by Jurgen Brauer, December 2002
Copyright: J. Brauer. No reproduction without permission.

It is false to suggest that firms "produce" and households "consume." Firms and households do both.

Ordinarily, economists present firms as producers and households like yours and mine as consumers of goods and services. But this is wrong. All firms are producers and consumers, and all households are also producers and consumers.

How so? Firms, faced with budget constraints, need to choose from among a variety of possible inputs to produce an output of goods and services of a desired quality. As purchasers of raw materials, and of financial, insurance, capital, and labor services they are, clearly, consumers. Similarly, you and I are in the business of producing "happiness," and to produce it we need to acquire inputs in the face of our own likes and dislikes (our "preferences"), our income and credit constraints, and the prices to be paid for the things we desire.

It is said that firms strive for profit-maximization. But so do I. I strive for happiness-maximization.

It is therefore a false dichotomy to suggest that firms "produce" and households "consume." Firms and households do both. Moreover, firms are said to strive for profit-maximization. But so do I! In the Brauer household, we strive for happiness-maximization. Profit of course is the difference between revenue and cost. By itself, revenue-maximization, at high cost, does not result in profit-maximization. Same for the Brauer's. High income, if purchased at the high cost of 80-hour workweeks, does not make for happiness. Similarly, cost-minimization, at the sacrifice of revenue, does not generate maximum profits either. Same for the Brauer's. Being a miser, never spending a dime on anything fun whatsoever, does not produce happiness. Firms and households both are producers and consumers, and both wish to maximize "profits" (or "happiness"). Conceptually, both are entirely alike.

In addition to the purchase of raw materials, labor services, and so on, firms face other costs. One of the most important of these is the coordination cost of having so very many different parts work together to produce maximum profit. The reason is that the many parts of the firm – the shareholders, directors, managers, employees, even its suppliers and customers – each have their own happiness agenda that only partially coincides with the happiness agenda of the firm. Same for the Brauer family. Each one of us has a private agenda of how to produce happiness. The Brauer family can be helpful in achieving my own, personal happiness, but not always necessarily so. Hence, conflict and coordination costs arise for the Brauer family firm, just as they arise in the kinds of firms we call IBM or General Electric or Coca-Cola.

Economists have made progress in better understanding the dynamics of decision-making within firms and within families. Ronald Coase and Oliver Williamson for instance are prominent names among those employing the transaction cost approach to understand industrial organization and hierarchy in firms. Amos Tversky (who died in 1996) and Daniel Kahnemann are prominent names in "behavioral economics" which seeks to better understand consumer decision-making. (Coase and Kahnemann are economics Nobel-Prize recipients.) Both approaches, however, reflect the continuing textbook division between producers and consumers, as if there were a difference. To me it's a difference in degree, not in kind, and I therefore believe that the transaction cost and behavioral economics approaches can learn from each other.

Furthermore, I find the emerging school of biological economics highly germane. It is not yet clear how biological economics is defined, but I view it from the point that, in order to reproduce themselves, all life-forms -- human and non-human -- need to produce and to consume. Plants, for instance, may be viewed as taking light energy from the sun and nutrients from the air, water, and soil in order to produce and self-consume their production. But many plants actually "trade." Nectar, for example, in exchange for pollination. Fruits in exchange for seed dispersal. Thus, only part of their production is for self-consumption, the other part being available for trade to "consume" match-making and transportation services. There's veritable economy of nature out there in which we, all of us, are both producers and consumers at all times.