The John Bates Clark Model

Like any other unit, a firm is 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 the firm can produce will depend on the land, labor and capital the firm puts to work.

In formulating the Neoclassical theory of the firm, John Bates Clark took over the classical categories of land, labor and capital and simplified them in two ways. First, he assumed that all labor is homogenous -- one labor hour is a perfect substitute for any other labor hour. Second, he ignored the distinction between land and capital, grouping together both kinds of nonhuman inputs under the general term "capital." And he assumed that this broadened "capital" is homogenous.

Of course, the simplifying assumptions aren't true -- John Bates' Clark's conception of the firm is highly simplified, like a map at a very large scale. In more advanced economics, we can get rid of the simplifying assumptions and deal with a much more realistic "map" of the business firm. But for most of this book, we'll take that on faith, and stick to the simplified version Clark gave us. That will make it simpler, and the principles we will discover are sound and applicable to the real world in all its complexity.

In the John Bates Clark model, there are some important differences between labor and capital, and they relate to the long and short run.