We are going to take a brief detour in an area of applied microeconomics known as the “Theory of the Firm.”. This area itself could take weeks to properly study — indeed in my Industrial Organization course I spend about 3 weeks on this topic — and a number of Nobel prizes in economics (most recently to Hart and Holmström in 2016). However, we study it for several reasons: to consider situations where team production is required to provide a valuable good, to consider why organization with inherent hierarchy may be necessary, and to consider new economic problems that any organization brings along with it.
While there are several contested theories of the firm (and the original goes back to a 1937 paper by Coase!), one of the most famous and fruitful is known as the “nexus of contract theory,” which originates in a famous 1972 paper by Armen Alchian and Harold Demsetz, which is your required reading.
Optional/Referenced Reading on Theory of the Firm
- Gardiner and Means, 1933, The Modern Corporation and Private Property
- Coase, 1937, “The Nature of the Firm”
- Manne, 1965, “The Market for Corporate Control”
- Jensen and Meckling, 1976, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”
- Cheung, 1983, “The Contractual Nature of the Firm”
- Grossman and Hart, 1986, “The Costs and Benefits of Ownership: A Theory of Vertical and Lateral Integration”
- Shleifer and Vishney, 1997, “A Survey of Corporate Governance”
- Hart, 2016, “Incomplete Contracts and Control” (Nobel Prize Lecture)
Questions to Guide Your Reading
Do firms exist in traditional economic models of production?
If markets are so great at allocating resources, why do firms exist?
When and why must we resort to hierarchy and command and control systems?
What do Alchian and Demsetz mean that a firm has no more power or authority than you or I do in the marketplace? Do you agree?
What is the fundamental economic problem with team production?
What new economic problems does the hiring of a monitor, an agent, or the establishment of a firm create?
What is the difference between a firm and other organizations? Like clubs? Like States?
Below, you can find the slides in two formats. Clicking the image will bring you to the html version of the slides in a new tab. Note while in going through the slides, you can type h to see a special list of viewing options, and type o for an outline view of all the slides.
The lower button will allow you to download a PDF version of the slides. I suggest printing the slides beforehand and using them to take additional notes in class (not everything is in the slides)!