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The price normalization problem in imperfect competition and the objective of the firm

Author

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  • Birgit Grodal

    () (ûkonomisk Institut, KÛbenhavns Universitet, StudiestrÖde 6, DK-1455 KÛbenhavn, DENMARK)

  • Egbert Dierker

    (Institut fØr Wirtschaftswissenschaften, UniversitÄt Wien, Hohenstaufengasse 9, A-1010 Wien, AUSTRIA)

Abstract

General equilibrium models of oligopolistic competition give rise to relative prices only without determining the price level. It is well known that the choice of a numÊraire or, more generally, of a normalization rule converting relative prices into absolute prices entails drastic consequences for the resulting set of Nash equilibria when firms are assumed to maximize profits. This is due to the fact that changing the price normalization amounts to altering the objective functions of the firms. Clearly, the objective of a firm must not be based on price normalization rules void of any economic content. In this paper we propose a definition of the objective of a firm, called maximization of shareholders' real wealth, which takes shareholders' demand explicitly into account. This objective depends on relative prices only. Real wealth maxima are shown to exist under certain conditions. Moreover, we consider an oligopolistic market and prove the existence of a Nash equilibrium in which each firm maximizes the real wealth of its shareholders.

Suggested Citation

  • Birgit Grodal & Egbert Dierker, 1999. "The price normalization problem in imperfect competition and the objective of the firm," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 14(2), pages 257-284.
  • Handle: RePEc:spr:joecth:v:14:y:1999:i:2:p:257-284
    Note: Received: July 10, 1997; revised version: July 27, 1998
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    Keywords

    The price normalization problem; Imperfect competition; Oligopoly; Firms' objectives; Real wealth maximization; Profits and shareholders' demand.;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly
    • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm

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