Coase, Theory of the Firm, Schumpeter, Kreps, Viner, Marshall Eric Rasmusen, erasmuse@Indiana

1. Coase, Theory of the Firm, Schumpeter, Kreps, Viner, MarshallEric Rasmusen, erasmuse@Indiana.edu G604, History of Thought, size of firms, march 23, 2006

2. Classics: OrganizationR. H. Coase (1937) "The Nature of the Firm," Economica, New Series, 4, 16: 386-405 (November 1937) •     Jacob Viner (1931) "Cost Curves and Supply Curves," Zeitschrift fur Nationalokonomie, 3: 23-46 (1931) •     Kreps, David, A Course in Microeconomic Theory, pp. 274-279 (Princeton University Press, 1990) •     Joseph A. Schumpeter. "The Fundamental Problem of Economic Development," The Theory of Economic Development, tr. Redvers Opie, pp. 57-94 (Oxford: Oxford University Press, 1934, 1st edition in German, 1911). •     Alfred Marshall, Principles of Economics, 8th edition, 1920 (1st edition, 1890), "Industrial Organization, Continued. Business Management,"Book IV, Chapter 12.

3. Marshall (1890/1920) • INDUSTRIAL ORGANIZATION, CONTINUED. BUSINESS MANAGEMENT …we have to inquire how it occurs that, though in manufacturing at least nearly every individual business, so long as it is well managed, tends to become stronger the larger it has grown; and though primâ facie we might therefore expect to see large firms driving their smaller rivals completely out of many branches of industry, yet they do not in fact do so.

4. Industrial Organization In remote villages in almost every county of England agents of large undertakers come round to give out to the cottagers partially prepared materials for goods of all sorts, but especially clothes such as shirts and collars and gloves; and take back with them the finished goods. … There is a continual contest between the factory and the domestic system, now one gaining ground and now the other:

5. Managers and Entrepreneurs … the manufacturer who makes goods not to meet special orders but for the general market, must, in his first rôle as merchant and organizer of production, have a thorough knowledge of things in his own trade. He must have the power of forecasting the broad movements of production and consumption, of seeing where there is an opportunity for supplying a new commodity that will meet a real want or improving the plan of producing an old commodity. … But secondly in this rôle of employer he must be a natural leader of men. He must have a power of first choosing his assistants rightly and then trusting them fully; of interesting them in the business and of getting them to trust him, so as to bring out whatever enterprise and power of origination there is in them; while he himself exercises a general control over everything, and preserves order and unity in the main plan of the business.

6. The Education of Children He himself was probably brought up by parents of strong earnest character; and was educated by their personal influence and by struggle with difficulties in early life. But his children, at all events if they were born after he became rich, and in any case his grandchildren, are perhaps left a good deal to the care of domestic servants who are not of the same strong fibre as the parents by whose influence he was educated.

7. Business Morality It is a strong proof of the marvellous growth in recent times of a spirit of honesty and uprightness in commercial matters, that the leading officers of great public companies yield as little as they do to the vast temptations to fraud which lie in their way. If they showed an eagerness to avail themselves of opportunities for wrong-doing at all approaching that of which we read in the commercial history of earlier civilization, their wrong uses of the trusts imposed in them would have been on so great a scale as to prevent the development of this democratic form of business. There is every reason to hope that the progress of trade morality will continue, aided in the future as it has been in the past, by a diminution of trade secrecy and by increased publicity in every form…

8. Moral Hazard and Adverse Selection … under the scheme of Profit-Sharing, a private firm while retaining the unfettered management of its business, pays its employees the full market rate of wages, whether by Time or Piece-work, and agrees in addition to divide among them a certain share of any profits that may be made above a fixed minimum; it being hoped that the firm will find a material as well as a moral reward in the diminution of friction, in the increased willingness of its employees to go out of their way to do little things that may be of great benefit comparatively to the firm, and lastly in attracting to itself workers of more than average ability and industry

9. Schumpeter (1911): The Entrepreneur • “When he swims with the stream in the circular flow which is familiar to him, he swims against the stream if he wishes to change the channel. What was formerly a help becomes a hindrance. What was a familiar datum becomes an unknown. Where the boundaries of routine stop, many people can go no further, and the rest can only do so in a highly variable manner.” • “...every man would have to be a giant of wisdom and will, if he had in every case to create anew all the rules by which he guides his everyday conduct.” • “In the breast of one who wishes to do something new, the forces of habit rise up and bear witness against the embryonic project.” • “It is no part of his function to “find” or “create” new possibilities. They are always present, abundantly accumulated by all sorts of people. Often they are also generally known and being discussed by scientific or literary writers.” • “For its success, keenness and vigor are not more essential than a certain narrowness which seizes the immediate chance and nothing else.”

10. 5 Types of Innovation 1. new goods (product innovation) 2. new methods of production (process innovation) 3. new markets 4. new sources of inputs 5. new organization

11. Coase (1937)

12. Transaction Costs

13. Using Marginalism

15. A link to the course website http://www.rasmusen.org/g604/0.g604.htm