Firm

Discussion

Two Theories of the Firm

Peter Dorman:

'There are two dominant theories of the firm in modern economics, one centered on transaction costs, the other viewing the firm as a nexus of contracts. Both are premised on the notion that, absent any frictions, and especially those due to incentive problems, market coordination would always be superior to the coordination supplied by firms. Hence firms are anomalies, and in the benchmark utopia of competitive general equilibrium they don’t exist at all except as accounting units.

There is a longstanding tradition that attempts to explain the existence and extent of firms according to their efficiencies rather than flaws in the market. Such a view is implicit in Schumpeter, for whom entrepreneurship was a creative force that could not arise in markets composed of infinitely small players. Chandler similarly tried to argue for efficiencies in coordination, especially in continuous process systems. Neither succeeded in providing a formal explanation of what it was about the mechanisms that concerned them that indicated that firms rather than markets would house them, and their views have been largely banished from economic theorizing. Nonetheless, the field of management, where questions of firm capacity and strategy are paramount, continues to draw on a conception of the firm in which administrative organization is capable of coordination that markets cannot supply." (http://econospeak.blogspot.com/2015/06/a-newold-theory-of-firm-put-to-use.html)