Neoclassical Economics Is Really Mathematics: Business Firms Are Merely Formulas; There Are No People, No Institutions; Entrepreneurship Has Been Ignored

The problem of entrepreneurship for economists is that the best-developed and best-understood part of economic theory—neoclassical economics—is really mathematics. Business firms in that system are merely formulas, “production function.” There are no people, no institutions; it is a timeless paradigm of resources shifting and forth according to changes in relative prices and costs. This has meant that entrepreneurship, the most forceful, dramatic, and obvious phenomenon in all of economic life, has perforce been ignored by theoretical economists in their story of how economic events happen. 

—Jonathan R. Hughes (1986 [1965]: x)

As the title of my book—An Entrepreneurial Theory of the Firm— shows, the goal of this work is to introduce the “most forceful, dramatic, and obvious phenomenon in all economic life”—namely entrepreneurship—into the theory of the firm. Indeed, the economic theory of the firm, like most of the rest of economic theory, does not really make room for entrepreneurial activity and thus does not account for the most fundamental aspect of the market process. 

Firms have always puzzled economists. They are an empirical phenomenon that must be explained along with other phenomena that constitute the market system. However, firms have never been really incorporated in conventional economic theory, thus my purpose in the following pages is to give an explanation for the emergence and the growth of firms in the marketplace that would be consistent with the approach of th4e modern Austrian school. This is an inquiry into the nature of the relationship that exists between firms and markets.

—Frédéric E. Sautet, introduction to An Entrepreneurial Theory of the Firm, Foundations of the Market Economy (London: Taylor and Francis e-Library, 2003), 1.

A Chicago-Style Equilibrium-Always Theory Entails a Closed View of the Universe

The Chicago use of the equilibrium concept entails the notion of an equilibrium-always world. This view replaced the old notion of competition around the period of the Second World War, thereby replacing Marshallian economics and the classical notion of competition as a rivalrous process. The economy is seen as being in a state of permanent equilibrium provided that the relevant costs are included in the analysis. An equilibrium-always theory entails a closed view of the universe. In such a system, there is no room for genuine uncertainty. . . .

Austrian economists understand genuine uncertainty as Knight saw it. Knightian uncertainty means that genuine changes can take place within the system under study. These changes are not determined by the state of the system at any moment and cannot be assigned (objective or subjective) probabilities. Therefore, they cannot be modeled and are beyond the realm of prediction: the universe is open-ended. An open-ended view of the universe entails that new knowledge can come into existence within the system, for sheer ignorance and genuine error are possible. As Brian Loasby (1976), quoting Karl Popper, shows, the notions of objective and subjective probabilities are in themselves quite controversial. He also argues that economists, when they deal with uncertainty, generally do not understand it the way the layman does. As Loasby puts it: “When someone says that he is uncertain, what he usually means is not just that he doesn’t know the chances of various outcomes [subjective probability], but that he doesn’t know what outcomes are possible [Knightian uncertainty]” (Loasby 1976).

—Frédéric E. Sautet, An Entrepreneurial Theory of the Firm, Foundations of the Market Economy (London: Routledge, Taylor and Francis e-Library, 2003), 10-11.