The traditional theory of the firm is denoting ‘the static partial-equilibrium analysis, assuming certainty, of the profit-maximising firm in an exogenously given environment’. Objections under 5 headings have been raised by Pat Devine, they are the relevance of lack of ‘realism in process’; the rationale of assuming profit maximisation as the firm’s objective; the adequacy of the static framework; the problem of oligopoly and the nature of the environment in which the firm is assumed to operate; and the assumption of perfect knowledge.
The first challenge was based on the empirical study of Hall and Hitch in 1939. The result showed that when businessman set prices, instead of took account of marginal cost or revenue, they appeared to follow some sort of ‘full-cost’ principle. The Hall and Hitch article attacked the traditional theory based upon its lack of realism in process from 3 main sources. Firstly, there are further ‘case studies’ of particular categories of business decision. Then there is the result studied by management scientists or consultants in ‘normative microeconomics’ exercises. Lastly are the organisational theory studies on human behaviour in firms. The controversy here was not over the way in which firms actually take decisions rather over methodological question the significance or relevance of this empirical work.
The second objection relates to the assumption of profit maximisation as the firm’s objective in traditional theory. The long run profit maximisation is a survival condition in perfect competition, but once the elements of monopoly power are admitted, firms can still survive in the static long run without maximising profits. An area of discretion then enters into the firm’s behaviour. Hence, the specification of objectiv ...