CHAPTER 10 Organizations, Money, and Calculation Introduction: Firms and Calculation

The discussion in the previous chapter suggests that firms derive their rationale from the fact that the organization of production matters for its results. By the same token, as the economy changes, and the production structure changes along with it, the advantages of different types of organization will also change. Still, with all the far-reaching economic changes that have occurred, the firm as a category (the modern business corporation) has remained a dominant form of economic organization. It is an institution that is unique to a market (“capitalist”) economy. In an important way the market economy owes its success to the business firm.

In his discussion on the feasibility of central planning under state socialism, Mises pointed to the ability of private owners (investors) to calculate profitability as being the indispensable ingredient of a decentralized system, the absence of which accounted for the inevitable failure of a centrally planned one (Mises 1920, 1981, 1966). This was part of the famous socialist calculation debate (Hayek 1935a; Hoff 1981; Lavoie 1985a; Ramsay-Steele 1992) which has recently shown signs of resurfacing (Horwitz 1996; Ramsay-Steele 1996). According to Mises, in a centrally planned economy (in which the means of production were collectively owned) the planners would lack any basis on which to price the means of production. Without private ownership, alternative outputs would not have prices; nor would the inputs required to produce them. Without this, the value of alternative uses would not be discernible. The scope of the debate was considerably broadened by Hayek (in the 1930s) in his consideration of what information would be necessary for private owners in their calculation of prospective profits, and the observation that much of this information was not simply available to be collected but, in fact, emerged from the market process itself. Abolishing private ownership thus abolished the source of this crucial information, much of it reflected in prices, necessary for basic economic calculation (Hayek 1935a:210–211). Mises wrote in 1927:

This is the decisive objection that economics raises against the possibility of a socialist society. It must forgo the intellectual division of labor that consists in the cooperation of all entrepreneurs, landowners, and workers as producers and consumers in the formation of market prices. But without it, rationality, i.e. the possibility of economic calculation, is unthinkable.

(Mises 1927:75)

Horwitz (1996) has recently pointed to the connection between these insights and the role of money. In a market economy the existence of money together with the institution of private property facilitate the emergence of money prices which form the basis of the necessary economic calculation that drives the market process. In the light of our discussion about business organizations above, how does the firm, a dominant market institution, fit in with this?

We should recall that the advantages of corporate organization derive from incentive, control, and information issues. By combining resources within the orbit of a single firm, it is sometimes possible to reduce the costs of monitoring and controlling production teams and of avoiding the need to monitor and enforce the fulfillment of specific arm’s-length contracts between independent parties. Instead, the firm provides the necessary relative predictability and stability of long-term open-ended contractual obligations with employees.¹ The boundaries of the firm are dynamically and experimentally balanced by these advantages weighed against the advantages of using specialists “from the market.” Juxtaposing this line of thinking with the Mises/Hayek rejection of the feasibility of socialist planning and production raises some interesting questions.

1. On the one hand, if socialism is indeed irrational, in the sense of precluding the ability to perform the necessary calculations, how is it that the firm is not similarly encumbered? After all, is not a state socialist system simply one large firm? And are firms not islands of socialism in a market sea? If so, how does calculation proceed inside the firm?

2. On the other hand, if the market is necessary because it provides the necessary prices for productive calculation, why are firms necessary at all? Why not simply conduct all transactions through market spot and forward contracts?

We have already answered question 2. In a nutshell, there are costs to using the market that are avoided by using the institution of the corporate firm. And these transaction costs are ultimately related to the presence of certain types of irreducible uncertainty. The answer often given to question 1 is more interesting. Of course, it is a non-sequitur to conclude that if state socialism is impossible then anything resembling central planning, such as a firm, should also be impossible. In fact, they are not the same things. Planning within firms proceeds against the necessary backdrop of the market. Planning within firms can occur precisely because “the market” furnishes it with the necessary prices for the factor inputs that would be absent in a fullblown state ownership situation.² And we have already seen what sorts of considerations determine the boundaries between the firm and the market.

The Firm Provides the Necessary Structure for the Calculation of Profit

These answers, however, are not fully satisfactory and raise some further interesting issues. We start by making the important assertion that if the market is necessary for the viability of the firm, the opposite appears to be just as true. That is, the firm is necessary for the smooth operation of the market process. This assertion is based on noting the central importance of economic calculation in the market process and the way in which the firm provides for such calculation. We see this by examining the calculation of profits. The calculation of profits is both simple and indispensable for production decisions. It is simple in the sense that the arithmetic is simple, even though the elements that constitute the evaluation are often highly speculative. It is indispensable in that it provides the basis for discrimination between viable and nonviable production projects (cf Hicks 1973b, as discussed in Chapter 6).

Retrospective Profits

First, consider profit in a retrospective context. That is, how do we decide which projects have been profitable? Profit is revenue minus cost.³ Revenue is the proceeds from the sale of the relevant outputs, and is relatively easy to measure in a monetary economy. Costs, however, present formidable problems that go to the heart of the nature of team production. In a market economy, when inputs are purchased their purchase price serves as the accounting cost. From an economic point of view, it can be seen to represent the market value of opportunities forgone as a result of purchasing the input in question. But what about inputs owned by the firm? How does one determine the costs of using them? What we require is an estimate of the opportunities forgone by using inputs in one combination rather than another (the next best alternative). This requires an estimate of the hypothetical relative contributions of inputs under alternative scenarios. We have already seen that the nature of team production is such that it is impossible to measure objectively the precise contribution of any member of the team (physical or human). If one were required to determine “completely accurate” contributions and to use these contributions as the basis of cost calculations the problem would be insoluble, as with fullblown state ownership devoid of monetary calculation where no clue at all is provided.

The question is: what is the relevant opportunity forgone? Should it be the value of the net revenue forgone by the firm by doing things one way rather than another, or is it alternatively the net revenue that would be added elsewhere in the economy by redeploying the input in question? This latter measure is an indication of what the input might fetch in the market if it were rented out, and is closer to what we usually understand by cost in the accounting sense. It is also the cost that is relevant for the (actual or prospective) investor in the firm, whose hypothetical alternatives involve moving between firms under the assumption that the firm takes care of the internal allocations. But from the point of view of efficient allocation as seen by the firm, the former measure, using the next best alternative wherever it occurs, is the more relevant.

Thus, in the case of the market firm, the labor inputs are paid according to a(n) (implicit or explicit) monetary contract, and similarly with physical inputs (capital goods) that are rented through the market. We leave aside for the moment the determination of these rental values. From the perspective of the decision-makers in the firm they are “given by the market.” For capital goods that are owned, however, the costs associated with their use are more problematic and have to be estimated according to certain accounting conventions. These conventions use procedures to estimate (implicitly) the value of the asset in the current rather than in alternative uses. This implies that a basic ingredient for this conventional calculation is, and apparently must be, the value of the asset itself, which in some way is derived from the estimated value of its estimated alternative possible contributions to output. An alternative way of looking at this is to say, having arrived at a cost for the asset—derived (again mostly implicitly) as the discounted value of its estimated next best output—one must then estimate (in order to arrive at an “accurate user-cost measure”) how much of this value is “used up” (per period—its displaced marginal value product) or sacrificed in current production. This is an estimate of how much value is forgone by pursuing this line of production as compared to the relevant alternative (how much revenue net of replacement could have been earned by this asset in the relevant period). There is obviously no “correct” way to do this. So again we are faced with the problem of measuring the relative contributions of the inputs. And we recall again the imputation problem.

In sum, then, where markets exist, the value of the joint output for any project as a whole, once measured (or estimated), is much easier to determine than in the absence of markets. In a sense, one half of the problem is solved: that of valuing an output however measured. As for measuring the (contribution to) output, there is no avoiding certain elements of convention (judgment). What the institution of the firm does (together with the institutions of money and accounting) is to provide these conventions. By distinguishing between contractual and owned inputs, one avoids the need to estimate the alternative marginal products of the former. The judgment involved in measuring the latter affects the profit calculation and lends it an unavoidable element of arbitrariness. This means that profit, even measured retrospectively, necessarily contains elements of subjective judgment or convention.

We should distinguish, however, two importantly different aspects of the profit calculation. Profit, understood as the residual after all contractual obligations have been met, but making no allowance for the costs of use of owned resources, is, from the perspective of the firm, not arbitrary in the sense just discussed. Market prices provide the necessary “objective” ingredients for a simple calculation. From the “long-term” perspective, therefore, where all capital assets must be used up or completely replaced, profit appears less arbitrary. It is the division between “true profit” and profit unadjusted for user cost that is the problem. However this division is done, it clearly does get done. And the profit calculations that emerge provide a widely accepted (peaceful) way of adjudicating between viable and nonviable projects. This is reinforced in the long term by the presence or absence of cash flow. If the short-term division is injudiciously made, the cash flow will eventually become negative as the underestimation of user costs becomes apparent and cash is absorbed in the replacement or repair of capital assets. So, in this way, the firm and the market together provide the indispensable basis for the calculation of profits.

We asserted that market prices provide the cost signal for contractual inputs, while leaving aside how the market price is determined. Of course, in the final analysis, even when a rental price of a durable asset (like a physical capital asset or the price of labor (human capital) services) is determined by contractual arrangement, the terms of the contract, most especially the price, must be determined with reference to exactly the same considerations that are relevant in the case of owned resources, namely the value of opportunities forgone. The market is, after all, just a shorthand reference to the results of decisions taken by everyone else. So what determines these other people’s decisions are the same things that determines the firm’s. Market prices emerge when assets are generic enough, have enough multiple uses in the market, that people’s judgments of their worth become embodied in the stock of information available to decision-makers in general (good examples are the published set of prices for used cars or certain kinds of production equipment or wages for certain kinds of labor services). As such they reflect to some extent the trial-and-error experience of many decision-makers. And as such this kind of information is not available without the market.

Thus, though necessarily subjective and involving elements of entrepreneurial judgment, calculations of profit, involving as they must the imputation problem, are facilitated by the framework provided by at least three interacting institutions, namely the firm, money, and accounting practices, all within the umbrella institution of private property. The indispensable element of judgment involves the attribution of relative shares (contributions) to the inputs, which is necessary to arrive at an estimate of what each input “costs,” that is what sacrifice each input entails.

Prospective Profits

This framework provides the basis for the prospective calculation of profits as entrepreneurs project, on the basis of past information and conjecture, the emergence of profits in the sense just discussed. And by comparison between prospective projections and retrospective calculations further decisions can be made over time.

Two important notes: First, there is nothing in this account to suggest that the decisions taken with regard to profitability are in a global sense “optimal.” Successful projects are viable, not optimal. There is no way to decide, in this open-ended framework, whether Pareto optimality will emerge or not. This is related to the second point (already discussed above in connection with the uncertainties surrounding team production). The prices of contractually purchased factor inputs (labor and capital or land) are sometimes said to be equal to, or to tend to be equal to, their marginal products. In so far as team production does not admit of any simple solution to the imputation problem it is difficult to see how this could happen in any simple way. To be sure, in a market environment of negative feedback, that is to say when certain key aspects of the environment, like the available set of techniques of production, consumer tastes, etc., are unchanging, or changing very slowly, then sufficient variations in adopted techniques are likely to result in the gravitation towards valuations of market traded inputs that, in a meaningful sense, represent the values of their marginal products. This is because, under the postulated conditions, the market provides for “continuous” variations in input and resultant variations, ceteris paribus, in output.⁴ But this is by no means assured, and in the absence of such “stable” processes, the prices of the factors must be seen to represent simply the market’s assessment of their worth. That is, these prices are what people, given their best guesses and estimates, have been willing to pay. As time passes, the prices will change as the projects in which the inputs are employed succeed or fail and to the extent that they are specific to those projects as discussed above. The market prices for inputs are not equilibrium prices, but they do furnish an important and indispensable basis for the calculation of profits. Without market prices, firms could not plan as they do.⁵

Money and Production: Back to Menger

The ability to calculate profit (both expected and past) is essential to the working of the market process as we know it. It cannot be duplicated by a central planning system. It is a trial-and-error process in which the variables are not only the varied and often spontaneously emerging techniques of production, but also the various incentive information alignments that come with different combinations of firm shapes and sizes and contractual obligations that characterize the market. In addition, the prices for the factor inputs, though not equilibrium prices, bear a crucial connection to the prices of the outputs that they help to produce and, therefore, to the preferences of the consumers who buy them. Producers take their signals from prospective revenues and (implicitly) impute values to inputs when they exercise judgment in the formation of capital combinations. Without the institution of money, this could not happen.

Without money and money prices, producers could not make the calculations necessary for production processes to be initiated and continued. While central planners could use administered prices as the basis for capital projects, the values of these projects would lack any basis in terms of the values of the outputs they produced. The administered prices would not be economically meaningful, not having emerged from a process of individual evaluations. The existence of money, together with private property and the division of labor and capital, is thus indispensable for economic development.

The phenomenon of money presupposes an economic order in which production is based on the division of labor and in which private property consists not only of goods of the first order (consumption goods) but also in goods of higher orders (production goods). In such a society production is “anarchistic”.

(Mises 1981:41)

This statement can be interpreted superficially as suggesting that these various ingredients (money, private property, division of labor, and capital goods) could exist independently and that it is their joint occurrence that ensures decentralized production. An advocate of central planning might wonder why each of these ingredients is so jointly necessary and concoct various substitutes for one or the other (see Cottrell and Cockshott 1993). This is a misconception. The institutions on which economic development is based do not only exist together, they are inextricably bound up with one another. They are, in an important sense, part of the same institutional nexus; if any one is compromised, they all collapse. So nationalizing the means of production will inevitably lead to a collapse of the monetary system and the unraveling of the fruits of the division of labor and capitalistic production. We can see this by considering how money develops, and of course for this we must go back to Menger.

In Menger’s work (1976) we find a full treatment of the question of the origins and development of money. Menger explains how, with the development of trade, certain commodities come to be traded more frequently than others. These products have a high level of marketability. At some point individuals begin to accept these commodities not in order to use or enjoy them but for the purpose of trading them at a later date for what they really want. At that point the product has become money.

Goods derive their value from individuals’ appraisal of them. Since different people value different goods differently, trade is mutually advantageous. Wherever people gather together in society, they develop trade. But trade without the benefit of money is severely limited by the need to uncover a double coincidence of wants. In perhaps more revealing terms, trade without money is limited by overwhelming information requirements. By providing a generalized means of purchase, money dramatically reduces the information necessary to conclude any number of transactions. This means that a monetary economy is fundamentally different from a barter economy. It is different precisely because a barter economy in which the same transactions are accomplished as in an existing monetary economy is literally inconceivable. It is inconceivable because without money individuals could not acquire the information necessary to conclude the necessary transactions. And without an explanation of how individuals could come by this information we have no methodological basis for postulating such an economy.

What Menger shows, then, is that money facilitates exchange. But he goes further. He shows that money also facilitates production. Without money the degree of specialization would be greatly attenuated because of the increased risks involved. Specialized economic activity (like all economic activity) is conditioned by the individual’s perceptions of the risks and benefits available. Specialization implies producing for exchange, i.e., producing more than one intends to consume. In a barter economy specialization is thus limited by what producers believe consumers will be willing to exchange for their (the producers’) surplus and to what extent this corresponds to their desires. By committing one’s resources to the production of only one or a few commodities a producer risks the accumulation of unwanted stocks because of the inability to find consumers willing to exchange what the producer needs. This risk is considerably reduced in a monetary economy since what the producer (in common with all producers) “needs” is money. Or more accurately, with money producers can be sure of obtaining what they need. Producers may also postpone their consumption decisions. In this way the existence of money supplies the degree of confidence necessary for producers to undertake an increasingly complex set of specialized activities. They need never worry about communicating their desires as consumers to the purchasers of their products. Thus money serves not only to separate the acts of purchase and sale but also to separate the acts of production and consumption.

When Mises writes, “The phenomenon of money presupposes an economic order” with the division of labor, etc., he means, as Menger has shown, that the phenomenon of money develops along with these things and, as Steven Horwitz correctly points out, “[F]rom the start, the existence and use of money is inherently linked with private property in the means of production” (1995:8, italics added; see also Horwitz 1996).

It is thus difficult to exaggerate the importance of money in the smooth functioning of a modern economy. The institution of money is intimately related to every other economic, and many noneconomic, institutions. Horwitz (1992) has done some work on the analogies between money and language. But this is not so much an analogy as a vital connection. Money could not exist without language; it is, in a sense, a derivative of language. The use of money, in fact all trade, implies verbal communication. It also implies the use of arithmetic and this brings us back to the question of calculation.

Money and Calculation: The Ability to Budget

Mises claims that the inability to calculate the economic significance of capital projects is what dooms central planning with public ownership of the means of production. Horwitz argues that Mises bases this claim on his understanding of the fundamental properties of money and the emergence of money prices for the heterogeneous means of production. We have discussed above the more precise context of these money prices. For Mises they are “aids to the human mind” in performing the calculations on which actions are based. The crucial point here, it seems to me, is that the institution of money and money accounting allows decision-makers to budget. Without the ability to budget, production could not occur, it could not be organized. Budgeting implies an intertemporal framework, the tracking of value over time. It provides the individual planner with meaningful orientation points against which to measure action. The meaningfulness derives from the fact that money prices within the framework of money accounting are socially meaningful, they are understood by all market participants, they are part of a shared language or orientation. When money is functioning normally (that is to say when there is no inflation), money prices represent a shared sense of “what things are worth” in the market, what can be got for them. Thus, meaningful money prices in the absence of private property is a contradiction. And it is private property that allows for the orderly development of production activities. By “orderly” we mean widely understood and accepted—peaceful.

We can understand this (once again) in terms of the simple idealized present-value arithmetic that we imagine decision-makers to use when appraising capital projects. The prospective capital value of any project (good or process) is thought of as the discounted present value of all of the useful outputs which it is expected to yield over its life. The retrospective capital value of the same project is the accumulated value of the investments actually made. Any difference between the two is a capital gain or loss (see Hicks 1973b and Chapter 6). As a result of the occurrence of capital gains and losses, producers alter the capital structure. Successful ventures displace unsuccessful ones. The whole process proceeds peacefully, though not painlessly, as the economy engages in a form of implicit experimentation whose results are calibrated in the form of money.

In a single firm’s accounting statement itemizing the total costs of a project and comparing this total to the revenues received is contained a wealth of scarcity information that neither the accountant not any other agent in the system could ever gather. Each price of purchased, rented, and hired factors reflects a complex tension among diverse plans that have tried to pull the relevant factor into alternative uses. The profit and loss calculus itself then determines whether the particular combination of inputs under consideration yields an output that is expected to pay its way in the market. The fact that all this scarcity information is expressed in quantitative form permits each decisionmaker to test extremely complex combinations of factors for their profitability while simultaneously relying on similar tests being conducted by rival decisionmakers.

(Lavoie 1985b:71)

The Effect of Macroeconomic Policy on Capital Calculation

One well-known application of Austrian capital theory is the Austrian theory of the business cycle. This theory, developed in different ways by Mises and Hayek, makes use of Böhm-Bawerk’s theory of capital as roundabout production. As suggested above (Chapter 8), Hayek uses a simplified version of Böhm-Bawerk’s theory to explain how the capital stock becomes distorted as a result of inappropriate monetary policies that reduce the market interest rate below the level that is consistent with the time preferences of the consumers in the economy.

This theory is well known and will not be surveyed or evaluated here. The vision of capital offered in the present work is one that is less abstract, less quantitative, and less aggregative than that of Böhm-Bawerk. In addition, our focus is primarily on the way in which a dynamic society evolves, how its capital structure changes in a peaceful but unpredictable way against the backdrop of a structure of institutions that include a sufficient commitment to the principles of private property. And in this chapter we have considered how it is that individuals are able to make capital project decisions in such an environment. It is of some interest, however, to consider briefly how short-term government policy actions might affect this ability.

We have already noted that inflation, by compromising the ability of money to connote value, will affect the ability of decision-makers to make successful decisions. Inflation, by compromising the institution of money, in effect compromises all of the related institutions, most notably the institution of accounting. In the extreme, in situations of hyperinflation, no capitalist production will take place—the economy will revert to a barter system. But what about less extreme monetary policies that aim only to “stimulate” economic activity by keeping interest rates low?

While it is difficult in a dynamic complex economy to know with any degree of confidence what the typical effects of such a policy might be (as contrasted with the degree of knowledge suggested by the Austrian business cycle theory), we can see immediately how individual business decisions might be affected. We recall that every capital investment decision can be generally characterized by a (necessarily subjective) capital value (vector) function as

k_t = k_t(w, α, p, ß, r, n)

indicating, in a general way, the determinants of capital value k_t of any project. We can thus say two things about the reduction of interest rates on the perceived value of any project:

1. As Hicks has explained, a reduction in r will, ceteris paribus, increase the value of any project.

2. This effect will (usually, depending on the precise nature of the income flow) be greater for those projects that have a longer time horizon.

Thus, in a situation in which there is a generally perceived decrease in the rate of discount, one may expect a shift toward projects of longer time horizon. In other words, there will be a change in the capital structure and a concomitant change in the pattern of employment. Interest has centered around whether this change is a sustainable one, or whether, because it was precipitated by a change in the supply of money rather than a spontaneous fall in individual time preferences, it is based on an illusion and must necessarily be only temporary.

Clearly, if one makes the assumption that individual time preferences, as expressed on the margin in the market, remain unchanged in the face of the policy, or, at least, remain above the (equivalent) market rate of interest, then it follows trivially, since the shift is based on an illusion, it must be temporary. The increase in production and employment will be reversed and there will be a cycle. The assumed illusion is of the form that the planned time structure of production, the planned arrival times of various products, is out of sync with the planned time structure of consumption. So the discoordination will become apparent when consumer demands in the shorter rather than the longer term go unsatisfied at prevailing prices, and when prices rise the capital values of the longer-term projects will, in general, be adversely affected (as shown in the capital value vector function above, considering w and p). So production plans become undone.

There is no guarantee, however, that the decline in market rates, precipitated by cheap monetary policy, will indeed be taken by investors as a signal of a decrease in time preference. In other words, there is no guarantee that producers in general will decide that r, the appropriate rate of discount for their projects, has fallen. If they regard the policy as inflationary they may well decide that a higher r is appropriate. The policy may be doomed from the start.

Nevertheless, it does seem possible to draw the conclusion that such policies, and particularly changes in policies, do introduce an added degree of uncertainty (noise) into individual decision-making. The world is full of changes anyway. Most capital projects will fail in part. To have to factor in an expectation of changes in government policies (interest rates, taxes, regulations, etc.) and their effects places an added burden on the decision-maker. The policies affect not only the viability of capital projects in terms of their straightforward incentive effects (by making them more or less expensive) but they affect their viability also by influencing the degree and type of risk that attaches to the projects. For risk-averse individuals, the attractiveness of any capital value is reduced. And this effect is likely to be greater the longer the time horizon of the project.

In general, short-term macroeconomic policies may be seen to disrupt the longer-term adaptations that we have been analyzing in this book, and are likely to affect adversely the creative dynamism of the economy. Interest rate policy is only one kind of a set of policies whereby the government, to a greater or lesser extent, encroaches on the decision-making territory of private consumers and investors. All of these policies rest on problematic assumptions about the nature of knowledge and incentives. We will return to this in the final chapter.

Conclusion

In this chapter we have investigated the role of money and monetary calculation in the determination of the production structure of the modern economy. We have found that the social institution of money is inextricably bound up with other social institutions like private property and business organizations. The possibility of conceiving theoretically of a system without money, in which all calculation is done in some arbitrary numeraire, should not blind us to the reality that in business organizations it is the ability to calibrate plans and results in the form of money that allows it to function smoothly. Money provides the report card for business. Anything that compromises the reliability of the monetary system thus compromises the functioning of the production system. This is as true for the attempt to impose a collectivist economy without the use of money, reminiscent of the Bolshevik experiment, as it is of the many experiences of inflation. So much has been asserted many times. What we have underlined here is the crucial dependence of ordinary business calculations, for the purpose of undertaking capital investments, on a reliable monetary system.

The ability to make useful calculations to guide decisions thus depends on the stability of certain critical elements of the institutional environment of which money is one and private property is another. The corporate structure also crucially facilitates calculation in providing a cognitive framework, a set of rules and routines (some of them tacit) governing individual behavior of firm members, to guide the decisionmakers’ expectations. It is important to note that, in addition to these considerations, useful calculation assumes the ability to calculate. Making useful calculations presupposes not only some basic arithmetic and accounting, but also other forms of knowledge and understanding relating to the various aspects of the business. Thus in the next chapter we turn to an examination of the nature and importance of human capital.

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[This chapter uses material from Lewin (1998).]

¹We have not mentioned the limitation on individual liability provided by the modern joint stock corporation that may also be a factor.

²Peter Klein has recently used this type of reasoning in interpreting Rothbard (who in turn was extending Mises on the impossibility of socialist calculation). “[N]o firm can become so large that it is both the unique producer and user of an intermediate product; for then no market based transfer prices will be available, and the firm will be unable to calculate divisional profit and loss and therefore unable to allocate resources correctly between divisions” (Klein 1996:15).

³Recall our discussion of profit as a category of earnings in Chapter 7. Profit depends crucially on the presence of uncertainty. In the present discussion the absence of uncertainty would imply that all earnings (wages, rents, and interest) could and would be contracted for and there would be no residual.

⁴This is, of course, a nutshell evolutionary argument with a stable equilibrium. It contains the necessary elements of mutation (variation), selection (competition), and replication (continuity in the firm as an institutional entity that replicates certain kinds of behaviors). See Vroman (1995).

⁵In the Hicksian framework developed earlier we might write a general (and necessarily subjective) capital value (vector) function as

k_t = k_t(w,α,p,ß,r,n)

indicating, in a general way, the determinants of capital value k_t of any project. The variable r is perhaps especially important because of its macroeconomic significance as the indicator of the relationship between present and future prices of consumption goods. However, the structure of market prices and wages in general may affect the project (through p and w) and technology (α and ß— the types and combinations of inputs and outputs) obviously matters. All of the insights offered by Hicks in terms of intertemporal behavior of k_t follow.