The Nature of the Firm #3

Market transactions can take many forms ranging from simple, one- time (“spot”) transactions to sequential transactions by the same parties to complex long-term contracts, including those between employers and employees. Contracts range from specific and complete to nonspecific and very incomplete, with different degrees of flexibility. Incomplete long-term contracts may be more attractive than sequential spot market trades, but such contracts require monitoring. Long-term contracts often include or permit different remedies if plans aren’t met or are modified.

Specific institutional arrangements emerge in response to various transactional considerations in order to minimize the cost of making transactions. The boundary between a firm and a market provides a rough distinction – make versus buy or lease – for resource utilization. (The Nature of the Firm, 119-122).

Sometimes a firm will utilize futures contracts to reduce risks from transactions for which price fluctuations or currency values are significant risks. An example of the former might be an oil refiner that hedges the price risk of buying crude oil and selling gasoline, aviation fuel, etc. The term crack spread – no, it has nothing to do with cocaine – describes a kind of contract used as a tool to hedge this kind of risk. An example of the latter would be an importer buying goods/commodities from a foreign supplier with the goods/commodities priced in the manufacturer’s country’s currency different than that of the buyer.