Group 1-Nature of the Firm

8/6/2019 Group 1-Nature of the Firm

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THE NATURE OF THE FIRM

R. H. COASE

PGPM Section B Group 1

Abhishek Goyal(10P 061 )

Debajyoti Mitra(10P072 )

Harsh Gandhi(10P076 )

Jayant Bahel(10P 081)

Richa Gupta (10P105)

Shantanu Dwivedi (10P110)


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About the Author: RONALD H. COASEAbout the Author: RONALD H. COASE

Showed that traditional basic microeconomic theory

was incomplete because it only included production

and transport costs, whereas it neglected the costsof entering into and executing contracts

and managing organizations.

Such costs are commonly known as transaction costs and they accountfor a considerable share of the total use of resources in the economy.

Awarded the Nobel Prize in Economics in 1991 for his Breakthrough inUnderstanding the Institutional Structure of the Economy


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IDENTIFICATION OF THE PROBLEMIDENTIFICATION OF THE PROBLEM

HOW IS PRODUCTION COORDINATED IN AN ECONOMY?

IN THE MARKET:

Price Control acts as an integrator coordinating production through a series of exchange

transactions

INSIDE A FIRM:

Market transactions are eliminated.

Entrepreneur1 acts as an integrating force directing production.

Alternative methodsofcoordinating production:

PRICE MECHANISM

ORGANIZATION

WHY THE FIRM AND NOT THE MARKET?


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DEVELOPMENT OF PROBLEMDEVELOPMENT OF PROBLEM

WHAT DRIVES MANAGERS TO PRODUCE SOMETHING INSIDE A FIRM

RATHER THAN ACQUIRE IT IN THE MARKET PLACE?

WHY ORGANIZE ECONOMIC ACTIVITY WITHIN A FIRM?

WHY DO FIRMS

EXIST?


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COASES EXPLANATIONCOASES EXPLANATION

Primary ReasonsPrimary Reasons

COST SAVINGS

Costofusingthe Price Mechanism

Organizing production within the firm makes sense because

operating costs are less than the transaction costs in the

market.

The most obvious cost of organizing production through the

price mechanism is that of discovering what the relevant

prices are.

Howdoesafirmshierchical structurecoordinate

production betterthanthe market?


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COASES EXPLANATION contd.COASES EXPLANATION contd.


COST SAVINGS

Contract Negotiationcostsand Vertical Integration

Both integration and long-term contracts are ways of binding people.

The scope of a contract may be increased by including more operations but this

comes mainly from an increase in the period of time for which the contract runs.

Integration improves quality of the product and also improves efficiency.

Why shouldoneintegratingforce (theentrepreneur) be

substitutedforanotherintegratingforce (the price

mechanism)?


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COASES EXPLANATION contd.COASES EXPLANATION contd.


COST SAVINGS

Governmentregulationsfosterfirm emergenceMarket transactions in a specialized exchange economy are regulated

by various taxes, quota schemes, other price control methods unlike the

same transaction organized within a firm.

Arethereother benefits ?


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COROLLARIESCOROLLARIES

Coases explanation also sheds light on the following

pertinent issues:

What Determines the Size of the Firm?

If organizations reduce cost of production, why are

there any market transactions at all?

Why is not all production carried on by one big firm?


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WHAT DETERMINES THE SIZE OF THE FIRM?

Tradeoff between Efficiency and Size

Additional transactions lead to increase in size of the firm

The entrepreneur fails to make the best use of the factors of production.

A point must be reached where the cost of additional transaction or loss through

the waste of resources is equal to:

the marketing costs of the exchange transaction in the open market, or

to the loss if the transaction was organized by another entrepreneur.


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WHAT DETERMINES THE SIZE OF THE FIRM?

Other things being equal, therefore, a firm will tend to be larger:

the less the costs of organizing and the slower these costs rise with anincrease in the transactions organized

the less likely the entrepreneur is to make mistakes and the smallerthe increase in mistakes with an increase in the transactions organized

the greater the lowering (or the less the rise) in the supply price offactors of production to firms of larger size1


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WHAT ELSE DOES COASE TALK ABOUT ?WHAT ELSE DOES COASE TALK ABOUT ?

COST CURVE OF THE FIRM

A cost curve is a graph of the Costs Of Productionas a function of Total Quantity Produced

Used to find the optimal point of production, i.e.,where firms make the most profits.

Argument exist - given a firm produces one product,incase of competitive scenario size of the firm islimited by cost curve slopes upwards.

Coase argues against this.


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WHAT ELSE DOES COASE TALK ABOUT ?WHAT ELSE DOES COASE TALK ABOUT ?

LEGAL ASPECTS OF EMPLYER-EMPLOYEE RELATION

Coase examines correspondence of his developed

theory with reality. The servant (employee) must serve the master

(employer). If not, the contract is as good as of contractof goods.

The master has the authority to control the servantswork either personally or through another servant.

The servant does not have any rights to work as anindividual.


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ANALYSISANALYSIS

A firm can be viewed as A collectivity of transactions (focus on costs)

A collection of resources (focus on firms skills, capabilities, knowledge)

The costs dealt in the paper are the costs of obtainingthe same output.

Similar output at lower cost

Superior output at same level of cost.

A firms comparative advantage also lies in producingsuperior goods/services which cannot be emulated bythe market or other firms within a reasonable cost ortime.


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ANALYSIS contd.ANALYSIS contd.

A firm, by its very existence, reduces transaction costs.Justifies existence in terms of cost reduction, but does not

expound how and why this happens inside a firm.

Treats a firm as a single entity rather than a complex set

of human interactions.

Agency theory: Cost reduction is achieved through theestablishment of agency relationships between

shareholders (principal) and manager (agent).1

(Jensen and Meckling, 1976)


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REFERENCESREFERENCES

The Nature of the Firm, R. H. Coase, 1937

The Nature of the Firm: Origin, R. H. Coase, 1988

The Nature of the Firm: Meaning, R. H. Coase, 1988

The Nature of the Firm: Influence, R. H. Coase, 1988

Web Resources:

http://www.dallasfed.org/research/ei/ei0303.pdf

http://wikisum.com/w/Coase:_The_nature_of_the_firm#Transaction_Costs

http://www.jstor.org/stable/25123810




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THANK YOU

Group 1-Nature of the Firm

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