Why Firms Exist? What Is A Firm?

2159 Words Oct 23rd, 2016 9 Pages
Why firms exist? What is a firm? Adam Smith started his magnum opus “The Wealth of Nations” with the perfect description of the division of labour in a pin factory, but he did not explain fully the core question about the existence of firms or the governance of firms. Neoclassical economics do not say much about this question. Ronald Coase and Oliver Williamson restored the position of pin factory (“firm”) to its merited place at the heart of economics. Coase (1937) was the first economist who tried to answer both fundamental questions in his seminal article of “the nature of the firm”. Coase opened his 1937 article by referring D.H. Robertson (1923) who posed an interesting question about the existence of firms in his book “control of industry”. Robertson considered firms as “islands of conscious power in the ocean of unconscious co-operation” and compared firms to “lumps of butter coagulating in a pail of buttermilk”. Coase developed a theory of firm which explained the existence of “islands of conscious power” through transaction cost economics. Oliver Williamson, one of the founding fathers of institutional economics, furthered Coase’s theory of firm by introducing transaction cost framework, which has changed the perception of economists about the firms, different type of contracts and economics of organizations.
Theory of the firm – Transaction cost framework:
Neoclassical theory of the firm described firm as a “black-box” into which resources go and out…
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