The Nature of a Firm

Topics: Economics, Transaction cost, Cost Pages: 2 (535 words) Published: January 18, 2014
Short Essay on Coase’s article: “The Nature of the Firm” Coase’s article “The Nature of the Firm” provides a set of answers to important questions such as “Why do firms exist?” “What characterizes firms?” and “What determines their scale and scope?” According to Coase, a firm has to find the most cheap, most productive goods and services by establishing contracts in an open, efficient market place. However, market places are not that pure to let firms to succeed in their needs; they are not fluid. This is due to the fact that transaction costs occur. There are several sources of transaction costs: “Costs of learning prices”, “Costs of negotiating contracts”, “Costs of writing contracts”, “Costs of searching for right people”, “Coordinating the work”, “Managing intellectual property” etc. These costs make it necessary that firms exist. Thus, these firms will emerge to produce what they need internally by avoiding these costs. According to Coase, the size of the firm is determined by the number of contractual relations that the firm has internally and by the number of contractual relations that the firm handles externally. Coase argues that no firm can grow indefinitely. Parallel to the growth of a firm, the overhead costs and difficulties to allocate resources will increase. These problems are called as “decreasing returns to the entrepreneur function”; and this is what prevents the firms to keep growing. So, a growing firm will reach a point where one more transaction within the firm will be the same as the cost of using alternative institutional arrangements. According to Coase, “production functions of firms”, “cost curves” and “demand curves” are what characterizes firms. As mentioned before, there are costs of using the price mechanism for coordinating economic activities. These costs are transaction costs and marketing costs. Thus, one observes that firms exist to economize on the cost of the process of coordinating economic activity. And therefore one...
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