finance. Traditionally, the theory of the firm has begun its analysis of production by positing a Marshallian short-run period in which, as the real capital employed in the firm was given and fixed, attention could focus on choosing the variable-factor inputs with which to produce specified levels of output. Then, at a later stage, the assumptions of the Marshallian long run took account of the possibility or desirability of varying the fixed factors also.

The problem in this scheme of things is that no significant place exists for money capital. The real capital–money capital dichotomy is not addressed. No meaningful discussion is given of the need for money capital, the sources from which it might be obtained, and the manner in which the cost and availability of it constrain the firm's structural and operating decisions. The Marshallian short-run and long-run fictions did, of course, point in the direction of an accounting for real time, as did Marshall's concern for the evolution, growth, and decay of firms. But the analogy of the “trees of the forest” (Marshall, 1920, p. 315f.), together with that of the representative firm, effectively collapsed the real-time argument to a timeless form and prepared it for Pigou's notion of the optimum size of the firm and its equilibrium condition (see Robinson, 1969, pp. v–vi).