theory of the firm

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A rationale for the existence of firms. Economists were slow to recognize that the existence of firms required explanation. The theory first developed by Ronald Coase in 1937 to account for these blisters of hierarchy on the skin of the market rested on the concept of transaction costs. Any market transaction between autonomous individuals required time and negotiation and therefore had a cost. Wherever and to whatever extent the firm, a fundamentally political entity, was able to coordinate production and exchange at less cost than the market, competition would allow it to prevail. As the public good of information became increasingly important in complex modern economies the advantage of firm over market increased in many sectors, leading to growth in the average size of firms. Information, once created, may very easily disperse across a large population without any diminution of its utility to each additional consumer. Because it is so easy to come by, unless protected, no individual has an incentive to declare and part with its true value. But if all refuse to pay, the incentive to create information disappears. The firm overcomes this problem by using authority to help ensure a return to those who acquire title to information, whether it be the location of a good, a technique for refining it, or an innovative and effective administrative system for bringing it to market.


Subjects: Social Sciences.

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