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Coase is best known for two articles in particular: The Nature of the Firm (1937), which introduces the concept of transaction costs to explain the size of firms, and The Problem of Social Cost (1960), which suggests that well defined property rights could overcome the problems of externalities (see Coase Theorem).
Coase's transaction costs approach is currently influential in modern organizational theory, where it was reintroduced by Oliver Williamson.
Coase is also often referred to as the 'father' of reform in spectrum policy, based on his article The Federal Communications Commission (1959) where he criticizes spectrum licensing, suggesting property rights as a more efficient method of allocating spectrum to users.
The Nature of the Firm
The Nature of the Firm is a brief essay in which Coase tries to explain why the economy is populated by a number of business firms, instead of consisting exclusively of a multitude of independent, self-employed people who contract with one another. Given that "production could be carried on without any organization [i.e. firms] at all", Coase asks, why and under what conditions should we expect firms to emerge?
Since modern firms can only emerge when an entrepreneur of some sort begins to hire people, Coase's analysis proceeds by considering the conditions under which it makes sense for an entrepreneur to seek hired help instead of contracting out for some particular task.
The traditional economic theory of the time suggested that, because the market is "efficient" (i.e. those who are best at providing each good or service most cheaply are already doing so), it should always be cheaper to contract out than to hire.
Coase noted, however, that there are a number of transaction costs to using the market; the cost of obtaining a good or service via the market is actually more than just the price of the good. Other costs, including search and information costs, bargaining costs, keeping trade secrets, and policing and enforcement costs, can all potentially add to the cost of procuring something with a market. This suggests that firms will arise when they can arrange to produce what they need internally and somehow avoid these costs.
There is a natural limit to what can be produced internally, however. Coase notices a "decreasing returns to the entrepreneur function", including increasing overhead costs and increasing propensity for an overwhelmed manager to make mistakes in resource allocation. This is a countervailing cost to the use of the firm.
Coase argues that the size of a firm (as measured by how many contractual relations are "internal" to the firm and how many "external") is a result of finding an optimal balance between the competing tendencies of the costs outlined above. In general, making the firm larger will initially be advantageous, but the decreasing returns indicated above will eventually kick in, preventing the firm from growing indefinitely.
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 an increase in the transactions organized.
- the less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes with an increase in the transactions organized.
- the greater the lowering (or the less the rise) in the supply price of factors of production to firms of larger size.
Coase does not consider non-contractual relationships, as between friends or family members.
- Coase, Ronald. "The Nature of the Firm". on-line version.
- Coase, Ronald. "The Nature of the Firm". In Readings in Price Theory, Stigler and Boulding, editors. Chicago, R. D. Irwin, 1952.
- Coase, Ronald. "The Problem of Social Cost". In Journal of Law and Economics, v. 3, no. 1 pp. 1-44, 1960.
- Coase, Ronald. "The Nature of the Firm". In Economica, Vol. 4, No. 16, Nov., 1937 pp. 386-405
- Horizontal integration
- Vertical integration
- Oliver E. Williamson
- List of economists
- List of economics consultancies and think tanks
- Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel
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