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How does Coase account for existence of firms and what factors does he suggest limits their growth? Compare the view of Coase and Marx on the relative efficiency of firm type and market type co-ordination.

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Introduction

How does Coase account for existence of firms and what factors does he suggest limits their growth? Compare the view of Coase and Marx on the relative efficiency of firm type and market type co-ordination. The existence of firms seems rather obvious and may be considered as unnecessary to explain to reasons of its existence. However, it was Coase who accomplished in making contribution to the understanding of how and why firms function and exist in the economy. Coase perceived and clarified the significance of transaction cost. He explains that firms arise to economise on transaction costs. In this essay, Coase's account for existence of firms will be demonstrated. Factors that Coase suggests, will limit the firms' growth will be explored. The Coase and Marx's view on the relative efficiency of firm type and market type co-ordination will also be compared later on in this essay. Economic theory assumes that the allocation of factors of production is determined by the notion of price mechanism. The traditional economic system as Sir Authur Salter demonstrated 'The normal economic system works itself. Price mechanism stands as the co-ordinator of economic activity, functioning automatically in all areas to direct resources between alternative uses' 1 However, Coase does not believe that is true at all and thinks that, within firm, the description does not fit. He suggested as an example that in the real world, an employee does not move between department because of the change in relatives prices but has been told to do so. ...read more.

Middle

* Smaller firms may get the advantages at lower supply price. In Coase's view, the limit of the firm growth is at the point where the marginal cost savings from transacting within the firm is equal to the cost of combined of errors and administrative rigidity. 'a firm will tend to expand until the costs of organising an extra transaction within the firm become equal to the costs of carrying out the same transaction by means of an exchange on the open market or the costs of organising in another firm'5. However, it is not clear than an employer can tell an employee what to do, any more than a consumer can tell her grocer what to do (what vegetables to sell at what prices); in either case, a refusal will likely lead to a termination of the relationship, a firing. Coase's theory is subject to the criticism that it is unclear why the problems of joint production and monitoring must be solved through the firm and cannot be solved through the market. The transaction costs approach is advantageous because it can be broadened to encompass a wide range of factors which may affect firm behaviour including informational uncertainty, the number of competitors (market concentration), and key human factors like bounded rationality and opportunism (Carlton and Perloff, 1994; pp. 5). The benefit of the transaction costs model in economics is that: ...Unlike neo-classical theory, This approach does not take production in the economy to be a purely technical question, a matter of combining inputs according to known blueprints. ...read more.

Conclusion

The idea is that in some situations these costs will be lower if a transaction is carried out within a firm rather than in the market. According to Coase, the main cost of transacting in the market is the cost of learning about and haggling over the terms of trade. But, according to Coase, this authority is precisely what defines a firm: within a firm, transactions occur as a result of instructions or orders issued by a boss, and the price mechanism is suppressed. In Coase's view, the boundaries of the firm occur at the point where the marginal cost savings from transacting within the firm equal the resulting cost of added of errors and administrative rigidity. However, it is not clear than an employer can tell an employee what to do, any more than a consumer can tell her grocer what to do (what vegetables to sell at what prices); in either case, a refusal will likely lead to a termination of the relationship, a firing. Coase's theory is subject to the criticism that it is unclear why the problems of joint production and monitoring must be solved through the firm and cannot be solved through the market. In this manner Coase's observation exclusively tied the existence of firms to the maintenance of internal control through the master/servant, employer/employee legal relationship. In so doing he postulated, I think without realising, a direct interdependence between the very existence of markets and the legal right of one human to control another human. 1 Coase, 1937a, p. 387 2 Coase, 1937a, p. 390-91 3 Coase, 1937a, p. 391 4 Coase, (1952, p. 341). 5 Coase, 1937a, p.395 ...read more.

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