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CHAPTER • Production 203 Today we take firms for granted It is hard for us to imagine the production of automobiles without large companies like Ford and Toyota, the production of oil and natural gas without companies like Exxon-Mobil and Shell, or even the production of breakfast cereal without companies like Kellogg and General Mills But stop for a minute and ask yourself whether we really need firms to produce the goods and services that we consume regularly This was the question raised by Ronald Coase in a famous 1937 article: If markets work so well in allocating resources, why we need firms?2 Why Do Firms Exist? Do we really need firms to produce cars? Why couldn’t cars be produced by a collection of individuals who worked independently and contracted with each other when appropriate, rather than being employed by General Motors? Couldn’t some people design a car (for a fee), other people buy steel, rent the equipment needed to stamp the steel into the shapes called for in the design, and then the stamping (also for negotiated fees), other people make steering wheels and radiators, still other people assemble the various parts, and so on, where again, every task would be performed for a negotiated fee? Or take another example: We—the authors of this book—work for universities, which are essentially firms that provide educational services along with research We are paid monthly salaries and in return are expected to teach regularly (to students recruited by our “firms” and in classrooms the “firms” provide), research and write (in the offices our “firms” give us), and carry out administrative tasks Couldn’t we simply bypass the universities and offer our teaching services on an hourly basis in rented classrooms to students who show up and pay us, and likewise research on a paid piecemeal basis? Do we really need colleges and universities with all their overhead costs? In principle, cars could indeed be produced by a large number of independent workers, and an education could be produced by a number of independent teachers These independent workers would offer their services for negotiated fees, and those fees would be determined by market supply and demand It shouldn’t take you long, however, to realize that such a system of production would be extremely inefficient Think about how difficult it would be for independent workers to decide who will what to produce cars, and negotiate the fees that each worker will charge for each task And if there were any change in the design of the car, all of these tasks and fees would have to be renegotiated For cars produced this way, the quality would likely be abysmal, and the cost astronomical Firms offer a means of coordination that is extremely important and would be sorely missing if workers operated independently Firms eliminate the need for every worker to negotiate every task that he or she will perform, and bargain over the fees that will be paid for those tasks Firms can avoid this kind of bargaining by having managers that direct the production of salaried workers—they tell workers what to and when to it, and the workers (as well as the managers themselves) are simply paid a weekly or monthly salary There is no guarantee, of course, that a firm will operate efficiently, and there are many examples of firms that operate very inefficiently Managers cannot always monitor what workers are doing, and managers themselves sometimes make Ronald Coase, “The Nature of the Firm,” Economica (1937), Vol 4: 386–405 Coase won a Nobel Prize in Economics in 1991
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