The Nature of the Firm #4

What is the essence of a firm? The Nature of the Firm (NF) gives two views, one the “orthodox” view and the other of Ronald Coase.

The orthodox view is that firms are “repositories of productive knowledge” (NF 184). Like consumers, producing firms are unitary actors and are economically rational. They maximize profit or present value.  There are spot markets for inputs and outputs. Contractual arrangements and other supports for the firm’s business are implicitly assumed to be flawless and costless. The focus is on decisions made about resource allocation for production. It is about inputs and outputs and how they relate to the given technology, to each other, and to market forces (NF 180). The orthodox view recognizes both interfirm and intrafirm aspects. Markets offer answers to the interfirm aspect. The intrafirm aspect when addressed is subsumed by the role of the entrepreneur.

According to Ronald Coase a firm’s essence is the coordination of a team of inputs.  Such coordination is a result of both interfirm and intrafirm aspects, and Coase’s theory gives far more attention to the latter than the orthodox theory and tradeoffs between the two aspects. He emphasized the firm not as an owner of assets but the control and coordination of cooperating inputs. “[T]he economic question regarding institutional form involves a comparison of the costs of coordinating the activities of the factors of production within the firm with the costs of bringing about the same result by market transactions or by mean of operations undertaken within some other firm” (NF 220-21).