This guy is always throwing around this claim on me. He’s the typical Keynesian whose arguments are always demolished by the broken window fallacy. Anyway, where is he getting this idea and how do I respond?
Because you adhere to a school of thought that cannot explain or even theorize firm creation/expansion, i do not expect you to agree; institutional costs (be whatever they may) have a direct long run connection to firm creation. Reason be, firms can exploit tacit knowledge to create what mainstream economists refer to as “economies of scale”. If you eliminate institutional costs, the need for firms goes to zero.
The theory of the firm
► Why do firms exist?
Transaction costs of market exchange (Coase 1937)
Entrepreneurial judgment is non-contractible (Knight, 1921)
► What determines the boundary of the firm?
Internal and external transaction costs
Entrepreneurial talent
Need for economic calculation (Rothbard)
► How should the firm be organized?
Costs and benefits of delegation (Foss, Foss, and Klein, 2007)
By the way, the theory of the firm is in the domain of microeconomics (where neo-classicals like to play), not macroeconomics (the usual Keynesian turf).
Aren’t we supposed to have just as many firms as we do entrepreneurs? Send ‘transaction costs’ to zero but you’ll never extinguish the firms, because we’ll never have a society of entrepreneurs. That would seem to be it: we have the firm because not everyone is an entrepreneur, and so they sell services to him instead of going solo.
Keep in mind, a firm is a collection of resources in the end, meant to maximise returns on investment in it to its owner. It’s thus a hub for an entrepreneur (or manager perhaps more appositely) to draw upon ideas to use for innovations.
This guy posed a question to me, and I really can’t tell the difference here now.
Basic micro dude. In the short run, if your revenue equals or exceeds variable cost, then a firm does not need to close. Firms do not close based on lack of profitability, but on a marginal revenue/marginal cost basis.
Isn’t revenue - cost your profit? What am I missing here?
Earlier you mentioned that Profit = Revenue - Cost. That is true, and nobody disputes that.
Then the question is, what is the correct output for a firm to maximize profit. In other words, if a firm decides how many widgets to product in a period of time (let’s say a month), how many should it produce?
From microeconomics, the answer is when marginal revenue is equal to marginal cost. For example, each additional widget will incrementally (marginally) increase your revenue, but it will also incrementally increase your cost.
The firm should stop producing more widgets when the marginal increase in cost exceeds the marginal increase in revenue, even though beyond that point the firm would still be profitable. Even though the firm would still be profitable making more widgets, the firm’s total profit will decrease with each additional widget beyond that point.
But anyways, I don’t think he is trying to prove anything, except your lack of understanding of the concept.
Here is a little background for the theory (and which I think was the basis for “Goldenboy219’s” argument).
How come an entrepreneur needs to start a firm in the first place, when he or she can simply outsource (or contract out) everything? From within the firm, there are no markets, and thus the entrepreneur will have to plan everything without an internal market. But instead of establishing a firm, the entrepreneur can simply contract out everything and use the external market to perform economic calculations, but why does he or she not do that?
So basically Goldenboy simply dismisses a book answering his (very snidely) phrased question because it wasn’t published in “major” journals? Ask him to provide an understanding of Klein’s book. If he can’t, tell him he has no coherent objection and is slithering away from the debate and hiding behind cop outs. Hammer this kind of person very hard. Also recommend Klein and Foss’s Entrepreneurship and the Firm which is a collection of various Austrian thinkers’ works on why the firm exists. Far from not having a theory, we have one that does a better job than the mainstream’s approach.
Thanks for that post Think Blue. Glad you could help.
And maybe I’m kind of lost on this, but why is it that a firm is considered centrally planned and that it is not a market? I don’t think I quite understand this. As far as I knew, firms set prices on goods based on competition. Are the prices that he is talking about capital goods?
From within a firm, there is an absence of an internal market, in sense that the accounting department does not sell goods and services to the I.T. department, and the I.T. department does not sell to the marketing department, and on. Instead, the owner of the firm (or his or her delegate) makes decisions on what to produce and how much, and allocate capital accordingly, in a command and control structure, which is a basic characteristic of a centrally planned economy.
However, since the firm exists within a larger marketplace, it can still do economic calculation, by its accounting of profits and losses, which are derived from external market prices.
If you think about it, this is similar to what happens within a socialist country, where everything is centrally planned. It stands to reason then, if a large firm can be successfully managed, why can’t a socialist country be likewise managed as well.
However, I think the answer is a matter of scale and scope. There is a fundamental limit on the size of the firm, such that the larger the firm, the greater the economic calculation problems. That is why it is highly unlikely that a One Big Firm will arise on the private market (like a Berkshire Hathaway or a Microsoft) that would swallow up all the industries, and take over the whole market.
Through understanding the theory of the firm, we can perhaps find better ways of managing an existing firm, maybe by introducing market based principles from within, instead of relying exclusively on a command and control regime.
Yeah, up to some point transaction costs make using the market system more costly than command-and-control. Eventually command-and-control becomes more costly than using the market system and people switch to that. A socialized economy is well past the point of command-and-control costs > transaction costs.
By the way, I don’t know much about Austrian economics. What basis is there for believing that Austrians pay no attention to institutional costs (and how many did before Coase?).
His thesis is, even though Ronald Coase should receive proper credit for the “Theory of the Firm”, the Austrian economists anticipated a number of important insights into the subject before he came up with the theory.
Then he proceeds though the Austrian critique of the modern theory, and how an “Austrian Theory of the Firm” would be constructed.
There is no basis for the claim that Austrians paid no attention to “institutional costs.” That came from some lame comments on another forum, which I posted a response in refutation.
And maybe I’m kind of lost on this, but why is it that a firm is considered centrally planned and that it is not a market?
Because many of them operate based on internal capital markets when these are, for whatever reason, advantageous. It isn’t central planning proper because these are supplementary devices when the entrepreneur/owner in the firm is better able to extract information within it than external investors; the firms still requires rivalrous competition with other firms and external capital markets to price efficiently and not arbitrarily (and the less this exists, the greater the cost of internal capital markets.) The person you’re debating with is clueless.