Book Series
Theories of the Firm
Fifth Edition
Demetri Kantarelis

Chapter 7: The transaction cost theory of the firm

163-196According to the neoclassical theory, the firm is a production function and its natural boundaries are defined by, primarily, technology or economies of scale and scope. Coase (1937) wondered why some economic activity takes place in the price system while other inside firms. He inferred that firms choose to produce some or all of their inputs internally because of high market use costs otherwise known as transaction costs. He asserted that the "firm and market were alternative modes for organizing the same transactions" [Williamson, (1993), p.4] and posed two questions that gave birth to the transaction cost theory of the firm: a What factors are responsible for the boundaries of the firm? (or, why does a firm exist?) and b Why is not all production carried on in one big firm?
1 Model I: the firm according to Coase
1.1 The answer to question (a)
1.2 The answer to question (b)
2 Model II: the firm as a minimiser of transaction costs subject to a given output level
3 Critical dimensions of transacting
3.1 Bounded rationality
3.2 Opportunism
4 Model II: modified
5 Model III: the firm according to Williamson
6 Model IV: vertical integration and asset ownership
7 The firm as a function of deals
7.1 Portfolio of deals
7.2 Factors that govern the effectiveness and efficiency of deals
7.3 Strategic nucleus
7.4 Mergers
7.4.1 The vertically integrated firm
7.4.2 The horizontally integrated firm
7.4.3 Conglomerate mergers
7.5 Strategic alliances and joint ventures
8 Summary
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