Distributed Knowledge and Economic Organization
28 Pages Posted: 7 Aug 2015
Date Written: August 5, 2015
This paper develops an explanation for why some activities are organized through firms and others through markets. It studies the problem of coordination in an idealized firm and an idealized market. Both the firm and the market face the problem of using knowledge that is widely dispersed among individuals. They solve the problem in different ways. In the market, decision-making rights are vested in the individuals who possess knowledge. Coordination happens through a process of decentralized interactions and the prices that emerge from these interactions. The market has to incur the cost of discovering prices. The firm does not have to incur the cost of discovering prices because coordination happens through managerial direction. However, this means that widely dispersed knowledge has to be transferred to the manager. Knowledge that changes with time is difficult to centralize, so is knowledge that is difficult to communicate. The firm has to incur the cost of collecting knowledge. The relative cost of the market and the firm depends on the relation between the cost of discovering prices and the cost of collecting knowledge.
Keywords: Firms, Markets, Knowledge, Coordination, Dynamic, Tacit, Organization
JEL Classification: D21, D80, L22
Suggested Citation: Suggested Citation