Employment, Markets, Contracts, and the Scope of the Firm
25 Pages Posted: 19 Dec 2013 Last revised: 6 Jan 2015
Date Written: January 6, 2015
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 new prices have to be agreed upon. Under natural conditions, employment, markets, or sequential contracting weakly dominate all other equilibria. As firms become larger, gains from standardization come at the cost of increasingly poor adaptation, ultimately bounding their scope. The model rests on standard assumptions, is consistent with the managerial literature on the scope of the firm, and makes predictions based on factors that do not play a role in contemporary theories of the firm.
Keywords: organization, institutions, labor
JEL Classification: D02, D23, L23
Suggested Citation: Suggested Citation