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

Birgit Grodal and Egbert Dierker

Economic Theory, 1999, vol. 14, issue 2, 257-284

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.

Keywords: The price normalization problem; Imperfect competition; Oligopoly; Firms' objectives; Real wealth maximization; Profits and shareholders' demand. (search for similar items in EconPapers)
JEL-codes: D21 D42 D43 L13 L21 (search for similar items in EconPapers)
Date: 1999-08-24
Note: Received: July 10, 1997; revised version: July 27, 1998
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Citations: View citations in EconPapers (39)

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Related works:
Working Paper: The Price Normalization Problem in Imperfect Competition and the objective of the Firm (1998)
Working Paper: The Price Normalization Problem in Imperfect Competition and the Objective of the Firm (1996)
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