Essential Coase: Why Do Firms Exist?
Welcome to the essential ideas of Ronald Coase.
Some of Coase's most powerful insights came from simple questions,
like “why do people join together to create businesses instead of just working on their own?”
Coase's answer is that firms are formed to minimize the costs that
people and businesses incur when they exchange goods and services,
which are known as transaction costs. These include the time it takes to find someone with
whom to exchange, the time and costs to negotiate a deal, and the costs to resolve disputes.
Let's explore Coase's explanation of why businesses exist with an example:
Jane is an avid cyclist who wants to create her own brand of bikes. But how does she decide
whether to work alone or form a business? Jane could, for instance, work on her own
and contract with other people for the goods and services she needs to make and sell her bikes.
This includes sourcing all the materials and components needed,
hiring outside contractors to assemble the bikes, working with wholesalers to sell her bike,
and using a warrantee company to service the bikes after the sale.
But at every exchange, Jane and the other people with whom she trades face transaction costs.
They have to find each other, research the others services, negotiate terms of their contracts, pay
to have the contracts legally enforced, and so on. And so, given all the transaction costs,
Jane might discover that she can reduce those costs and be more profitable if she hires someone
to assemble the bikes rather than contracting out. And Jane might discover that transaction costs are
further reduced if she sold her bikes directly to bike stores by hiring her own salespeople
and perhaps Jane's mountain bikes become so popular—and
the transaction costs associated with working with bike shops become high enough—that she discovers
it's more profitable for her to open her own chain of stores, and hire her own sales staff.
Jane's decision to create a business, instead of working alone, and then when and how to
expand are all linked with reducing transaction costs, which make her business more profitable.
And for Coase, that's why firms exist—to minimize transaction costs.
Coase's insights into the nature of firms sparked new research and created entirely
new fields of study in economics, business management and even political science.
For more information on Ronald Coase visit EssentialCoase.org,
and to learn about more essential scholars, visit EssentialScholars.org