The Nature of the Firm
Author: Ronald H. Coase
Economica Vol. 4 (November 1937)
pp. 386-405
Presented by Danielle Jones
Background
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Born in 1910 in London, England
On faculty at London School of Economics when
The Nature of the Firm was published
“Father” of transaction costs economics
Currently Professor Emeritus of Economics at
University of Chicago Law School
Nobel Memorial Prize in Economics in 1991
Still alive and conducting research
Problem
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Economic theory fails to clearly state its
assumptions
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Economic analysis tends to begin with the
individual firm
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Economists and people in the “real world” have
different definitions of a firm
Purpose
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Definition and clarification of the firm
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To provide a definition that is realistic and
tractable (manageable)
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To clarify when resources are allocated by the
price mechanism (the market) and when they are
allocated by the entrepreneur (firm)
Why does the firm exist?
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There are market (transaction) costs associated with
using the price mechanism to organize production
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Price discovery costs
Contract and negotiation costs
Regulation costs (taxes)
Uncertainty costs
A firm (under the authority of an entrepreneur) can
coordinate resources and minimize transaction costs
Definition of firm
“…the system of relationships which
comes into existence when the direction
of resources is dependent on an
entrepreneur” (p. 393).
What determines firm size?
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Amount of transactions
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Mistakes
– Failure to utilize factors of production properly
– Waste of resources
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Supply price of factors of production
Cost curve of the firm
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As firm gets larger, there may be
decreasing returns to the
entrepreneur
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Loss in efficiency
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The firm will engage in the
number of transactions where
the costs of doing so in the firm
are equal to the transaction
costs in the market or to the
costs of organizing by another
entrepreneur
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Also determines number of
products produced by the firm
(Washington, 2013)
Application of the firm to the “real world”
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Looks at legal relationships of master and servant
(employer and employee)
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Servant must be under the duty of rendering
personal services to the master
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Master must have the right to control the
servant’s work
Tractability (manageability) of the firm
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The principal of marginal returns works
“smoothly” with determining firm size
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At the margin, the costs of organizing within the
firm will be equal either to the costs of organizing
in another firm or to the costs involved in leaving
the transaction to be organized by the price
mechanism