How Does He Suggest Limits Their Essay Example

and industries.

The question of why firms exist persists despite the belief that the price mechanism regulates production and transactions on its own. Coase posed the question: if the market exchange mechanism is flawless, what is the purpose of firms? Why must resources be arranged in a particular way when they are already available in the market? Coase identified transaction costs, which are expenses associated with transactions, as the answer. Firms exist due to the discovery, planning, and contracting costs that accompany transactions. The belief is that in certain situations, costs are lower when transactions occur within firms versus the market.

Establishing a firm is profitable because there is a cost associated with utilizing the price mechanism, leading to the presence of firms in the market. The main expense of transacting in the market is identifying the relevant prices, which necessitates research and expenditure. Although conducting transactions within a firm may result in lower costs, firms still need to determine whether to transact internally or in the market.

Besides production costs, firms also incur expenses for preparing and monitoring contracts and implementing allocative measures. If we take these additional costs into account, we can conclude that firms exist because they can successfully carry out allocative measures with lower administrative, production, and contractual costs than those involved in market transactions. Coase hypothesizes that firms arise as a means of economizing on transaction costs and suggests that the market functions optimally when transaction costs are minimized. When transaction costs are high, firms have an incentive to prefer internal mechanisms over market transactions.

As transactions become increasingly complex and challenging for individual management in a firm, the market can step in to

maintain competitiveness. Although completing transactions within a firm may be cheaper, the need for contracts cannot be eliminated entirely. As a result, the number of unnecessary contracts can be reduced by replacing them with a single longer-term contract. This contract establishes the entrepreneur's power to direct production and control factors. At a certain expansion point, firms may find that further internal measures are more costly than utilizing the market.

Assuming zero transaction costs, individuals would rely on small contracts rather than firms for transactions. Coase identified the factors that keep firms together. He examined entrepreneurial practices and their impact on production factors, employee management, and marketing costs.

When buyers start relying on the directions of resources, it establishes firms' relationships and may result in longer-term contracts. This prompts the question regarding the size of firms. According to this essay, if firms were to transact internally, their size and number of transactions internally would increase rather than through the price mechanism. However, Coase questioned why, if the costs of internal transactions are lower, we don't have just one large firm to carry out the transactions. Coase explained that there are 'diminishing returns to management' and suggested three problems that limit the growth of firms.

The expenses associated with managing extra internal transactions may increase, while returns may decrease as firms grow in size. The cost of an additional transaction within the firm could be similar to transacting in the market. Additionally, as the number of internal transactions grows, entrepreneurs may struggle to allocate resources where they have the highest value. Smaller firms may be able to take advantage of lower supply prices.

In Coase's perspective, a firm's growth is

limited by the point where the cost savings from transactions within the firm are equal to the combined cost of errors and administrative inflexibility. The firm will continue to expand until the cost of organizing an extra transaction within the firm is equal to the cost of carrying out the same transaction through an exchange on the open market, or organizing it within another firm. However, it is uncertain if an employer can direct an employee, just as a consumer cannot instruct their grocer on what vegetables to sell and at what prices, as refusal may lead to termination of the relationship.

Coase's theory faces criticism over why joint production and monitoring issues need solving through a firm, when they could be achieved through market solutions. The transaction costs approach has advantages since it can incorporate various factors that affect firm behavior, such as informational uncertainty, market concentration, and key human factors like bounded rationality and opportunism (Carlton and Perloff, 1994; pp. 5).

One advantage of the transaction costs model in economics is that it differs from neo-classical theory by acknowledging that production in the economy is not solely a technical matter of combining inputs based on established blueprints.

In essence, economic activity requires skills and organisation as these are not inherent traits. Economic actors must strive to overcome the constraints of human knowledge and rely on their tacit understanding, described by Michael Polanyi. Therefore, organisations can act as co-ordinating institutions, reducing the costs of communicating and convincing potential contracting parties who may hold different beliefs in innovation or even the world view. This concept has been extensively discussed in works by Silver (1984), Langlois (1988) and Langlois

(1994).

The transaction costs model (referring to pages 175-177) is of significance due to its relevance to present economic transformations. During the industrial period, there was a high demand for essential goods at minimal prices. Consequently, companies concentrated on achieving economies of scale, producing standardized items at the most affordable rates.

In the past, industrial firms operated based on the neo-classical production function and aimed for optimally priced products, resulting in a lack of demand for unique goods. However, since the 1970s, there has been an increase in demand for specialized products due to advances in flexible manufacturing made possible by computers. This shift from a transforming function to a creative co-ordinating process is attributed to David Lyon's belief that flexible production methods have enabled new products to be developed without significant price increases. The decline in demand for standardized mass-produced goods and competition from newly industrialized countries like those on the Pacific rim has led to a search for less rigid and confining strategies than Fordism.

The post-Fordism era has introduced flexibility in manufacturing, which has led to an unstable job market, faster shifts in product production, and a stronger emphasis on meeting consumer needs. To keep up with these changes, businesses are rushing to adopt advanced technologies, new management practices, and international connections across finance capital and markets (Lyon,1994 pp. 45). As the demand for standardized products decreases, niche goods are now being developed using flexible manufacturing techniques. The growing influence of consumerism is driving the desire for unique and innovative products that require a reevaluation of business practices. In this changing environment, companies need to exhibit adaptability to smoothly transition as demand for

their products frequently changes.

Industrial companies may face difficulties in re-aligning their products due to two factors. Firstly, these firms have traditionally focused on manufacturing a single item. However, with advancements in information technology enabling greater flexibility, larger firms must restructure themselves as interest in mass-produced goods decreases and product lifecycles shorten. Secondly, such companies prioritize signing long-term contracts for stability. According to Coase (1991; p. 21), these contracts can aid in planning by reducing uncertainty.

Historically, co-ordinating a firm's activities required legally binding agreements which allowed for detailed planning. Multi-year contracts allowed firms to use long-run forecasts to provide goods or services. However, in today's rapidly changing demand environment, inflexible firms unable to adapt may fail. Thankfully, firms using technology like computers and telecommunications benefit from increased managerial control. This extended control allows one person to oversee more individuals and a larger space.

The advent of computers and telecommunications has enabled the swift dissemination of information, thereby diminishing the ambiguity inherent in coordinating activities. Consequently, there has been a reduction in transaction expenses and the appearance of decentralized organizational frameworks that are more adaptable to fluctuations in demand. According to Coase's theory on transaction costs, all economic transactions incur a discernible cost that must be factored into considerations. As interactions become more intricate, enterprises arise to manage and curtail these expenses.

According to Coase, the factors that keep firms together can be observed in the practices of entrepreneurs and managers, who are able to control and direct workers within the firm thanks to the legal employment relationship of master and servant. Coase postulated that without this legal right to control, transaction costs would be uncontrollable and consequently

the firm could not exist. This argument is widely accepted.

Coase's observation established a connection between the presence of firms and internal control via the master/servant or employer/employee relationship, implying a direct interdependence of the legal right to govern with the very existence of markets. However, this contradicts the well-known fact that markets depend on individual freedom to choose both legally and in reality. Therefore, Coase's observation of the employment control structure of firms does not explain free markets but rather highlights market restrictions and distortions. Ultimately, firms operating under master/servant models exemplify anti-market models.

Moreover, the assumption of "right to control" in macroeconomic modeling opposes the principles of a market economy. The formation of companies is aimed at reducing transaction costs which arise due to the cognitive, strategic and contractual expenses involved in any transaction. Typically, the neoclassical paradigm disregards these costs, but in certain cases, conducting transactions within a company results in lower overall costs than engaging with the market.

According to Coase, the main cost of conducting transactions in the market is the cost of negotiating terms. He argued that this is exactly what distinguishes a firm from a market. A firm functions when transactions occur as a result of instructions issued by a boss, suppressing the price mechanism. Coase believed that the boundaries of a firm are determined by the marginal cost savings of in-house transactions versus the added costs of errors and administrative rigidity. However, it is uncertain whether an employer can dictate an employee's actions more than a consumer can dictate a grocer's inventory. In both cases, refusal may result in termination of the relationship. Critics question why joint production and

monitoring issues must be resolved through firms and cannot be resolved through markets.

Coase's observation implies that firms only exist because of the master/servant or employer/employee legal relationship that allows for internal control. This suggests a direct connection between the existence of markets and the legal power one person has to control another.