the nature of the firm r.h. coase
TRANSCRIPT
The Nature of the FirmR.H. Coase (1937)
Sociology 224February 9, 2010
Mary Carol MazzaHBS
Introduction
Problem:
Economists often fail to examine the foundations of economic theory
Coase proposes:
to show a definition of the firm that both:-corresponds to the real world meaning of the word-tractable by tools of economic analysis (idea of the margin and substitution)
Introduction I. II. III. IV. V.Questions
Introduction I. II. III. IV. V.Questions
I. The Economic System as Treated by Economists
• Price mechanism
determines the allocation of
the factors of production
• The process is automatic,
responsive, and elastic: it
adjusts supply to demand
and production to
consumption
Economists View of Economic System
Coases View of Economic System
Outside the firm:
• Price movements direct
production, coordinated
through exchange
transactions on the market
Within the firm:
• The entrepreneur directs
production
Introduction I. Economic System: Economists vs. Coase II. III. IV. V. Questions
Introduction I. Economic System: Economists vs. Coase II. III. IV. V. Questions
Outside the firm: Price movements direct production
Inside the firm: Entrepreneur directs production (because there are no market transactions within the firm)
**Mark of the Firm the supersession of the price mechanism (by some organizational director/person)
Why is there an organization? What is the distinguishing mark of the firm?
Introduction I. Economic System: Economists vs. Coase II. III. IV. V. Questions
Introduction I. Economic System: Economists vs. Coase II. III. IV. V. Questions
“bridg[ing] the apparent gap in economic theory between the assumption that resources are allocated by the price mechanisms for some purposes and by the entrepreneur-co-ordinator for others” (p.389)
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
Purpose of the Paper
Introduction I. Economic System: Economists vs. Coase II. III. IV. V. Questions
Introduction I. Economic System: Economists vs. Coase II. III. IV. V. Questions
II. Why does a firm emerge in a specialized exchange economy
**There is a cost to using the price mechanism (“transaction costs” or “marketing costs”)
• Finding out prices
• Negotiating separate contracts
• Difficulty creating long-term contracts
The firm: saves costs by allowing an entrepreneur to direct resources
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
Why does a firm emerge in a specialized exchange economy?
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
A firm “consists of the system of relationships which comes into existence when the direction of resources is dependent on an entrepreneur” (p.393).
This definition imparts scientific meaning to the idea of a firm getting larger or smaller
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
Definition of the Firm
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
In response to Knight:
If the firm, by definition, reduces marketing/production costs, why are there any market transactions at all?
Why not one big firm?
•Diminishing marginal returns (increasing marginal costs of organizing more transactions within the firm)
•Decreasing returns of managerial ability (misallocation of resources, knowledge, etc)
•Potential for rising supply prices
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
Can we treat the determinants of the size of the firm scientifically?
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
A firm will tend to be larger:
1) The lower the costs of organizing and the slower these costs rise with an increase in the transactions organized
2) The less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes with an increase in the transactions organized
3) The greater the lowering in the supply price of factors of production to firms of larger size
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
Can we treat the determinants of the size of the firm scientifically?
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
Introduction I. II. Why a firm emerges in specialized exchange economy III. IV. V. Questions
III. Why the price mechanisms needs to be substituted by the entrepreneur
Others: Firm exists because of division of labor
The firm integrates these various parts that came about from economic differentiation
…BUT
Coase says: The price mechanism already existed as an integrating force
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
Why is Coase’s reason for the emergence of the firm to be preferred over others?
Introduction I. II. III. Why this explanation of firm emergence is preferred IV. V. Questions
Introduction I. II. III. Why this explanation of firm emergence is preferred IV. V. Questions
Professor Knight: the firm exists because of Uncertainty!• People have to forecast future wants (special class
arises who directs the activities and guarantees wages)• But they could just sell their advice
• It would be odd for one man to guarantee another a result from the other’s work without being given power over his work
• But that is what contracts are for
But even without uncertainty, there would need to be coordinators…never says why price mechanism should be superseded
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
Why one integrating force (the entrepreneur) Needs to substitute for another (price mechanism)
Introduction I. II. III. Why the entrepreneur substitutes for price mechanism IV. V. Questions
Introduction I. II. III. Why the entrepreneur substitutes for price mechanism IV. V. Questions
IV. The Cost Curve of the Firm
Prior discussion of firm size based on the simplifying assumption that only one product will be produced.
MC=MR
The number of products produced by a firm is determined by:A point where it’s less costly to organize the exchange transactions of a new product than to organize further exchange transactions of the old product (including marketing costs & costs of organizing different entrepreneurs)
INTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSIONINTRO STUDY 1 STUDY 2 STUDY 3 STUDY 4 DISCUSSION
The Cost Curve of the Firm
Introduction I. II. III. IV. The Cost Curve of the Firm V. Questions
Introduction I. II. III. IV. The Cost Curve of the Firm V. Questions
V. The Firm: Realistic and Manageable?
Examining the relationship of servant/master (employer/employee):
1) The servant must render personal services to the master/on his behalf
2) The master must have the right to control the servant’s work
Agent vs Servant: the freedom with which an agent carries out his employment
Is this concept of the firm realistic and is it manageable
Introduction I. II. III. IV. V. Concept fit with real world and manageable? Questions
Introduction I. II. III. IV. V. Concept fit with real world and manageable? Questions
Scope of the firm is determined at the margin• Marginal Cost of organizing an additional transaction within the firm equals the cost of alternative institutional arrangements (ie: another firm or the market)
Is this concept of the firm realistic and is it manageable
Introduction I. II. III. IV. V. Concept fit with real world and manageable? Questions
Introduction I. II. III. IV. V. Concept fit with real world and manageable? Questions
So Coase’s definition of a firm might have worked for 1937 (and maybe into the 1970s when other’s built on his work), but in 2010, how relevant is Coase?
If Coase were to revise his “Theory of the Firm” for today’s world, what would he change?
Questions…
Introduction I. II. III. IV. V. QuestionsIntroduction I. II. III. IV. V. QuestionsIntroduction I. II. III. IV. V.Questions
Introduction I. II. III. IV. V.Questions
Give a clear definition of what is meant by a “firm” in economics that is both realistic (corresponds to general usage) and manageable for economic analysis. Bridge the gap in economic theory between assumptions of allocation by price mechanism and by fiat of the entrepreneur. Under what conditions one or the other? Why do firms emerge at all in a specialized economy? (if it is a matter if information efficiency, independent consultants and specialists could do just as well) A firm consists of the system of relationships that come into being when the direction of resources is dependent on an entrepreneur. Distinguishing mark of firm is the supersession of pure price mechanism (i.e., pricing is not only thing that guides the emergence of firms)
•
Introduction I. II. III. IV. V. QuestionsIntroduction I. II. III. IV. V. QuestionsSummarySummary
The main reason why it is profitable to establish a firm is that there is a cost of using the price mechanism (transaction cost). a) the cost of price information, b) the cost of making separate contracts for each exchange transaction (Firms reduce these contracts to one, the employee’s salary and range of duties), c) risk attitudes, firms prefer long-term contracts, but uncertainties involved require a vague contract, d) external actions: sales tax on market exchange (but not inside firm) , quotas, and rationing all would raise transaction costs outside the firm. “The operation of a market costs something and by forming an organization and allowing some authority (an “entrepreneur”) to direct the resources, certain marketing costs are saved.” (p. 392)
Introduction I. II. III. IV. V. QuestionsIntroduction I. II. III. IV. V. QuestionsSummarySummary
You can also use these conceptions to describe and predict changes in the size of firms. Growth occurs when more (types or volume of) transactions are organized by the entrepreneur. Maximum size of firms corresponds to the point at which it is no longer cheaper to organize transactions “in house” compared to the market. Two ways a firm can expand: combination occurs when transaction originally done by 2 or more entrepreneurs become organized by one; integration occurs when transactions between entrepreneurs on the market become organized by one.
Introduction I. II. III. IV. V. QuestionsIntroduction I. II. III. IV. V. QuestionsSummarySummary
So, all else equal, a firm will tend to be larger if it faces a) decreased cost of organizing and slower cost increase if transaction organized b) decreased likelihood of entrepreneur making mistakes c) increased lowering of supply price factors of production.
Influenced wlliamson
Introduction I. II. III. IV. V. QuestionsIntroduction I. II. III. IV. V. QuestionsSummarySummary
The End