Employment, Markets, Contracts, and the Scope of the Firm

24 Pages Posted: 7 Dec 2013

See all articles by Birger Wernerfelt

Birger Wernerfelt

Massachusetts Institute of Technology (MIT) - Sloan School of Management

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Date Written: December 4, 2013

Abstract

We look at the economic functions of firms, contracts, and markets and characterize the optimal scope of the firm. Governance structures appear as equilibria and are compared in terms of production costs - determined by a tradeoff between standardization and adaptation - and adjustment costs – sometimes incurred when prices have to be agreed upon. Under weak conditions, employment, markets, or sequential contracting weakly dominate all other equilibria. As firms become larger, they lose their focus and gains from standardization decrease, ultimately bounding their scope. The model does not rest on non-standard assumptions and is consistent with the managerial literature on the scope of the firm. Its predictions depend on several factors that do not play a role in other contemporary theories of organization.

Keywords: Theory of the Firm, Institutions, Organization

JEL Classification: D02, D23, L23

Suggested Citation

Wernerfelt, Birger, Employment, Markets, Contracts, and the Scope of the Firm (December 4, 2013). Available at SSRN: https://ssrn.com/abstract=2364411 or http://dx.doi.org/10.2139/ssrn.2364411

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