Comparison of theories of the firm

Ronald Coase is the author of the first popular theory of the company, titled "Characteristics of the Firm". He was the first to question and evaluate the reason why of firm presence throughout the market. Coase's "Characteristics of the Organization" lifted both negative and positive critics among other economists which led to creation of other theories of the firm. One particular theories is "Production, information costs, and monetary organization" compiled by A. Alchian and H. Demsetz. Their theory had not been designed to dispute Coases' theory, but it explained some new reasons that Coase didn't sophisticated on.

"Nature of the Firm" is based on the Coase Theorem, for which Coase was granted with the Nobel award. In brief, the idea discusses about business deal costs between two contractors, and what impact they have on the outcome of each agreement. He compares the unrealistic circumstance of no purchase costs with the reasonable one making them present in everyday life. Even the best and perfect markets may only be perfect from the point of view of price, but not from the point of view of information. Coase divided transaction costs of using any market into costs of searching inputs and suppliers, measuring their suitability, negotiating the purchase price, monitoring the resources and the costs of renegotiation and litigation. Coase states that these costs make an incentive of forming a company, as company would avoid them if it was producing the same good instead of buying it. The company avoids the purchase price device cost through internet marketers authority. This goes up another question of why the market exist at all and just why there isn't only 1 big company producing all the products. The answer is in the transaction cost of the organization itself. Even though company solves some market costs, it creates new costs of hierarchy, such as employment agreements. Its cost can be divided just as as market transaction costs: costs of searching appropriate workers, calculating their suitability, negotiating their pay, supervising and disciplining them. These costs aren't related only to the lifetime of the company, but to its size as well. Mentioned by Coase, the costs of growing size of the firm are the decreasing returns to business people' function, this means less efficient organisation of additional transactions within the firm, and less useful use resources. Coase also mentioned three conditions for a company to expand: 1. if the expenses of organising are smaller then the benefits, 2. if the entrepreneur is not likely going to make more blunders in allocation of resources 3. if the price tag on inputs decreases(economies of range). Weighed against the perfect market, companies may bring some communal costs such as decrease in invention, higher prices because of earnings maximization and less economies of range although the organization may cause economies of range. The costs and great things about markets and companies is what puts them in the total amount. Among our basic assumptions is that both firms and individuals want to increase their profits, which means equating the marginal costs and marginal great things about expanding the firm and using the purchase price mechanism of the marketplace.

Alchian and Demsetz agree with Coase about the transfer costs, nevertheless they argue that exchange costs aren't the main reason for creation of businesses. The point where they disagree with Coase is specialist and ability within the organization. "Production, information costs, and monetary organization" begins with detailing how contracts within the organization have no greater importance or consequences if broken than those in the market. Results of failed contracts or services can either fix in the termination of any future contracting between your two parties or with a court case. It really is illustrated with a good example of how firing your staff is not so different from breaking a agreement whit your grocer by preventing purchasing his goods. What Alchian and Demsetz emphasize as the reason of firm lifestyle is teamwork and monitoring. They dispute that if employment could be done more efficiently in just a team that it ought to be done so. But teamwork brings a negative result known as the "tragedy of the commons". It happens consequently of different person and sociable rationalities. The individual will have a tendency to act in an opportunistic way whenever he can gain privately and at the same time share the expenses with others. One example is overusing common resources, e. g. over-fishing, other example is adding less to the common resources, e. g. shirking in a teamwork. In extreme cases when everyone would respond in that way there would be no common resources as they would either be overused in the first example or not made whatsoever in the next. If individuals were altruistic there would be no problem in any way, but unfortunately that is not the situation. So when there are exchange costs, it concerns very much who is the owner of which assets and how these are used. So what enables the organization to successfully decreases shirking among the workers are the property protection under the law of the firm. They contain positive privileges which condition what owner can do to his property, and negative rights which condition what owner cannot do. Additionally it is important to note that under the ideal conditions, a competent property privileges system has three subsequent factors: universality, exclusivity and transferability. Universality means that all the belongings are managed, by one or between more parties, exclusivity means that non-owners can be excluded from any property rights and transferability means that the house may be sold. The dog owner has the directly on the profits, which is his biggest motivation never to shirk himself and to monitor his employees. He also has the to hire and fire personnel and has complete control of all other inputs.

In final result, the points which Coases' theory differs from the main one of Alchian and Demsetz is the fact that Coases' main and only reason for living of the organization is the existence of transfer costs. According to him, owners' power will displace costs of the market, and the organization should grow before marginal cost of market and company become similar. Alchian and Demsetz disagreed with the importance of authority, they introduced the "tragedy of the commons" and offered companies' monitoring function as a its solution. What both theories agree on is the presence of transaction costs, as stated above, and on diminishing profits to size. While Coase says that development of an additional device within the organization may become more costly than buying it on the market Alchian and Demsetz say that monitoring a supplementary worker may be more costly than the contribution he'd bring.

1) Alchian and Demsetz. 1972. Development, information costs, and monetary organization. American Economic Review 62 (December): 777-795

2) Coase. 1937. The nature of the company. Economica 4 (November): 386-405.

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