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Answer Iv ( II ) From Midterm

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Answer IV (ii) from midterm Dr. Ronald Coase is best known for his highly influential essay “The Nature of the Firm”, in which he argues as to why firms exists and what determines the size and scope of these firms. He explains that firms emerge to reduce the transaction costs of coordinating economic activity. A transaction can be any exchange between the supplier and consumer in the economy. Some primary examples of a transactions are exchange of goods for money, or exchange of goods for other goods, or even the exchange of information and intermediate products. And all these exchanges in the market entail costs, also known as transaction costs. Coase determined that the costs involved in the functioning of the pricing mechanisms are significantly reduced when undertaken under a firm, thus, presenting the reason of a firm’s establishment and existence. He also discusses various pervasive transaction costs in the market such as the cost of finding a business partner, establishing contracts for every transaction, etc. He demonstrates that interacting with in the market through the firm is utilitarian only as long as the cost of organizing internally in the firm is lesser than the cost of an exchange in the open market or the cost of organizing through another firm. Coase challenged Sir Arthur Salter’s definition of Economic System, in which the direction of resources is dependent on price mechanism alone, by questioning that if the production is regulated only by price

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