(Uncertainty and) The Firm in General Equilibrium Theory

Abstract

The firm fits into general equilibrium theory as a balloon fits into an envelope: flattened out! Try with a blown-up balloon: the envelope may tear, or fly away: at best, it will be hard to seal and impossible to mail... . Instead, burst the balloon flat, and everything becomes easy. Similarly with the firm and general equilibrium though the analogy requires a word of explanation. General equilibrium theory GET for short has two attributes. First, it defines clearly the boundary between economic analysis and the exogenous primitive data or assumptions from which it proceeds; that is, it defines a precise, self-contained 'model'. Second, it verifies the overall consistency of the economic analysis. A natural step in verifying overall consistency is to exhibit sufficient conditions for the existence of the proposed solutions, or 'equilibria'. This step is usually amenable to mathematical reasoning. Still, I do not mean to identify general equilibrium theory with that potent cocktail of economics and mathematics known as mathematical economics. (To some, mathematical economics is merely a pleonasm; to others, it is a branch of mathematical pornography; the word cocktail, with its element of pornographic pleonasm, is purposedly neutral.) Work in mathematical economics lacking the GET attributes is abundant. Conversely, let me remind you of our friend Harry Johnson: He was a beautiful member of our GET-set, for he was skilful at integrating partial contributions into consistent general pictures; yet he needed little algebra, because he was a master at the declining art of expressing complex rigorous arguments in literate English. The two attributes of General Equilibrium Theory stand out, for instance, in the classic work Theory of Value hereafter referred to as TV (not inappropriately, given the recent successes of its author as a TV-star). In Theory of Value, an 'economy' is defined by a set of commodities; a set of consumers, individually described by their needs and abilities (consumption sets), their initial assets, and their tastes (preferences); and a set of producers of firms, individually described by their technological possibilities (production sets). These are the primitive data, which the economist treats as exogenous and does not seek to explain. Basically, they correspond to the opportunities and motivations of all agents a structure which is even clearer in the 'abstract economies' approach; see Shafer and Sonnenschein (1975).