Essay : Coase the Nature of the Firm

Ronald Coase: The Nature of the Firm

In times of a lot of perfect competitive markets and a lot of transactions between firms in the b2b or b2c sector the term of transaction costs arises. First of all you have to define what transactions are: Transactions are the implicit and explicit contract negotiations for goods and services between at least 2 people. The transactions theory now tells us that there are costs for every step of these contract negotiations and also costs after the contract conclusion.

Transaction costs could appear before (ex-ante) the contract conclusion and after (ex-post) the conclusion. Ex-Ante costs are Information-, Negotiation- or Contract costs. Ex-Posts costs are for example costs for monitoring the behavior of your contract member or you have to change something ex-post in the contract. The ex post costs are more important because experts consider that a lot of contracts have errors or are bad formulated and so these transactions costs arise for sure.

During the past century, different economists had different approaches and conclusions about the theory of the firm and the importance of transaction costs.

Alchian & Demsetz (1972) stated in their work, that there would be no substaintial difference between using the market or an organization for the allocation of resources, making firms seem useless.

Ronald Coase opposed this view in 1937 in his famous work "The nature of the Firm". For Coase, the main reason for establishing a firm is, that making contracts is costly and that using a firm would not eliminate, but reduce the number of contracts, hence, reduce the transaction costs by a large amount.

The graphic above supports this statement, as it clearly shows, that with rising transaction complexity or difficulty, i.e. increasing number of contracts, there is a certain break-even point, where it is more efficient using the firm, which constitutes the answer to the question, why do firms exist....