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Beyond Simple Profit Maximization in Uncertain Markets: How Innovation and Entry Change Supply Curves and Producer Surplus
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Beyond Simple Profit Maximization in Uncertain Markets: How Innovation and Entry Change Supply Curves and Producer Surplus
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Journal Article
Beyond Simple Profit Maximization in Uncertain Markets: How Innovation and Entry Change Supply Curves and Producer Surplus
2023
Overview
This article challenges the conventional wisdom that decreases in total revenue always cause firms to be worse off. Instead, innovations and entry causing clockwise rotations or parallel supply shifts can increase producer surplus even when total revenue decreases. Textbooks claiming producers are worse off when total revenue declines are misleading because producer surplus increases initially even when revenue declines. Schumpeterian entrepreneurs who create innovations that benefit low-productivity/high-marginal-cost production cause clockwise supply rotations, and entrepreneurs that create innovations that provide similar benefits to both high- and low-productivity producers cause parallel supply shifts. The article's focus on entry and innovation illustrates the importance of Julian Simon's argument that focusing on allocation rather than innovation often leads to wrong conclusions and Alchian's argument that uncertain foresight makes profit maximization meaningless as a guide to specifiable action. Though producer surplus increases then declines, consumer and total surplus always increase. Producer surplus eventually declines when clockwise supply rotations lead supply to be more elastic than demand, where the price-reducing effect of the innovation dominates the cost-reducing and quantity-enhancing effects. Entry and innovation that generate rightward parallel supply shifts cause producer surplus to increase at an increasing rate when supply is elastic until the inflection point where supply is unit elastic. Beyond the inflection point, parallel rightward supply shifts cause producer surplus to increase at a decreasing rate and, eventually, decline. Last, we conduct a numerical 3D analysis illustrating how entry and innovation that cause supply to rotate and shift affect producer surplus.
Publisher
Association of Private Enterprise Education
Subject
