The literature on risk and uncertainty gives an important place to studies comparing behavioral and comparative static results obtained under certainty and uncertainty. The standard neoclassical theory of the firm, however, has much more to offer than behavioral results. For example, the optimizing behavior of the profit-seeking firm insures that the degree of the firm's returns to scale can be measured by the ratio of cost to revenue. Furthermore, it is also possible to isolate measures of the rate of technical change for a profit-maximizing firm which depend solely upon observed prices and quantities. This note demonstrates some of the implications of uncertainty for measuring scale economies and the rate of technical change. Specifically, using a model developed by Agnar Sandmo (1971), it is demonstrated that under conditions of risk and uncertainty, there are generally no measures of the scale elasticity or the rate of technical change which can be derived from observations on prices and quantity without information on either the structure of production or the utility function which underlies Sandmo's analy-
Louis De Alessi's paper (1983) begins in an ecumenical spirit and suggests that rights and the X-efficiency approach have not drawn on each other's contributions. I share that spirit. There is much to learn from a variety of approaches. But, as De Alessi proceeds, the ecumenical spirit withers. last three sections argue to the effect that neoclassical (i.e., rights theory)' obtains the same results as X-efficiency theory, but has a superior methodology. De Alessi's paper puts me in the position of a reluctant dualist. His approach resembles an intellectual takeover bid since it argues 1) that neoclassical is flawed, 2) that the rights approach has corrected the flaws, and 3) by implication that it supercedes other micro approaches.2 concepts of rights, transaction costs, and adjustment costs, and their motivational implications, are certainly useful. I see no reason to argue against them, or against rights theory. But I believe that there is more to the explanation of inefficiency. Thus I will stress the special nature of the X-efficiency approach, examine our differences, and attempt to correct some of De Alessi's misinterpretations. Nevertheless, I believe that De Alessi's article renders an important service since it gives a succinct summary of rights and explains its significance. main differences between us lie in the basic presupposition behind the two approaches. In answering the motivation question, rights seems to say that rights are the only motivating force, and that people act to fully maximize wealth given the limits of their rights. When they do so, their activities are efficient. X-efficiency approach raises a different type of question. Namely, it asks (within the firm and outside of the exchange relationship) what are the motivating forces that determine effort and productivity, including the motivating forces leading to maximizing or less-than-maximizing behavior. Property rights are, of course, a motivating force. However, it is one of many, not the only motivating force, nor in many instances is it the most important one determining effort. It is important to highlight these differences because different modes of analysis determine not only results, but what the analyst looks for and possibly finds. value of a depends in part on the research it generates. Another difference lies in the interest in inefficiency. It is not clear whether De Alessi cares about inefficiency. postulate of maximization of utility by all individuals and the explicit assertion by De Alessi that The equilibrium solution associated with a given set of constraints is efficient (p. 73) gives the impression that inefficiency is assumed away. Clearly, the X-efficiency approach sees inefficiency as a major problem. Only if one employs an approach that at least recognizes within it the possibility of inefficiency can one have empirical results which indicate an approximation to efficiency. Inefficiency must be a variable if we are to be able to find meaningful empirical instances which are efficient. Compared to the neoclassical approach, the rights approach seems to dissect the firm into component individuals and their implicit contracts. After dissection, the rights approach assumes that the ordinary utility-maximization rules still apply. *Professor of Economics and Population, Department of Economics, Harvard University, 204 Littauer Center, Cambridge, MA 02138. I am indebted to H. Barkai, J. Dean, R. Frantz, E. Helpman, J. Medoff, and J. Rothenberg for valuable comments. They are not responsible for errors or viewpoints. 'The labels property rights theory and general neoclassical theory will be used interchangeably. 2To stake his claim, De Alessi might have considered at least some other alternative approaches, such as the work of Oliver Williamson (1970) and that of Richard Nelson and Sidney Winters (1982).
A situation traditionally identified conducive to imperfect competition is when average costs decline and the cheapest scale of production is large relative to the size of the market. However, some of the more recent literature on industrial organization has emphasized supposed distinction between fixed costs of production and sunk costs of production. A point frequently made is that while the possibility of sunk costs can create genuine barriers to entry, fixed costs per se do not inhibit competitive market performance. This approach finds its logical extreme in the norm or abstraction of perfect contestability. Perfect contestability is essentially theory of the polar case of frictionless entry and exit. As William Baumol stated, a contestable market is one into which entry is absolutely free and exit is absolutely costless (p. 3). Certainly this is the most reasonable interpretation of situation where potential entrants feel free to disregard an incumbent's price response. Suppose every potential and actual producer has access to the same technology. In perfectly contestable market, there are no set-up or shut-down losses. The main result is that even with declining average costs of production, the incumbent firm does not dare to post price higher than average cost. Price above cost invites being undercut by hit-and-run shadow entrant capable of producing at the same flow rate and at identical unit cost during just the briefest instant of time. I argue that this line of reasoning is misleading. Perfect contestability gets around the problem of increasing returns only by, in effect, assuming it away. A hit-and-run technology makes the firm behave as if it is competitive in market precisely because the convexity preconditions for competition are de facto being met in that market. This comment shows that, strictly speaking, there is no such thing pure fixed cost. Unless there are sunk costs located somewhere in the relevant production technology, all costs are variable. As matter of formal theory, you cannot have range of decreasing average cost without sunk costs. Presumably there is also an approximation theorem which states that when sunk costs are close to being negligible then average production costs are practically nondecreasing. Perfect contestability holds approximately in market only to the extent that production costs for the market are approximately nondecreasing. My discussion will be restricted to the familiar case of single, well-defined, homogeneous, fully divisible commodity. While more general approaches are possible, for the sake of simplicity the following definition is used. The average cost function A C(y, t) describes, say, the minimum cost per unit of output produced at uniform flow rate y throughout the time interval (0, t]. Especially in applications to industrial organization theory it is essential to remember that cost functions are not generally timeless, and that writing AC function of y alone can be dangerously vague. Behind the free entry and exit of hitand-run technology in perfectly contestable market is the abstraction of no sunk costs-investments are fully reversible because nothing is lost in setting up or shutting down production.