Firm Formation

Topics: Economics, Transaction cost, Ronald Coase Pages: 4 (1547 words) Published: December 8, 2012
Firms did not flourish until the early 20th century. They emerged as an authorized structure and were granted exclusive rights to trade and conduct business in certain markets and products. The fact that firms are a different way to organize economic activities cannot explain explicitly and adequately the reason of firm formation. Many socialists and economists have given their interpretations of the conditions under which firms emerged and developed in certain ways in a specialised exchange economy. These explanations are drawn from each other yet have different identified emphases. In 1937, Ronald Coase came out of the plausible explanation for why the firm existed by publishing the ‘The Nature of the Firm’, making it one of the first attempts to define the firm theoretically in relation to the market. He pointed out that ‘‘there is a cost of using the price mechanism’’ and ‘‘the most obvious cost of ‘organising’ production through the price mechanism is that of discovering what the relevant prices are’’ (Coase 1937, p.390). Making contracts, purchasing assets and other properties incurred more costs that were not accounted for by the price mechanism. These costs or what he referred to generally as the ‘‘uncertainties’’, are the main factors that drive firm formation. Therefore, he argued that ‘‘by forming an organization and allowing some authority to direct the resources, certain marketing costs are saved’’ (Coase 1937, p.392), and contracts are greatly reduced but not eliminated for it is not necessary to make a series of contracts with someone within the firm. Overall the distribution of resources is regulated. Another factor which furnished the reason why firms formed is that ‘‘exchange transactions on a market and the same transactions organised within a firm are often treated differently by governments or other bodies with regulatory powers’’ (Coase 1937, p.393). However, in his descriptions the definition of ‘‘transaction costs’’ is not explicit, and...
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