英國dissertation網提供英國留學生經濟學dissertation定制-The Nature of the Firm
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The Nature of the Firm
ECONOMItCh eory has suffered in the past from a failureto state clearly its assumptions. Economists in buildingup a theory have often omitted to examine the foundationson which it was erected. This examination is, however,essential not only to prevent the misunderstanding andneedless controversy which arise from a lack of knowledgeof the assumptions on which a theory is based, but also
because of the extreme importance for economics of goodjudgment in choosing between rival sets of assumptions.
For instance, it is suggested that the use of the word " firm "in economics may be different from the use of the termby the " plain man."l Since there is apparently. a trendin economic theory towards starting analysis with theindividual firm and not with the i n d u ~ t r y ,i~t is all themore necessary not only that a clear definition of the word" firm " should be given but that its difference from a
firm in the " real world," if it exists, should be made clear.Mrs. Robinson has said that " the two questions to beasked of a set of assumptions in economics are : Are theytractable ? and : Do they correspond with the real world ? "3Though, as Mrs. Robinson points out, " more often one setwill be manageable and the other realistic," yet there maywell be branches of theory where assumptions may beboth manageable and realistic. It is hoped to show inthe following paper that a definition of a firm may be obtainedwhich is not only realistic in that it corresponds to whatis meant by a firm in the real world, but is tractable bytwo of the most powerful instruments of economic analysisdeveloped by Marshall, the idea of the margin and that ofsubstitution, together giving the idea of substitution at#p#分頁標題#e#
1 Joan Robinson, Economics is a Serious Subject, p. 12.
2 See N. Kaldor, "The Equilibrium of the Firm," Ecolrotnic Jounzal, March, 1934Op. cit., p. 6.
19371 THE NATURE OF THE FIRM 387
the margin.' Our definition must, of course, " relate toformal relations which are capable of being conceivedexa~tly."~
It is convenient if, in searching for a definition of a firm,we first consider the economic system as it is normallytreated by the economist. Let us consider the descriptionof the economic system given by Sir Arthur Salter.3 "Thenormal economic system works itself. For its currentoperation it is under no central control, it needs no centralsurvey. Over the whole range of human activity and humaneed, supply isadjusted to demand, and production toconsumption, by a process that is automatic, elastic andresponsive." An economist thinks of the economic systemas being co-ordinated by the price mechanism and societybecomes not an organisation but an organism.' The economicsystem "works itself." This does not mean that there isno planning by individuals. These exercise foresight andchoose between alternatives. This is necessarily so if thereis to be order in the system. But this theory assumes thatthe direction of resources is dependent directly on the pricemechanism. Indeed, it is often considered to be an objectionto economic planning that it merely tries to do what isalready done by the price mechanism.6 Sir Arthur Salter'sdescription, however, gives a very incomplete picture ofour economic system. Within a firm, the description doesnot fit at all. For instance, in economic theory we findthat the allocation of factors of production between differentuses is determined by the price mechanism. The priceof factor A becomes higher in X than in Y. As a result,A moves from Y to X until the difference between theprices in X and Y, except in so far as it compensates forother differential advantages, disappears. Yet in the realworld, wefindthatareaswherethis does
not apply. If a workman moves from department Y todepartment X, he does not go because of a change in relativeprices, but because he is ordered to do so. Those who
1 J. M. Keynes, Essays in Biography, pp. 223-4.
8 L. Robbins, Nature and Significance of Economic S&cc, p. 63.
a This description is quoted with approval by D. H. Robertson, Confrol of Industry,
p. 85, and by Professor Arnold Plant, "Trends in Business Administration," ECONOMICA,
February, 1932. It appears in Allied Sbipping Control, pp. 16-17.
See F. A. Hayek, " The Trend of Economic Thinkmg," Ec o ~ omr c ~M, ay, 1933.
See P. A. Hayek, op. cit.
388 ECONOMICA [NOVEMBER
http://www.400190.com/dissertation_writing/Ecommerce/object to economic planning on the grounds that the problemis solved by price movements can be answered by pointingout that there is planning within our economic systemwhich is quite different from the individual planningmentioned above and which is akin to what is normallycalled economic planning. The example given above istypical of a large sphere in our modern economic system.Of course, this fact has not been ignored by economists.Marshall introduces organisation as a fourth factor ofproduction; J. B. Clark gives the co-ordinating functionto the entrepreneur ; Professor Knight introduces managerswho co-ordinate. As D. H. Robertson points out, we find<c islands of conscious power in this ocean of unconsciousco-operation like lumps of butter coagulating in a pail ofbuttermilk."' But in view of the fact that it is usuallyargued that co-ordination will be done by the price mechanism,why is such organisation necessary ? Why are there these#p#分頁標題#e#
c c islands of conscious power " ? Outside the firm, pricemovements direct production, which is co-ordinated through
a series of exchange transactions on the market. Withina firm, these market transactions are eliminated and in
place of the complicated market structure with exchangetransactions is substituted the entrepreneur-co-ordinator,who directs ~r o d u c t i o n .~I t is clear that these are alternative Imethods of co-ordinating production. Yet, having regard
to the fact that if production is regulated by price movements,production could be carried on without any organisationat all, well might we ask, why is there any organisation ?Of course, the degree to which the price mechanism issuperseded varies greatly. In a department store, the
allocation of the different sections to the various locationsin the building may be done by the controlling authorityor it may be the result of competitive price bidding forspace. In the Lancashire cotton industry, a weaver canrent power and shop-room and can obtain looms and yarn
on redi it.^ This co-ordination of the various factors ofproduction is, however, normally carried out without theintervention of the price mechanism. As is evident, theamount of "vertical " integration, involving as it does
1 Op. cit., p. 85.
In the rest of this paper I shall use the term entrepreneur to refer to the person orpersons who, in a competitive system, take the place of the price mechanism in the directionof resources.3urve.y of 'Textile Industries, p. 26,
19371 THE NATURE OF THE FIRM 389
the supersession of the price mechanism, varies greatlyfrom industry to industry and from firm to firm.
It can, I think, be assumed that the distinguishing markof the firm is the supersession of the price mechanism.
It is, of course, as Professor Robbins points out, " relatedto an outside network of relative prices and costs,"l butit is important to discover the exact nature of this relationship.This distinction between the allocation of resourcesin a firm and the allocation in the economic system hasbeen very vividly described by Mr. hlaurice Dobb whendiscussing Adam Smith's conception of the capitalist :"It began to be seen that there was something moreimoortant than the relations inside each factory or unitcaptained by an undertaker; there were the relations ofthe undertaker with the rest of the economic world outsidehis immediate sphere . . . . the undertaker busies himselfwith the division of labour inside each firm and he ~ l a n sand organises consciously,~b~u t "he is related to the kuch
l a r"~ e re conomic sI~ ecialisation.o f which he himself is merelvone specialised unit. Here, he plays his part as a single cell in alarger organism, mainly unconscious of the wider r81e he fills."ZIn view of the fact that while economists treat the pricemechanism as a co-ordinating instrument, they also admitthe co-ordinating function of the '' entrepreneur," it issurely important to enquire why co-ordination is the workof the price mechanism in one case and of the entrepreneurin another. The purpose of this paper is to bridge whatappears to be a gap ill economic theory between the assumption(made for some purposes) that resources are allocatedby means of the price mechanism and the assumption(made for other purposes) that this allocation is dependenon the entrepreneur-co-ordinator. We have to explainthe basis on which, in practice, this choice between alternativesis effected.3#p#分頁標題#e#
1 Op. cit., p. 71.
英國dissertation網提供英國留學生經濟學dissertation定制-Cap$ialisr Gnr~rprisra. nd Social Progress, p. zo. Cf., also, Henderson, Siipply and Dc~na;id,PP :-5
3 I t is easy to see when the State takes over the direction of an industry that, in planningit, it is doing something urhich was previously done by the price mechanism. What isusually not realised is that any business man in organising the relations between his departmentsis also doing something which could be organised through the price mechanism. Thereis therefore point in Lit. Durbin's answer to those rvho emphasise the problems involvedin economic planning that the same problems have to be solved by business men in thecompetitive system. (See " Economic Calculus in a Planned Economy," Econornir Journal,
December, 1936.) The important difrerence between these two cases is chat economicplanning is irnposed on industry while firms arise voluntarily because they represent a moreefficient method of organising production. In a competitive system. there is an " optimum "amount of planning !390 ECONOMICA [NOVEMBER
II
Our task is to attempt to discover why a firm emergesat all in a specialised exchange economy. The price
mechanism (considered purely from the side of the directionof resources) might be superseded if the relationship whichreplaced it was desired for its own sake. This would bethe case, for example, if some people preferred to workunder the direction of some other person. Such individualswould accept less in order to work under someone, andfirms would arise naturally from this. But it would appearthat this cannot be a very important reason, for it wouldrather seem that the opposite tendency is operating if onejudges from the stress normally laid on the advantage of< L being one's own master."l Of course, if the desire wasnot to be controlled but to control, to exercise power overothers, then people might be willing to give up somethingin order to direct others ; that is, they would be willingto pay others more than they could getunder the pricemechanism in order to be able to direct them. But thisimplies that those who direct pay in order to be, able todo this and are not paid to direct, which is clearly not truein the majority of cases.2 Firms might also exist if purchaserspreferred commodities which are produced by firms tothose not so produced; but even in spheres where onewould expect such preferences (if they exist) to be of negligible
importance, firms are to be found in the real world.3Therefore there must be other elements involved.The main reason why it is profitable to establish a firmwould seem to be that there is a cost of vsing the pricemechanism. The most obvious cost of " organisiilg "
production rhrough the price mechanism is that of discoveringwhat tlie relevant prices a r e . V l i i s cost may be reduced#p#分頁標題#e#
but it will not be eliminated by the emergence of specialists
~vhowill sell this information. The costs cf negotiating and
1 Cf. Harry Dawes, '' Labour nlobility in the Steel Industry," E~oiio,iiicgourtzal, hlarcl?.r?j+,, who inst:~ncca " t h e trek to retail shopkeeping and insurance work by the better paidor sk~l l edin en due t o the desire (often t h e ma in aim in lite of a worker: L O he independent "
(P. 86).
2 None tlie !ess, this is not altogether fancifl~l. Some small shopkeepers are said to eaznless than their assistants.
3 G. F . Siiove, " T h e Imperfection of the hlarkrc : a Fur the r Notr!" Ecorion~icJ ouriinl,
Atarch, 1933, p. " 6 , note I, points out that such preferences niay exist, although therxample he gives is almost the reverse of the instance given in the text.
1 According to !<. hnldor, "A Classificatory Iiote of the Detern3inaicness of Equilibriiun,"
Raviw gi Ecoizo,,tlr Studies, February, 1934, it is onr of the ;issumptions oi static theorythat ":?I1 rhe relevzint prices arc known to all individuzils." Rut i h i r is clearly not trueof the real world.
19371 THE NATURE OF THE FIR^^ 391concluding a separate contract for each exchange transaction
which takes place on a market must also be taken intoaccount.] Again, in certain markets, e.g., produce exchanges,
a technique is devised for minimising these contract costs ;but they are not eliminated. It is true that contracts are
not eliminated when there is a firm but they are greatlyreduced. A factor of production (or the owner thereof)does not have to make a series of contracts with the factorswith whom he is co-operating within the firm, as would benecessary, of course, if this co-operation were as a directresult of the working of the price mechanism. For thisseries of contracts is substituted one. At this stage, it is
important to note the character of the contract into whicha factor enters that is employed within a firm. The contractis one whereby the factor, for a certain remuneration (whichmay be fixed or fluctuating), agrees to obey the directionsof an entrepreneur within certain linzits.2 The essence ofthe contract is that it should only state the limits to thepowers of the entrepreneur. Within these limits, he cantherefore direct the other factors of production.
There are, however, other disadvantages-or costsofusing the price mechanism. It may be desired to makea long-term contract for the supply of some article or service.
This may be due to the fact that if one contract is madefor a longer period, instead of several shorter ones, thencertain costs of making each contract will be avoided. c 3Or, owing to the risk attitude of the people concerned,thev mav refer to make a long rather than a short-term i , I "contract. Now, owing to the difficulty of forecasting, thelonger the period of the contract is for the supply of thecommodity or service, the less possible, and indeed, theless desirable it is for the person purchasing to specify whatthe other contracting party is expected to do. It may wellbe a niatter of indifference to the person supplying theservice or commodity which of several courses of actionis taken. but not to the ~urchaser of that service or corn- Imodity. But the purchaser will not know which of these#p#分頁標題#e#
several courses he will want the supplier to take. Therefore,
1 This influence was noted by Professor Usher when discussing the development of capitalisn~.Hr says : " Tne successire buying and selling of partly finished products were sheer wasteili energy." (1,rtrodtdrtion i o the I ~ ~ d u s t r i aHlistory of England, p. 13). But he does notdevelop the idea nor consider why it is that buying and selling operations still exist.
11 would be possible for no limits to the powers of the entrepreneur to be fixed. 'l'liis~roiildbe voluntary slavery. According to Professor Batt, The La:; o j .Ilasiet. nrrd Scrvonl,
p. IS, such a contract mould be void and unenforceable.39= ECONOMICA [NOVEMBER
the service which is being provided is expressed in generalterms, the exact details being left until a later date. Allthat is stated in the contract is the limits to what the personssupplying the commodity or service is expected to do.
The details of what the supplier is expected to do is notstated in the contract but is decided later by the purchaser.When the direction of resources (within the limits of thecontract) becomes dependent on the buyer in this way,that relationship which I term a " firm " may be obtained.'
A firm is likely therefore to emerge in those cases where avery short term contract would be unsatisfactory. It isobviously of more importance in the case of serviceslabour-than it is in the case of the buying of commodities.In the case of commodities, the main items can be stated
in advance and the details which will be decided later willbe of minor significance.
We may sum up this section of the argument by sayingthat the operation of a market costs something and byforming an organisation and allowing some authority (an" entrepreneur ") to direct the resources, certain marketingcosts are saved. The entrepreneur has to carry out hisfunction at less cost, taking into account the fact that hemay get factors of production at a lower price than themarket transactions which he supersedes, because it isalways possible to revert to the open market if he failsto do this.
The question of uncertainty is one which is often consideredto be very relevant to the study of the equilibrium of thefirm. It seems improbable that a firm would emerge withoutthe existence of uncertainty. But those, for instance,Professor Knight, who make the mode oj payment thedistinguishing mark of the firm-fixed incomes beingguaranteed to some of those engaged in production by aperson who takes the residual, and fluctuating, incomewouldappear to be introducing a point which is irrelevantto the problem we are considering. One entrepreneur maysell his services to another for a certain sum of money,while the payment to his employees may be mainly orwholly a share in profit^.^ The significant question would' OI course, it is not possible to draw a hard and fast line which determines whetherthere is a fir111 or not. There may be more or less direction. It is similar to the legalquestion of whether there is the relationship of master and servant or principal and agent.See the discussion of this problem belolv. ' The viel~jsof Professor Knight are examined below in more detail.#p#分頁標題#e#
19371 THE NATURE OF THE FIRM 393appear to be why the allocation of resources is not donedirectly by the price mechanism.
Another factor that should be noted is that exchangetransactions on a market and the same transactions organised'within a firm are often treated differently by Governmentsor other bodies with regulatory powers. If we consider theoperation of a sales tax, it is clear that it is a tax on markettransactions and not on the same transactions organisedwithin the firm. Now since these are alternative methods
of " organisation "-by the price mechanism or by theentrepreneur-such a replation would bring into existence
firms which otherwise would have no raison d'itrs. It wouldfurnish a reason for the emergence of a firm in a specialisedexchange economy. Of course, to the extent that firmsalready exist, such a measure as a sales tax would merelytend to make them larger than they ~vould otherwise be.
Similarly, quota schemes, and methods of price controlwhich imply that there is rationing, and which do not applyto firms producing such products for themselves, by allowingadvantages to those who organise within the firm and notthrough the market, necessarily encourage the growth offirms. But it is difficult to believe that it is measures suchas have been mentioned in this paragraph which havebrought firms into existence. Such measures would, however,tend to have this result if they did not exist for otherreasons.
'These, then, are the reasons why organisations such asfirms exist in a specialised exchange economy in which itis generally assumed that the distribution of resources is" organised " by the price mechanism. A firm, therefore,consists of the system of relationships which comes intoexistence when the direction of resources is dependent onan entrepreneur.
The approach which has just been sketched would appearto offer an advantage in that it is possible to give a scientificmeaning to what is meant by saying that a firm gets largeror smaller. rZ firm becomes larger as additional transactions(which could be exchange transactions co-ordinated throughthe price mechanism) are organised by the entrepreneurand bcconles smaller as he abandons theorganisation ofsuch transactions. The question which arises is whetherit is possible to study the forces which determine the sizeoi the firm. Why does thc entrepreneur not organise one
394 ECONOMICA [NOVEMBER
less transaction or one more ? It is interesting to notethat Professor Knight considers that :"the relation between efficiency and size is one of themost serious problems of theory, being, in contrast with
the relation for a lant, largely a matter ofand historical accic 'elnt rather than of intelligi% le"" ligteneralprinciples. But the question is peculiarly vital becausethe possibility of monopoly gain offers a powerful incentiveto continuous and unlimhd expansion of the firm, which
force must be o&et by some equally powerful one makingfor decreased efficiency (in the production of moneyincome) with growth in size, if even boundary competitionis to exist."'#p#分頁標題#e#
Professor Knight would appear to consider that it is impossibleto treat scientifically the determinants of the size of thefirm. On the basis of the concept of the firm developedabove, this task will now be attempted.
It was suggested that the introduction of the firm wasdue primarily to the existence of marketing costs. Apertinent question to ask would appear to be (quite apartfrom the monopoly considerations raised by ProfessorKnight), why, if by organising one can eliminate certaincosts and in fact reduce the cost of production, are thereanv market transactions at all la Whv is not all uroductioncaked on by one big firm ? ~ h e r l would apiear to becertain ~ossible exulanations.First,'as a firmL gets larger, there may be decreasing
returns to the entrepreneur function, that is, the costs oforganising additional transactions within the firm may
rise.3 Naturallv,.. a ~ o i n tm ust be reached where the costs I of organising an extra transaction within the firm are equalto the costs involved in carr,v i=n ~o ut the transaction inthe open market, or, to the costs of organising by another
entrepreneur. Secondly, it may be that as the transactionswhich are organised increase, the entrepreneur fails toplace the factors of production in the uses where their value
1 Risk, Uncertainty and PrqlE1, Preface to the Re-issue, London School of Ecol~ornics Seriesof Reprints, No. 16, 1933.
2 There are certain marketing costa which could only be eliminated by the abolition of"con6umers' choice " and these are the costa of retailing. It is conceivable that these costsmight be so high that people would be willing to accept ratio~is because tha extra productobtained was worth the loss of their choice.
3 This argument assumes that exchange transactio~~osn a market can be considered ashomogeneous; which is clearly untrue in fact. This complication is taken into accountbelow.
19373 THE NATURE OF THE FIRM 395is greatest, that is, fails to make the best use of the factorsof production. Again, a point must be reached ~vllere theloss through the waste of resources is equal to the marketingcosts of the exchange transaction in the open market orto the loss if the transaction was organised by anotherentrepreneur. Finally, the supply price of one or more ofthe factors of production may rise, because the " otheradvantages" of a small firm are greater than those of alarge firm.' Of course, the actual point where the expansionof the firm ceases might be determined by a combinationof the factors mentioned above. The first two reasonsgiven most probably correspond to the economists' phraseof " diminishing returns to management."'J
The point has been made in the previous paragraph thata firm will tend to expand until the costs of organising anextra transaction within the firm become eaual to the costsof carrying out the same transaction by mear?ls of an exchangeon the ouen market or the costs of orranisinr in another 0 "firm. But if the firm stops its expansion at a point belowthe costs of marketine in the ouen market and at a uoint Uequal to the costs of organisini in another firm, in mostcases (excluding the case of " combination "9, this willimply that there is a market transaction between thesetwo vroducers. each of whom could or~ani seit at less thanthe ictual marketing costs. How isvthe paradox to beresolved i If we consider an examulc the reason for thiswill become clear. Suppose A is buying a product from#p#分頁標題#e#
B and that both A and B could organise this marketingtransaction at less than its present cost. B, we can assume,is not organising one process or stage of production, butseveral. If A therefore wishes to avoid a market transaction,he will have to take over all the urocesses of uroduction I Icontrolled by B. Unless A takes over all the processes of
1 For a discussion of the variation of the supply price of factors of production to firms
of varying size, see E. A. G. Robinson, The Strticture of Coruperiiiz'e Ifidustry. I t is someiirnes
said that the supply price of organising ability increases as the size of the firm increases
because inen prefer to be the heads of small independent businesses rather than thr heads
of departments in a large business. See Jones, The Pi.nst P7oblrm: p, j;~.and Xacgregor,
licd~~stri:Cl o~~ibinationp,. 63. This is :I common argumtnt of tiiose %>haa dvocate Rationalisation.
It is said that larger units would be more eificient, but owing to the individualistic~pirit of the smaller entrepreneurs, they prefer to rernain independent, apparently in spiteof the higher income which their increased eficiency under Rationalisation makes possible.
3 This discussion is, of course, brief and incomplete. For a more thorough discussionof this particular problem, see N. Kaldor, "The Equilibrium of the Firm," Economic Journal!Xarch, 1934, and E, A. G. Robinson, "The Problem of Management 2nd thc Sizc of theFirm," Econoiiiic Jottrnal. June, 1934.
8 .A definition of this term is given below.production, a market transaction will still remain, although
it is a different product that is bought. But we havepreviously assumed that as each producer expands he
becomes less efficient ; the additional costs of organisingextra transactions increase. It is probable that A's costof organising the transactions previously organised by
B will be greater than B's cost of doing the same thing.
A therefore will take over the whole of B's or"ga nisationonly if his cost of organising B's work is not greater than
B's cost by an amount equal to the costs of carrying outan exchange transaction on the open market. But onceit becomes economical to have a market transaction, italso pays to divide production in such a way that the costof organising an extra transaction in each firm is the same.Up to now it has been assumed that the exchange transactionswhich take place through the price mechanism arehomogeneous. In fact, nothing could be more diversethan the actual transactions which take place in our modernworld. This would seem to imply that the costs of carryingout exchange transactions through the price mechanismwill vary considerably as will also the costs of organisingthese transactions within the firm. It seems thereforepossible that quite apart from the question of diminishingreturns the costs of organising certain transactions withinthe firm may be greater than the costs of carrying out the
exchange transactions in the open market. This wouldnecessarily imply that there were exchange transactionscarried out through the price mechanism, but would itmean that there would have to be more than one firm ?Clearly not, for all those areas in the economic systemwhere the direction of resources was not deoendent directlvon the price mechanism could be organised within onefirm. The factors which were discussed earlier would seemto be the important ones, though it is difficult to say whether" diminishing returns to management " or the rising supplyprice of factors is likely to be the more important.Other things being equal, therefore, a firm will tendto be larger :#p#分頁標題#e#
(a) the less the costs of organising and the slower thesecosts rise with an increase in the transactions organised.
(b) the less likely the entrepreneur is to make mistakesand the smaller the increase in mistakes with an increasein the transactions organised.19371 THE NATURE OF THE FIRM 397
(6) the greater the lowering (or the less the rise) inthe supply price of factors of production to firms of largersize.
Apart from variations in the supply price of factors ofproduction to firms of different sizes, it would appear thatthe costs of organising and the losses through mistakes willincrease with an increase in the spatia'l distribution of thetransactions organised, in the dissimilarity of the transactions,and in the probability of changes in the relevantprices.l As more transactions are organised by an entrepreneur,it would appear that the transactions would tendto be either different in kind or in different places. Thisfurnishes an additional reason why efficiency will tend todecrease as the firm gets larger. Inventions which tendto bring factors of production nearer together, by lesseningspatial distribution, tend to increase the size of the firm.2Changes like the telephone and the telegraph which tendto reduce the cost of organising spatially will tend to increasethe size of the firm. All changes which improve managerialtechnique will tend to increase the size of the firm.3-4
It should be noted that the definition of a firm whichwas given above can be used to give more precise meanings
to the terms " combination " and " integration."5 There
is a combination when transactions which were previously
1 This aspect oi the problen~ is emphasised by N. Kaldor, op, cit. Its in~portance in
this connection had been previously noted by E. A. G. Robinson, The Structure of Competitine
I~dustry, pp. 83-106. This assumes that an increase in the probability of price
movements increases the costs of organising within a firm more than it increases the cost
of carrying out an exchange transaction on the market-which is probable.
2 This would appear to be the importance of the treatment of the technical unit by
2. A. G. Robinson, op, cit., pp. 27-33 The larger the technical unit, the greater the
concentration of factors and therefore the firm is likely to be larger.
3 It should be uoted that most inventions will change both the costs of organising and
the costs of using the price mechanism. In such cases, whether the invention tends to
make firms larger or smaller will depend on the relative effect on these two sets of costs.
For instance, if the telephone reduces the costs of using the price mechanism more than
it reduces the costs of organising, then it will have the effect of reducing the size of the
firm.
An illustration of these dynamic forces is furnished by Maurice Dobb, Russian Economic
Deuelopment, p. 68. "With the passing of bonded labour the factory, as an establishment#p#分頁標題#e#
where work was organised under the whip of the overseer, lost its raison d'iire until this
was restored to it with the introduction of power machinery after 1646.'' It seems important
to realise that the passage from the domestic system to the factory system is not a mere
historical accident! but is conditioned by economic forces. This is shown by the fact that
it is possible to move from the factory system to the domestic system, as in the Russian
example, as well as vice versa. I t is the essence of serfdom that the price mechanism is
not allowed to operate. Therefore, there has to be direction from some organiser. When,
however, serfdom passed, the rice mechanism was allowed to operate. I t was not until
machinery drew workers into one locality that it paid to supersede the price mechanism
and the firm again emerged.
This is often called I' vertical integration," combination being termed " lateral integratiol~."
398 ECONOMICA [NOVEMBEK
organised by two or more entrepreneurs become organised
by one. This becomes integration when it involves the
organisation of transactions which were previously carried
out between the entrepreneurs on a market. A firm can
expand in either or both of these two ways. The whole
of the " structure of competitive industry" becomes tractable
by the ordinary technique of economic analysis.
The problem which has been investigated in the previous
section has not been entirely neglected by economists and
it is now necessary to consider why the reasons given above
for the emergence of a firm in a specialised exchange economy
are to be preferred to the other explanations which have
been offered.
It is sometimes said that the reason for the existence
of a firm is to be found in the division of labour. This is
the view of Professor Usher, a view which has been adopted
and expanded by Mr. Maurice Dobb. The firm becomes
" the result of an increasing complexity of the division of
labour . . . . The growth of this economic differentiation
creates the need for some integrating force without which
differentiation would collapse into chaos ; and it is as the
integrating force in a differentiated economy that industrial
forms are chiefly significant."l The answer to this argument
is an obvious one. The " integrating force in a differentiated
economy " already exists in the form of the price mechanism.
It is perhaps the main achievement of economic science
that it has shown that there is no reason to suppose that
specialisation must lead to chaos.2 The reason given by
Mr. Maurice Dobb is therefore inadmissible. What has
to be explained is why one integrating force (the entrepreneur)
should be substituted for another integrating force (the
price mechanism).
The most interesting reasons (and probably the most#p#分頁標題#e#
widely accepted) which have been given to explain this
fact are those to be found in Professor Knight's Risk,
Uncertainty and Profit. His views will be examined in
some detail.
1 Op. cit.,, p. 10. Professor Usher's vieas are to be found in his Ztzrroducrion to the
Industrial Hzsrory of England, pp. 1-18
2 Cf. J. B. Clark, Disaiburiotl of Wealtb, p. 19, who speaks of the theory of exchange as
being the "theory of the organisation of industrial society."
19371 THE NATURE OF THE FIRM 399
Professor Knight starts with a system in which there
is no uncertaintv :
" acting as ihdividuals under absolute freedom but
without collusion men are supposed to have organised
economic life with the primary and secondary division
of labour, the use of capital, etc., developed to the point
familiar in present-day America. The principal fact
which calls for the exercise of the ima~ination is the Q
internal orgariisation of the productive groups or establishments.
VTTith uncertainty entirely absent, every individual
being in possession of perfect knowledge of the situation,
there would be no occ?sion for anything of the nature
of responsible management or control of productive
activity. Even marketing transactions in any realistic
sense would not be found. The flow of raw materials
and productive services to the consumer would be entirely
a~tornatic."~
Professor Knight says that we can imagine this adjustment
as being '' the result of a long process of experimentation
worked out by trial-and-error methods alone," while it
is not necessary " to imagine every worker doing exactly
the right thing at the right time in a sort of ' pre-established
harmony 'with the work of others. There might be managers,
superintendents, etc., for the purpose of co-ordinating the
activities of individuals," though these managers would
be performing a purely routine function, " without responsibility
of any sort."Z
Professor Knight then continues :
"With the introduction of uncertainty-the fact of
ignorance and the necessity of acting upon opinion rather
than knowledge-into this Eden-like situation, its character
is entirely changed . . . . With uncertainty present doing
things, the actual execution of activity, becomes in a
real sense a secondary part of life ; the primary problem
or function is deciding what to do and how to do it."3
This fact of uncertainty brings about the two most
important characteristics of social organisation.
" In the first place, goods are produced for a market,
on the basis of entirely impersonal prediction of wants,
not for the satisfaction of the wants of the producers
themselves. The producer takes the responsibility of
Risk, Unceriainiy and Projit, p. 267.#p#分頁標題#e#
Op. cit., pp. 267-8. Op. cit., p. 268.
400 ECONOMICA [NOVEMBER
forecasting the consumers' wants. In the second place,
the work of forecasting and at the same time a large
part of the technological direction and control of production
are still further concentrated upon a very narrow class
of the ~roducers. and we meet with a new economic I
functionary, the entrepreneur. . . . . When uncertainty
is present and the task of deciding what to do and how
to do it takes the ascendancy over that of execution the
internal organisation of the productive groups is no
longer a matter of indifference or a mechanical detail.
Centralisation of this deciding and controlling function
is imperative, a process of ' cephalisation ' is inevitable."'
The most fundamental change is :
" the system under which the confident and venturesome
assume the risk or insure the doubtful and timid by
guaranteeing to the latter a specified income in return
for an assignment of the actual results. . . . With human
nature as we know it it would be impracticable or very
unusual for one man to guarantee to another a definite
result of the latter's actions without being given power
to direct his work. And on the other hand the second
party would not place himself under the direction of
the first without such a guarantee. . . . The result of
this manifold specialisation of function is the enterprise
and wage system of industry. Its existence in the world
is the direct result of the fact of ~ncertainty."~
These quotations give the essence of Professor Knight's
theory. The fact of uncertainty means that people have
to forecast future wants. Therefore, ypu get a special
class springing up who direct the activities of others to
whom they give guaranteed wages. It acts because good
judgment is generally associated with confidence in one's
j~dgment.~
Professor Knight would appear to leave himself open
to criticism on several grounds. First of all, as he himself
points out, the fact that certain people have better judgment
or better knowledge does not mean that they can only
get an income from it by themselves actively taking part
in production. They can sell advice or knowledge. Every
business buys the services of a host of advisers. We can
imagine a system where all advice or knowledge was bought
1 Op. cit., pp. 268-95 ' Op. cit., pp. 269-70
Wp. cit., p. 270.
19371 TEE NATURE OF THE FIRM 401
as required. Again, it is possible to get a reward from
better kn~wledge or judgment not by actively taking part
in prod~iction but by making contracts with people who
are producing. A merchant buying for future delivery
represents an example of this. But this merely illustrates
the point that it is quite possible to give a guaranteed#p#分頁標題#e#
reward providing that certain acts are performed without
directing the performance of those acts. Professor Knight
says that "with human nature as we know it it would be
impracticable or very unusual for one man to guarantee
to another a definite result of the latter's actions without
being given power to direct his work." This is surely
incorrect. A large proportion of jobs are done to contract,
that is, the contractor is guaranteed a certain sum providing
he performs certain acts. But this does not involve any
direction. It does mean, however, that the system of
relative prices has been changed and that there will be a
new arrangement of the factors of production.l The fact
that Professor Knight mentions that the " second party
would not place himself under the direction of the first
without such a guarantee" is irrelevant to the problem
we are considering. Finally, it seems important to notice
that even in the case of an economic system where there
is no uncertainty Professor Knight considers that there
would be co-ordinators, though they would perform only
a routine function. He immediately adds that they would
be " without responsibility of any sort," which raises the
question by whom are they paid and why I It seems that
nowhere does Professor Knight give a reason why the price
mechanism should be superseded.
It would seem important to examine one further point
and that is to consider the relevance of this discussion to
the general question of the " cost-curve of the firm."
It has sometimes been assumed that a firm is limited
in size under perfect competition if its cost curve slopes
upward,2 while under imperfect competition, it is limited
1 This shows that it is possible to have a private enterprise system without the existence
of firms. Though, in practice, the two functions of enterprise, which actually influences
the system of relative prices by forecasting wants and acting in accordance with such forecasts,
and management, which accepts the system of relative prices as being given, are
normally carried out by the same persons, yet it seems important to keep them separate
in theory. This point is further discussed below.
2 See Kaldor, op, cit., and Robinson, The Problem of Managdment and the Size qfthe Firnr.
402 ECONOMICA [NOVEMBER
in size because it will not pay to pioducc illore than the
output at which marginal cost is equal to margin21 revenue.l
But it is clear that a firm may produce more than one product
and, therefore, there appears to be no prima facie reason
why this upward slope of the cost curve in the case of perfect
competition or the fact that marginal cost will not always
be below marginal revenue in the case of imperfect competition
should limit the size of the firn1.2 Mrs. Robinson3#p#分頁標題#e#
makes the simplifying assumption that only one product
is being produced. But it is clearly important to investigate
how the number of products produced by a firm is determined,
while no theory which assumes that only one product is
in fact produced can have very great practical significance.
It might be replied that under perfect competition, since
everything that is produced can be sold at the prevailing
price, then there is no need for any other product to be
But this argument ignores the fact that there
may be a point where it is less costly to organise the exchange
transactions of a new product than to organise further
exchange transactions of the old product. This point can
be illustrated in the following way. Imagine, following
von Thunen, that there is a town, the consuming centre,
and that industries are located around this central point
in rings. These conditions are illustrated in the following
diagram in which A, B and C represent different industries. -@
1 Yr. Robinson calls this the Imperfect Competition solution for the survival of the small firm.
W r . Robinson's conclusion, op. cit., p. 249, note I, &rrould appear to be definitely wrong.
He is followed by Horace J. White, Jr., " lono no pol is tic and Perfect Competition,'' Americnrn
Economic Review, December, 1936, p. 645, note 27. Mr. White states " I t is obvious that
the size of the firm is limited in conditions of lnonopolistic competition."
3 Econotitics of Imperfect Competition.
19371 THE NATURE OF THE FIRM 403
Imagine an entrepreneur who starts controlling exchange
transactions from x. Now as he extends his activities in
the same produce (B), the cost of organising increases until
at some point it becomes equal to that of a dissimilar product
which is nearer. As the firm expands, it will therefore
from this point include more than one product (A and C).
This treatment of the problem is obviously incomplete,l
but it is necessary to show that merely proving that the
cost curve turns upwards does not give a limitation to the
size of the firm. So far we have only considered the case
of perfect competition ; the case of imperfect competition
would appear to be obvious.
To determine the size of the firm, we have to consider
the marketing costs (that is, the costs of using the price
mechanism), and the costs of organising of different entrepreneurs
and then we can determine how many products
will be produced by each firm and how much of each it
will produce. It would, therefore, appear that Mr. Shoves
in his article on "Imperfect Competition " was asking
questions which Mrs. Robinson's cost curve apparatus
cannot answer. The factors mentioned above would seem
to be the relevant ones.
Only one task now remains ; and that is, to see whether#p#分頁標題#e#
the concept of a firm which has been developed fits in with
that existing in the real world. We can best approach the
question of what constitutes a firm in practice by considering
the legal relationship normally called that of " master and
servant " or " employer and employee."s The essentials
of this relationship have been given as follows :
"(I) the servant must be under the duty of rendering
personal services to the master or to others on behalf
1 As has been shown above, location is only one of the factors influencinp the cost of
organising.
a G. F. Shove, "The Imperfection of the Market," Economic Journal, March, 1933, p. 1x5
In connection with an increase in demand in the suburbs and the effect on the price charged
by suppliers, Mr. Shove asks ". . . . why do not the old firms open branches in the
suburbs ? " If the argument in the text is correct, this is a question which Mrs. Robinson's
apparatus cannot answer.
8 The legal concept of "employer and employee" and the economic concept of a firm
are not identical, in that the firm may imply control over another person's property as well
as over their labour. But the identity of these two concepts is sufficiently close for an
examination of the legal concept to be of value in appraising the ~vorth oi the economic
concept.
404 ECONOMICA [NOVEMBER
of the master, otherwise the contract is a contract for
sale of goods or the like.
(2) The master must have the right to control the
servant's work, either personally or by another servant
or agent. It is this right of control or interference, of
being entitled to tell the servant when to work (within
the hours of service) and when not to work, and what
work to do and how to do it (within the terms of such
service) which is the dominant characteristic in this
relation and marks off the servant from an independent
contractor, or from one employed merely to give to his
employer the fruits of his labour. In the latter case,
the contractor or uerformer is not under the emulover's I i
control in doing the work or effecting the service ; he
has to shape and manage his work so as to give the result
he has contracted to effect."l
We thus see that it is the fact of direction which is the
essence of the legal concept of " employer and employee,"
just as it was in the economic concept which was developed
above. It is interesting to note that Professor Batt says
further :
"That which distinguishes an agent from a servant is
not the absence or presence of a fixed wage or the payment
only of commission on business done, but rather the
freedom with which an agent may carry out his employment."
2
We can therefore conclude that the definition we have given#p#分頁標題#e#
is one which approximates closely to the firm as it is considered
in the real world.
Our definition is, therefore, realistic. Is it manageable ?
This ought to be clear. When we are considering how
large a firm will be the principle of marginalism works
smoothly. The question always is, will it pay to bring an
extra exchange transaction under the organising authority ?
At the margin, the costs of organising within the firin
will be equal either to the costs of organising in another
firm or to the costs involved in leaving the transaction to
be " organised " by the price mechanism. Business men
will be constantly experimenting, controlling more or less,
and in this way, equilibrium will be maintained. This
gives the position of equilibrium for static analysis. But
' Batt, The Lam of Master and 'Seroatrt, p. 6
a Op, cit.. p. 7 .
19371 TH?? NATURE OF THE FIRM 405
it is clear that the dynamic factors are also of considerable
importance, and an investigation of the effect changes have
on the cost of organising within the firm and on marketing
costs generally will enable one to explain why firms get
larger and smaller. We thus have a theory of moving
equilibrium. The above analysis would also appear to have
clarified the relationship between initiative or enterprise
and management. Initiative means forecasting and operates
through the price mechanism by the making of new contracts.
Management proper merely reacts to price changes, rearranging
the factors of production under its control. That the
business man normally combines both functions is an obvious
result of the marketing costs which were discussed above.
Finally, this analysis enables us to state more exactly what
is meant by the " marginal product " of the entrepreneur.
But an elaboration of this point would take us far from
our comparatively simple task of definition and clarification.
You have printed the following article:
The Nature of the Firm
R. H. Coase
Economica, New Series, Vol. 4, No. 16. (Nov., 1937), pp. 386-405.
Stable URL:
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visit your library's website or contact a librarian to learn about options for remote access to JSTOR.
[Footnotes]
2 The Equilibrium of the Firm
Nicholas Kaldor
The Economic Journal, Vol. 44, No. 173. (Mar., 1934), pp. 60-76.
Stable URL:

3 Trends in Business Administration
Arnold Plant
Economica, No. 35. (Feb., 1932), pp. 45-62.
Stable URL:

4 The Trend of Economic Thinking
F. A. von Hayek
Economica, No. 40. (May, 1933), pp. 121-137.
Stable URL:#p#分頁標題#e#

5 The Trend of Economic Thinking
F. A. von Hayek
Economica, No. 40. (May, 1933), pp. 121-137.
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1 Labour Mobility in the Steel Industry
Harry Dawes
The Economic Journal, Vol. 44, No. 173. (Mar., 1934), pp. 84-94.
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3 The Imperfection of the Market
G. F. Shove; Joan Robinson
The Economic Journal, Vol. 43, No. 169. (Mar., 1933), pp. 113-125.
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4A Classificatory Note on the Determinateness of Equilibrium
Nicholas Kaldor
The Review of Economic Studies, Vol. 1, No. 2. (Feb., 1934), pp. 122-136.
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2 The Equilibrium of the Firm
Nicholas Kaldor
The Economic Journal, Vol. 44, No. 173. (Mar., 1934), pp. 60-76.
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1 The Equilibrium of the Firm
Nicholas Kaldor
The Economic Journal, Vol. 44, No. 173. (Mar., 1934), pp. 60-76.
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2 The Equilibrium of the Firm
Nicholas Kaldor
The Economic Journal, Vol. 44, No. 173. (Mar., 1934), pp. 60-76.
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2A Review of Monopolistic and Imperfect Competition Theories
Horace G. White, Jr.
The American Economic Review, Vol. 26, No. 4. (Dec., 1936), pp. 637-649.
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2 The Imperfection of the Market
G. F. Shove; Joan Robinson
The Economic Journal, Vol. 43, No. 169. (Mar., 1933), pp. 113-125.

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