J O I N T C E N T E R AEI BROOKINGS JOINT CENTER FOR REGULATORY STUDIES Entrepreneurship and Invention Toward Their Microeconomic Value Theory William J Baumol Related Publication 05 38 December 2005 Harold Price Professor of Entrepreneurship and Academic Director Berkley Center for Entrepreneurial Studies New York University and Senior Economist and Professor Emeritus Princeton University I am very grateful to Elizabeth Bailey Alan Blinder Robert Hahn Michael Levine and as usual to Sue Anne Batey Blackman for very helpful comments and suggestive ideas I am also deeply indebted to the Ewing Marion Kauffman Foundation for its generous support of this work A portion of this material was previously presented in another context at an AEIBrookings Institution meeting where I received extremely helpful observations Executive Summary I have already and repeatedly joined other voices in noting the virtual expulsion of the entrepreneur from the contemporary mainstream literature of economics I have also joined the call for the restoration of the entrepreneurs place in the theory given the fact that no one seems to deny their importance for the workings of the free market economy in general and for its growth and innovation in particular Here I begin by offering my own explanations for the entrepreneur s exclusion More important I hope to show how inventors and entrepreneurs can be restored to their proper place in production and distribution theory and actually take first steps toward realization of that objective 1 Entrepreneurship And Invention Toward Their Microeconomic Value Theory William J Baumol 1 Introduction I have already and repeatedly joined other voices in noting the virtual expulsion of the entrepreneur from the contemporary mainstream literature of economics I have also joined the call for the restoration of the entrepreneurs place in the theory given the fact that no one seems to deny their importance for the workings of the free market economy in general and for its growth and innovation in particular Here I begin by offering my own explanations for the entrepreneur s exclusion More important I hope to show how inventors and entrepreneurs can be restored to their proper place in production and distribution theory and actually take first steps toward realization of that objective I will offer theory that undertakes to explain inventors and entrepreneurs activities that analyzes their remuneration and shows that discriminatory pricing is a normal state of affairs in this arena even in the classic Schumpeterian model The model on which the analysis focuses is not just applicable to the entrepreneurs rather it deals with a considerably broader arena in pricing and distribution theory But I do claim that as a particular application it deals with the pricing and remuneration of entrepreneurs and so perhaps largely for the first time brings us toward incorporation of this fourth factor of production into established value theory Here I will be dealing throughout with innovative rather that what I have called replicative entrepreneurs that is with those who launch a firm with the aid of a new product or some other innovation rather than opening a company similar to a multitude of previously started enterprises And I will argue that in a wide range of cases competitive market forces make those who conduct innovative activities into discriminatory price takers and that the vector of discriminatory prices that the supplier of innovation is forced to adopt will if competitive pressures are sufficiently strong tend to be Ramsey optimal Furthermore I will argue that this state of affairs fits right in with the Schumpeterian model in which however the discrimination entails prices that differ over time rather than differing among submarkets as occurs in common models of differential pricing But the noteworthy observation here is that the formal analysis of 2 intra temporal and inter temporal price discrimination in terms of differences in elasticities of demand is just the same The theory offered here also rests on the fact that much of today s innovative activity is carried out by the economy s giant corporations although contrary to Schumpeter s prediction this has not marginalized the role of the independent entrepreneur I will argue that what has happened rather is that the two have taken on complementary roles with each undertaking a critical portion of the economy s innovative activity I will also show beginning with the largefirm contribution that the two have very analogous formal value theory analyses That is the appropriate pricing models applicable to the two types of innovative enterprise are very similar in formal structure To create a systematic microanalysis it will be necessary to discuss the supply of the innovative activities of both groups as well as the equilibrium pricing structures to which they are driven by market forces Of course at least in the case of the independent inventors and entrepreneurs being self employed and self appointed to their occupations the ordinary sort of analysis of the demand for their services will not apply 2 Why the Entrepreneur has been Exiled from Standard Microeconomic Theory There are actually at least two very good reasons why the entrepreneur is virtually never mentioned in modern theory of the firm and distribution The first and less significant reason is summed up in what I call Baumol s Third Tautology Innovation is an entirely heterogeneous output Production of whatever was an invention yesterday is mere repetition today So in an analysis of entrepreneurial activities there are none of the homogeneous elements that lend themselves to formal mathematical description let alone the formal optimization analysis that is the foundation of the bulk of microeconomic theory The more critical explanation of the absence of the entrepreneur is that in mainstream economics the theory is generally composed of equilibrium models in which structurally nothing is changing But this excludes the entrepreneur by definition She is absent from such a model because she does not belong there This has been definitively argued by Joseph A Schumpeter 1911 and Israel M Kirzner 1979 who have demonstrated that sustained equilibrium is something that the entrepreneur does not tolerate any more than she tolerates sustained disequilibrium Here Schumpeter s key insight is that the entrepreneur s occupation is 3 the search for profitable opportunities to
View Full Document
Unlocking...