Competing Micro Economic Theories of Industrial Profits: An Empirical Approach
The Jerome Levy Economics Institute Working Paper No. 3
62 Pages Posted: 12 Nov 1999
Date Written: March 1988
Contrary to the impression given by most textbooks, microeconomics is not a homogeneous discipline. At least two major alternative theories exist which account for the long-run behavior of industrial prices and the between economic sectors in ways which are distinct from standard neoclassical explanations. Both Post Reynesian and Classical (Marxian/NeoRicardian) approaches to economics have developed a growing literature on microfoundations in recent years (see, e.g. Eichner, 1985; Dumenil & Levy, 1985).
The coexistence of three apparently incompatible theories is an anomaly for any scientific discipline. In the case of microeconomics this might be explained, in part, by an absence of an orthcdox literature which submits their econonic theory to ocwparisons with alternative approaches, thus lending credence to such alternatives (Eichner, 1985, p. 178). Moreover, orthodox theory has been remiss in applying the correspondence test, i.e., the generation of elgirically testable hypotheses, to its own predictions.
It has been argued that neoclaccical economics has been more concerned with comprehensiveness and osherence than with realism (see, e.g., the arguments in Dumenil & Levy, 1986). Post-Keynesian and The New Classical microeconomics, since they are relatively new disciplines, have also largely focused on theoretical development at the expense of empirical testing. Another reason for the lack of efforts such as this one in the past may have been the lack of reliable data. Recent efforts by the Eureau of Economic Analysis have now produced consistent industry-level data on an establishment basis, including profit variables and assets at replacement-cost valuations. Earlier empirical studies were forced to construct rough industry aggregates from small firm samples and to use book values of assets.
If economics is to advance as a social science, diverse accounts of contemporary economic phenomena should be subjected to comparative empirical testing. In this paper a first attempt is made to appraise empirically one aspect of these three competing microeconomic theories: their explanations of industry-level profit differentials.
Each theory provides a different explanation of the profit margin on sales. Since all three theories recognize that costs are included in output price, focusing on the differentials of the markup in effect provides a basis for testing the theories of unit price. However, as will be seen, our results do not provide a clear empirical differentiation. The alternative predictions are embedded in complex economic theories which are capable of developing alternative scenarios to explain the evidence presented below.
Nevertheless, this evidence can help direct future theoretical work into relevant directions. Further empirical work must begin to test the actual mechanisms posted by the theories and possibly even deeper aspects of each approach. We only skim the surface of such our second set of empirical results investment. Hopefully, the real value of this research is that it will act as a base for further and deeper correspondence tests of these three competing theories.
JEL Classification: D20
Suggested Citation: Suggested Citation