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1、The Nature of the Firm (1937)R. H. COASEEconomic theory has suffered in the past from a failure to state clearly its assumption. Economists in building up a theory have often omitted to examine the foundations on which it was erected. This examination is, however, essential not only to prevent them
2、is understanding and needles controversy which arise from a lack of knowledge of the assumptions on which a theory is based, but also because of the extreme importance for economics of good judgment in choosing between rival sets of assumptions. For instance, itis suggested that the use of the word
3、“firm” in economics may be different from the use of the term by the “plain man.” Since there is apparently a trend in economic theory towards starting analysis with the individual firm and not with the industry,2 it is ail the more necessary not only that a clear definition of the word firm should
4、be given but that its difference from a firm in the real world, if it aists, should be made clear. Mrs. Robinson has said that the two questions to be asked of a set of assumptions in economics are: Are they tractable? And : Do they correspond with the real world?3 Though, as Mrs. Robinson points ou
5、t, More often one set will be manageable and the other realistic, yet there may well be branches of theory where assumptions may be both manageable and realistic. It is hoped to show in the following paper that a definition of a firm may be obtained which is not only realistic in that it corresponds
6、 to what is meant by a firm in the real world, but is tractable by two of the most powerful instruments of economic analysis developed by Marshall, the idea of the margin and that of substitution, together giving the idea of substitution at the margin.4 Our definition must, of course, relate to form
7、al relations which are capable of being conceived exactly.5 IIt is convenient if, in searching for a definition of a firm, we first consider the economic system as it is normally treated by the economist. Let us consider the description of the economic system given by Sir Arthur Salter6. “The normal
8、 economic system works itself. For its current operation it is under no central control, it needs no central survey. Over the whole range of human activity and human need, supply is adjusted to demand, andproduction to consumption, by a process that is automatic, elastic and responsive.” An economis
9、t thinks of the economic system as being co-ordinated by the price mechanism and society becomes not an organization but an organism.7 The economic system “works itself. This does not mean that there is no planning by individuals. These exercise foresight and choose between alternatives. This is nec
10、essarily so if there is to be order in the systemBut this theory assumes that the direction of resources is dependent directly on the price mechanism. Indeed, it is often considered to be an objection to economic planning that it merely tries to do what is already done by the price mechanism.8 Sir A
11、rthur Salters description, however, gives a very incomplete picture of our economic system. Within a firm, the description does not fit at all. For instance, in economic theory we find that the allocation of factors of production between different uses is determined by the price mechanism. The price
12、 of factor A becomes higher in X than in Y. As a result, A moves from Y to X until the difference between the prices in X and Y, except if 50 far as it compensates for other differential advantages, disappears. Yet in the real world, we find that there are many areas where this does not apply. If a
13、workman moves from department Y to department X, he does not go because of a change in relative prices, but because he is ordered to do 50. Those who object to economic planning on the grounds that the problem is solved by price movements can be answered by pointing out that there is planning within
14、 our economic system which is quite different from the individual planning mentioned above and which is akin to what is normally called economic planning. The example given above is typical of a large sphere in our modem economic system. 0f course, this fact has not been ignored by economists. Marsh
15、all introduces organization as a fourth factor of production; J.B. Clark gives the co-ordinating function to the entrepreneur; Professor Knight introduces managers who co-ordinate. As D. H. Robertson points out, we find islands of conscious power in this ocean of unconscious co-operation like lumps
16、of butter coagulating in a pail of buttermilk.”9 But in view of the fact that it is usually argued that co-ordination will be done by the price mechanism, why is such organization necessary? Why are there these islands of conscious power? Outside the firm, price movements direct production, which is
17、 coordinated through a series of exchange transactions on the market. Within a firm, these markets transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur co-ordinator, who directs production.10 It is clear that these ar
18、e alternative methods of co-ordinating production. Yet, having regard to the fact that if production is regulated by price movements, production could be carried on without any organization at all, well might we ask, why is there any organization?0f course, the degree to which the price mechanism is
19、 superseded varies greatly. In a department store, the allocation of the different sections to the various locations in the building may be done by the controlling authority or it may be the result of competitive price bidding for space. In the Lancashire cotton industry, a weaver can rent power and
20、 shop-room and can obtain looms and yarn on credit.11 This co-ordination of the various factors of production is, however, normally carried out without the intervention of the price mechanism. As is evident, the amount of “vertical” integration, involving as it does the supersession of the price mec
21、hanism, varies greatly from industry to industry and from firm to firm. It can, I think, be assumed that the distinguishing mark of the firm is the supersession of the price mechanism. It is, of course, as Professor Robbins points out, “related to an outside network of relative prices and costs,” 12
22、 but it is important to discover the exact nature of this relationship. This distinction between the allocation of resources in a firm and the allocation in the economic system has been very vividly described by Mr. Maurice Dobb when discussing Adam Smiths conception of the capitalist: “It began to
23、be seen that there was something more important than the relations inside each factory or unit captained by an undertaker; there were the relations of the undertaker with the rest of the economic world outside his immediate sphere. the undertaker busies himself with the division of labour inside eac
24、h firm and he plans and organises consciously,” but “he is related to the much larger economic specialisation, of which he himself is merely one specialised unit. Here, he plays his part as a single ceIl in a larger organism, mainly unconscious of the wider rle he fills.”13In view of the fact that w
25、hile economists treat the price mechanism as a coordinating instrument, the? also admit the co-ordinating function of the “entrepreneur,” it is surely important to enquire why co-ordination is the work of the price mechanism in one case and of the entrepreneur in another. The purpose of this paper i
26、s to bridge what appears to be a gap in economic theory between the assumption (made for some purposes) that resources are allocated by means of the price mechanism and the assumption (made for other purposes) that this allocation is dependent on the entrepreneur-co-ordinator. We have to explain the
27、 basis on which, in practice, this choice between alternatives is effected.14IIOur task is to attempt to discover why a firm emerges at ah in a specialized exchange economy. The price mechanism (considered purely from the side of the direction of resources) might be superseded if the relationship wh
28、ich replaced it was desired for its own sake. This would be the case, for example, if some people preferred to work under the direction of some other person. Such individuals would accept less in order to work under someone, and firms would arise naturally from this. But it would appear that this ca
29、nnot be a very important reason, for it would rather seem that the opposite tendency is operating if one judges from the stress normally laid on the advantage of “being ones own master;”15 0f course, if the desire was not to be controlled but to control, to exercise power over others, then people mi
30、ght be willing to give Up something in order to direct others; that is, they would be willing to pay others more than they could get under the price mechanism in order to be able to direct them. But this implies that those who direct pay in order to be able to do this and are not paid to direct, whi
31、ch is clearly not true in the majority of cases.16 Firms might also exist if purchasers preferred commodities which are produced by firms to those not 50 produced; but even in spheres where one would expect such preferences (if they exist) to be of negligible importance, firms are to be found in the
32、 real world.17 Thereforethere must be other elements involved.The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism. The most obvious cost of “organizing” production through the price mechanism is that of discovering what the rele
33、vant prices are.18 This cost may be reduced but it will not be eliminated by the emergence of specialists who will sell this information. The costs of negotiating and concluding a separate contract for each exchange transaction which takes place on a market must also be taken into account.19 Again,
34、in certain markets, e.g., produce ex-changes, a technique is devised for minimizing these contract costs; but they are not eliminated. It is true that contracts are not eliminated when there is a firm but they are greatly reduced. A factor of production (or the owner thereof) does not have to make a
35、 series of contracts with the factors with whom he is co-operating within the firm, as would be necessary, of course, if this co-operation were as a direct result of the working of the price mechanism. For this series of contracts is substituted one. At this stage, it is important to note the charac
36、ter of the contract into which a factor enters that is employed within a firm. The contract is one whereby the factor, for a certain remuneration (which may be fixed or fluctuating), agrees to obey the directions of an entrepreneur within certain limits.20 The essence of the contract is that it shou
37、ld only state the limits to the powers of the entrepreneur; Within these limits, he can therefore direct the other factors of production.There are, however, other disadvantages - or costs - of using the price mechanism. It may be desired to make a long-term contract for the supply of some article or
38、 service. This may be due to the fact that if one contract is made for a longer period, instead of several shorter ones, then certain costs of making each contract will be avoided. Or, owing to the risk attitude of the people concerned, they may prefer to make a long rather than a short-term contrac
39、t. Now, owing to the difficulty of forecasting, the longer the period of the contract is for the supply of the commodity or service, the less possible, and indeed, the less desirable it is for the person purchasing to specify what the other contracting party is expected to do. It may well be a matte
40、r of indifference to the person supplying the service or commodity which of several courses of action is taken, but not to the purchaser of that service or commodity. But the purchaser will not know which of these several courses he will want the supplier to take. Therefore, the service which is bei
41、ng provided is expressed in general terms, the exact details being left until a later date. All that is stated in the contract is the limits to what the persons supplying the commodity or service is expected to do. The details of what the supplier is expected to do is not stated in the contract but
42、is decided later by the purchaser. When the direction of resources (within the limits of the contract) becomes dependent on the buyer in this way, that relationship which I term a firm may be obtained.21 A firm is likely therefore to emerge in those cases where a very short-term contract would be un
43、satisfactory. It is obviously of more importance in the case of services -labor-than it is in the case of the buying of commodities. In the case of commodities, the main items can be stated in advance and the details which will be decided later will be of minor significance.We may sum Up this sectio
44、n of the argument by saying that the operation of a market costs something and by forming an organization and allowing some authority (an entrepreneur) to direct the resources, certain marketing costs are saved. The entrepreneur has to carry out his function at less cost, taking into account the fac
45、t that he may get factors of production at a lower price than the market transactions which he supersedes, because it is always possible to revert to the open market if he fails to do this. The question of uncertainty is one which is often considered to be very relevant to the study of the equilibri
46、um of the firm. It seems improbable that a firm would emerge without the existence of uncertainty. But those, for instance, Professor Knight, who make the mode of payment the distinguishing mark of the firm - fixed incomes being guaranteed to some of those engaged in production by a person who takes
47、 the residual, and fluctuating, income-would appear to be introducing a point which is irrelevant to the problem we are considering. One entrepreneur may sell his services to another for a certain sum of money, while the payment to his employees may be mainly or wholly a share in profits.22 Thesigni
48、ficant question would appear to be why the allocation of resources is not done directly by the price mechanism.Another factor that should be noted is that exchange transactions on a market and the same transactions organized within a firm are often treated differently by Governments or other bodies
49、with regulatory powers. If we consider the operation of a sales tax, it is clear that it is a tax on market transactions and not on the same transactions organized within the firm. Now since these are alternative methods of organization-by the price mechanism or by the entrepreneur-such a regulation would bring into existence firms which otherwise would have no raison dtre. It would furnish a reason for the emergence of a firm in a specialized exchange economy. 0f course, to the extent that firms already exist, such a measure as a
