Kirzner and Alchian/Demsetz on the Firm

Jonathan Finegold has a nice post arguing that Armen Alchian and Harold Demsetz's article, “Production, Information Costs, and Economic Organization,” follows the work of Ronald Coase and Ludwig von Mises. The Coase/Alchian connection is well known. The Alchian/Mises connection is not. Finegold discussing Alchian/Demsetz's article-

In it, he advances a theory of the firm that both builds from and adds on to Ronald Coase’s transaction cost theory of the firm. It may be surprising to find out that, in the same sense, Achian (sic) and Demsetz’ theory adds on to Ludwig von Mises’ theory of economic calculation. The argument advanced in Alchian and Demsetz (1977) is that it can be cheaper to organize a firm as a means of calculating the marginal productivity of inputs, rather than rely on exchange across markets (i.e. the pricing process).(Links in original)

This makes sense. Mises is giving a theoretical framework for how the market through prices conveys information. Alchian and Demsetz are trying to apply a broadly similar theory to organization of a firm. Owners respond to incentives from both within the firm to decrease costs and outside to increase sales.

Jonathan then brings Israel Kirzner into the story-

For Alchian and Demsetz, using Kirzner’s terminology, the monitor is an entrepreneur who earns a profit by best using a given pool of inputs in team production. The monitor is either rewarded or punished, through profit and loss, based on his ability to measure and control each input’s marginal productivity.

Again, I agree with Jonathan that Alchian/Demsetz and Kirzner are trying to answer similar questions, which are the right questions. However, due to a different foundation in price theory and method, I want to argue that Kirzner and Alchian/Demsetz come to different conclusions, at least from Kirzner's viewpoint.

Kirzner, defining entrepreneurship unique to most economists, develops a book length argument for why modern economics is wrong about the very nature of competition and entrepreneurship. Profit and entrepreneurship have completely different meanings for Kirzner than to most other economists. To cut a 200 page book to 1 sentence, entrepreneurship is the ability to see price discrepancies that others miss.

The key point is that pure entrepreneurship is exercised only in the absence of an initially owned asset. Other market roles invariably involve a search for the best exchange opportunities for translating an initially owned asset into something more eagerly desired. The "pure" entrepreneur observes the opportunity to sell at a price higher than that at which he can buy. (Competition and Entrepreneurship, page 16)

Competition is a process, not a state of being like the statics of monopoly/oligopoly theory. Ownership does not drive awareness. There is no mention of the costs of monitoring or shirking like in Alchian/Demsetz. Instead, these are just more input costs. In fact, Kirzner really saw himself as departing from the work of Alchian. Here Kirzner is directly addressing him-

We have already noticed that the conventional theory of the firm tends to mask the purely entrepreneurial element in the decision-making of producers. Yet the fact that the firm is assumed to make decisions which maximize "profits" tens to promote the misunderstanding that it is indeed entrepreneurship that is at the core of the theory of the firm. On the other hand, it has become the fashion to identify the urge to maximize profits not with entrepreneurship but with ownership! (Competition and Entrepreneurship, page 54)

As an economist who believes many "schools of thought" have something to add to economics, I appreciate Jonathan pointing out the common ground between the Austrians and the New Institutionalists. However, Kirzner wants to create a foundation that is almost completely, besides Mises' work. I believe that is why Kirzner has not been integrated into modern price theory to its own detriment.

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