UW-Madison UW-Madison

Staff Paper No. 516 - Abstract

On Microeconomic Efficiency and Entrepreneurship under Bounded Rationality

Jean-Paul Chavas [jchavas@wisc.edu]
Bradford Barham [barham@mailplus.wisc.edu]

Staff Paper No. 516, October 2007, 36p.


We present a dynamic model of economic behavior of an owner-operated firm under bounded rationality, and develop the implications for the assessment of economic efficiency and the understanding of entrepreneurship. Under bounded rationality, information about technology and market conditions is not perfectly known, creating the possibility for learning. Uncertainty is represented using a general state-contingent approach. Efficiency analysis is explored using a certainty equivalent measure, which is the sum of three parts: expected net income, a conditional value of information, and a risk premium (measuring the implicit cost of private risk bearing). The analysis yields critical insights about the role of learning in technical efficiency, allocative efficiency, and their implications for an improved understanding of entrepreneurship. These insights also provide micro-theoretic grounding to some classic debates (e.g., Leibenstein and Stigler) about what contributes to efficiency and technological progress in an economy.
Last updated on Fri, Oct 5, 2007 12:39pm