The John Bates Clark Model

Like any other unit, a firm is also limited by the technology available. Thus, it can increase its outputs only by increasing its inputs. As usual, this will be expressed by a production function. The output that a firm can produce depends on the land, labor and capital the firm puts to work.
In formulating the neoclassical theory of a firm, John Bates Clark took over the classical categories of land, labor and capital and simplified them in two ways. These are as follows:
1. He assumed that all labor is homogenous-- One labor hour is a perfect substitute for any other labor hour.
2. He ignored the distinction between land and capital, grouping together both kinds of non-human inputs under the general term “capital.” And he assumed that this broadened “capital” is homogenous.
Ofcourse, the simplifying assumptions are not true. John Bates Clark’s conception of a firm is highly simplified, like a map at a very large scale. In more advanced economics, one can get rid of the simplifying assumptions and deal with a much more realistic “map” of a business firm.
In the John Bates Clark model, there are some important differences between labor and capital and they relate to the long and short-run.

Theory of the Firm

For developing the supply and demand approach to economics, the economists first worked out the basis of the demand curve. By treating the demand for a product or service as a rational decision by a (primarily) self-interested individual or family, the economists were able to understand the relation of the demand for one product or service to the demands for other products and services and to many other forms of economic

activity. It was natural to apply the same approach to supply. As a first step, one needs to think about the decision-makers in supplying goods and services and what a “rational decision” to supply goods and services would mean. In economics, this is often called the “theory of the firm.”

A firm is a unit that does business on its own account. Firm is from the Italian word, firma, a signature and the idea is that a firm can commit itself to a contract. Thus, a firm is the decision-maker in supplying goods and services.

There are three main kinds of firms in modern market economies which are as follows:

Proprietorships

A proprietorship (or proprietary business) is a business owned by an individual known as the “proprietor.” Many “mom and pop stores” and other “mom and pop” businesses are proprietorships. Some of the proprietorships are too small even to employ a person full time. Craftsmen, such as plumbers and painters, may have “day jobs” and work as selfemployed proprietors part time after hours. The computer programmers and others may also do that. At the other extreme, some proprietary businesses employ many hundreds of workers in a wide range of specializations. In a proprietorship, a proprietor is almost always the decision-maker for the business.