Nature of the firm rationale

Prof.Pramod D. Borhade
Pirens Tecnical Campus
[email protected]
mobile-9890919972

1. Prof.Pramod D. Borhade Pirens Technical Campus [email protected] Nature of the Firm-Rationale

2. Nature Of The Firm A firm is an association of individuals who have organized themselves for the purpose of turning inputs into output. The firm organizes the factors of production to produce goods and services to fulfill the needs of the households. Each firm lays down its own objectives which is fundamental to the existence of a firm.

3. The major objectives of the firm are: To achieve the Organizational Goal To maximize the Output To maximize the Sales To maximize the Profit of the Organization To maximize the Customer and Stakeholders Satisfaction To maximize Shareholder’s Return on Investment To maximize the Growth of the Organization

4. Firms are established to earn profit, to keep the shareholders happy. To increase their market share, they try to maximize their sales. In the present business world firms try to produce goods and services without harming the environment.

5. Firms are not always able to operate at a profit. They may be facing the operating loss also. Economists believe that firms maximize their long run rather than their short run profit. So managers have to make enough profit to satisfy the demands of their shareholders and to maximize their wealth through the company

6. “The Nature of the Firm”   “The Nature of the Firm”  (1937), is an article by  Ronald Coase . It offered an economic explanation of why individuals choose to form partnerships, companies and other business entities rather than trading bilaterally through  contracts  on a market.

7. Given that production could be carried on without any organization, Coase asks, "Why and under what conditions should we expect firms to emerge?" Since modern firms can only emerge when an  entrepreneur  of some sort begins to hire people, Coase's analysis proceeds by considering the conditions under which it makes sense for an entrepreneur to seek hired help instead of contracting out for some particular task. The traditional economic theory of the time suggested that, because the market is "efficient" (that is, those who are best at providing each good or service most cheaply are already doing so), it should always be cheaper to contract out than to hire.

8. Coase noted, however, that there are a number of  transaction costs  to using the market; the cost of obtaining a good or service via the market is actually more than just the price of the good. Other costs, including search and information costs, bargaining costs, keeping  trade secrets , and policing and enforcement costs, can all potentially add to the cost of procuring something via the market. This suggests that firms will arise when they can arrange to produce what they need internally and somehow avoid these costs.

9. There is a natural limit to what can be produced internally, however. Coase notices "decreasing returns to the entrepreneur function", including increasing overhead costs and increasing propensity for an overwhelmed manager to make mistakes in resource allocation. This is a countervailing cost to the use of the firm. Coase argues that the size of a firm (as measured by how many contractual relations are "internal" to the firm and how many "external") is a result of finding an optimal balance between the competing tendencies of the costs outlined above. In general, making the firm larger will initially be advantageous, but the decreasing returns indicated above will eventually kick in, preventing the firm from growing indefinitely.

10. Other things being equal, a firm will tend to be larger: the less the costs of organizing and the slower these costs rise with an increase in the transactions organized. the less likely the entrepreneur is to make mistakes and the smaller the increase in mistakes with an increase in the transactions organized. the greater the lowering (or the less the rise) in the supply price of factors of production to firms of larger size. The first two costs will increase with the spatial distribution of the transactions organized and the dissimilarity of the transactions. This explains why firms tend to either be in different geographic locations or to perform different functions.

11. Additionally, technology changes that mitigate the cost of organizing transactions across space will cause firms to be larger—the advent of the telephone and cheap air travel, for example, would be expected to increase the size of firms. On a related note the use of the  internet  and related modern  information and communication technologies  seem to lead to the existence of so-called  virtual organizations . Coase does not consider non-contractual relationships, as between friends or family.

12. COASE THEOREM In The Problem of Social Cost”, Coase laid a critical foundation of modern law and economics – the so-called Coase theorem. The Coase theorem has been formulated in various ways, but one useful statement might be that: “When the parties can bargain successfully, the initial allocation of legal rights does not matter.” According to the Coase theorem, rights will be acquired by those who value them most highly, which creates an incentive to discover and implement transaction cost minimizing governance forms. The Coase Theorem describes the economic efficiency of an economic allocation or outcome in the presence of externalities. The theorem states that when trade in an externality is possible and there are no transaction costs, bargaining will lead to an efficient outcome regardless of the initial allocation of property rights. The Coase theorem is an important basis for most modern economic analyses of government regulation, especially in the case of externalities.

13. Whether a transaction would be organized within a firm or whether it would be carried out on the market depended on a comparison of the costs of organizing such a transaction within the firm with the costs of a market transaction that would accomplish the same result. All this is very simple and obvious. But it took me a year to realize it – and many economists seem unaware of it (or its significance) to this day…As it was a new approach (I think) to this subject, I was quite pleased with myself. One thing I can say is that I made it all up myself. As I said in my Nobel Prize lecture, I was then twenty-one and the sun never ceased to shine.” – Ronald Coase

14. Thank You