Friday, 6 May 2011

Firms in economics 2

In their 2007 JEL survey of the empirical literature on vertical integration and firm boundaries Lafontaine and Slade write,
Understanding what determines firm boundaries and the choice between interacting in a firm or a market is not only the fundamental concern of the theory of the firm, but it is also one of the most important issues in economics. Data on value added, for example, reveal that, in the United States, transactions that occur in firms are roughly equal in value to those that occur in markets.
In a footnote they also explain that
For manufacturing the ratio is about one third, whereas for services it is twice that.
Which may just tell us that transaction costs are lower in manufacturing than services.

What is interesting in what Lafontaine and Slade write is that despite noting the importance of knowing what determines firm boundaries they still go on to argue that firms are the poor relation in economics,
The economics profession, however, has devoted much more attention to the workings of markets than to the study of firms, and even less attention to the interface between the two.
If fact it has only been since the mid-1970s that the mainstream "theory of the firm" has moved away from asking questions about how the firm acts in the market, how it prices its outputs or how it combines its inputs, to questions about the firm's existence, boundaries and internal organisation. That is, it is only relatively recently that there has been a movement away from the theory of the firm being seen as developing a component of price theory, namely issues to do with firm behaviour, to the theory being concerned with the firm as a subject in its own right.

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