The Firm, the Market, and the Law Paperback – 15 Feb 1990
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The most interesting essay is on the origins of the firm. It seeks to address the question of why firms exist at all, rather than simply contractual relationships. Very simply, Coase argues that firms exist because this structure helps reduce transaction costs. Contracting with all the necessary parties is costly and time-consuming, so up to a point it is easier for operations to be brought in-house. And once you get your head around the argument, you can see that it has implications elsewhere (not sure about capital markets, but that's another story). Coase makes his case very clearly so it's not hard work.
I was less interested in the article on externalities, although again it's well-argued and made me think a bit. I like his style of writing which really does run through the logical implications of various scenarios. You might get a bit bored of hearing about ranchers and farmers, but it's ultimately a rewarding read as he exhausts the various scenarios.
The essay on the lighthouse in economics is great. He points out that although numerous writers on economics have used the lighthouse as an example of a resource that needs to be provided by the state (because no one private sector organisation has enough incentive to do it themself) actually this ignores the actual history of lighthouses.
Definitely a good read, with some interesting perspectives.
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The book consists of seven essays. Very briefly, the first essay is an introduction in which Coase describes his economic outlook while introducing the concepts contained in each of the following essays. The remaining six essays can be divided up as follows. Chapters two and three contain discussions of the firm. The second essay is the highly influential "The Nature of the Firm" essay while the third essay applies these arguments to a general research proposal on industrial organization. Chapter four and seven are essays which can be described as historical. Chapter four summarizes and contributes to the "marginal cost controversy." For those with little exposure to this issue, this essay can be passed over. Chapter seven is the famous "The Lighthouse in Economics" which challenges the public goods argument by showing that the lighthous has historically been provided by private companies. The remaining two chapters contain arguments and notes on what has come to be called "The Coase Theorem." Chapter five is the actual essay "The Problem of Social Cost" and chapter six contains a series of replies to various criticisms that have been directed at the arguments presented in "The Problem of Social Cost" essay.
Clearly, the best aricles in this book are chapters two and five, "The Nature of the Firm" and "The Problem of Social Cost". As I mentioned earlier, Coase begins his analysis by asking a very novel and challenging question: If the price system works itself, as is conventionally taught, then why do we see firms? His answer is that there are costs to conducting transactions through the market. The two examples he gives in various forms are:
1. discovering what the relevant prices are, since outside equilibrium the relevant prices are not known.
2. The costs of negotiating and concluding contracts.
To my disappointment, Coase inexplicably spends the rest of the essay extending the example of the costs of contractual arrangements. Now this is an important problem, but until the question of relevant prices is resolved, the problem of executing costly contracts seems to be almost insuperable because if we still have no way of discovering what the relevant prices are, then how can we measure the degree of costs involved in "negotiating and concluding contracts" (page 38)?
I would have liked to see Coase concentrate his remarkable intellectual abilities on the first problem; namely, that of disovering what the relevant prices are. He mentions this problem just once, and then omits it from all subsequent discussions of costs and market transactions. I cannot make sense of this.
This problem is carried into his other famous essay "The Problem of Social Cost". Now the economic analysis contained in this essay is both rigorous and logically consistent. Given certain prices, and given a world in which transaction costs are absent, it would seem superfluous to assign rights because they would simply be re-negotiated in a way which maximizes the social product. This world is a world of equilibrium, and in such a world we can presume that the relevant prices are known. What I like about this argument is that it demonstrates to the advocates of this model (equilibrium) that economists cannot simultaneously present theories of perfect competition and market failure. In a world of perfect competition, rights will be arranged in a way consistent with the maximization of the social product. It does not make any sense to speak of market failire in conditions of perfect equilibrium. We can use Coase's analysis and say to economists:
"The nature of the choice is clear: [perfect competition] or [market failure]. What answer should be given is, of course, not clear unless we know the value of what is obtained as well as teh value of what is sacrificed to obtain it" (page 96).
But when Coase does admit the existence of transaction costs into the analysis, he falls into the same error of assuming that the relevant prices are still known in such a world. He writes:
"In earlier sections, when dealing with the problem of the rearrangement of legal rights through the market, I argued that such a rearrangement would be made through the market whenever this would lead to an increase in the value of production. But this assumed costless market transactions. Once the costs of carrying out market transactions are taken into account, it is clear that such a rearrangement of rights will only be undertaken when the increase in the value of production consequent upon the rearrangement is greater than the costs which would be involved in bringing it about" (page 115).
This argument, while laudable in its emphasis on transaction costs, still begs the question. We first must know what the relevant prices are before we can compare the relative advantages of alternative sets of rights. I think Coase's argument would be strengthened considerably once these considerations are brought into clearer light. To my knowledge, this observation has yet to be made. Before we can speak of transaction "costs", it behooves us to know, as Coase recognized, what the relevant prices are. We could not speak of cost without first solving this very important problem.
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