What is the importance for the theory of the firm of transaction costs, teamwork and the divorce between ownership and management?

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  1. What is the importance for the theory of the firm of transaction costs, teamwork and the divorce between ownership and management?

K&R 198, 220

        Workshop 4

PLAN:

Introduction

Explain relevance to theory of the firm including definitions of Transaction costs, teamwork, divorce between ownership and control.

What can firm do to counteract problems arising involving these factors.

Conclusion

P198-199

Transaction Costs: cost of conducting an economic exchange between two parties.

Transaction costs have two important implications for the theory of the firm; firstly the theory of transaction costs predicts that economic exchange will tend to be organized in ways that minimize the costs of those exchanges (explaining the very existence of the firm), secondly transaction costs play an considerable role in limiting the size of firms.

Coase wrote in 1937 that Economic exchange will tend to be organised in ways that minimize the cost of exchanges. One way to do this is to offer general contracts. If firms do not have general contracts, an employee cannot be asked to perform beyond his specific task- limiting the size of the firm. The firm, by offering general contracts, can minimize transaction costs. The firm may be described as a tool to minimise transactions costs. Any contract will be incomplete; there will be some chance of something happening that the contract does not cover. This is because, firstly it would be impossible to foresee everything that can happen, secondly, even if everything were foreseeable, it would be prohibitively costly to have a contract that covered all possible bases.

Consider what happens when an uncovered contingency arises. Under market based relationship, each party would bargain to get a good deal for themselves. Bargaining is costly, waste of time, may break down cooperation. Also if purchase made now, other party may take advantage of this in future bargaining (Williamson 1985). However, when transaction takes place within firm, one party has residual control rights. Transaction costs are minimised as bargaining taken out of the equation. For this reason we expect to see large scale firms which require the coordination of, and cooperation among, many people to take place within a firm, rather than through a market.

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Something that suggests that the size of the firm should be limited is specialisation. If the costs of buying in the product for firm 1 are less than the actual costs of making the product, then it should be left to the other firm 2 to make this product which it specialises in, and firm 1 to buy it. For example, take the household as a firm 1 and a bakery as firm 2. It is more efficient for the household to buy in bread from the bakery, as the transactions costs are less than the cost of a bread ...

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