pn: coase,1937 I :The substitutive relationship of Market and firm

Coase, 1937, p386 The substitutive relationship of Market and firm

It is hoped to show in the following paper that a definition of a firm may be obtained which is not only realistic in that it corresponds to what is meant by a firm in the real world, but is tractable by two of the most powerful instruments of economic analysis developed by Marshall, the idea of the margin and that of substitution, together giving the idea of substitution at the margin.

Coase, 1937, p387 about economic system

Sir Arthur Salter. " The normal economic system works itself. For its current operation it is under no central control, it needs no central survey. Over the whole range of human activity and human need, supply is adjusted to demand, and production to consumption, by a process that is automatic, elastic and responsive." An economist thinks of the economic system as being co-ordinated by the price mechanism and society becomes not an organisation but an organism.

Indeed, it is often considered to be an objection to economic planning that it merely tries to do what is already done by the price mechanism.

Sir Arthur Salter's description, however, gives a very incomplete picture of our economic system. Within a firm, the description does not fit at all.

Marshall introduces organisation as a fourth factor of production; J. B. Clark gives the co-ordinating function to the entrepreneur; Professor Knight introduces managers who co-ordinate. As D. H. Robertson points out, we find "islands of conscious power in this ocean of unconscious co-operation like lumps of butter coagulating in a pail of buttermilk."' But in view of the fact that it is usually argued that co-ordination will be done by the price mechanism,why is such organisation necessary ? Why are there these " islands of conscious power " ?

Outside the firm, price movements direct production, which is co-ordinated through a series of exchange transactions on the market.

Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the the entrepreneur-co-ordinator, who directs production.

It is clear that these are alternative methods of co-ordinating production.

Yet, having regard to the fact that if production is regulated by price movements, production could be carried on without any organisation at all, well might we ask, why is there any organisation ?

Of course, the degree to which the price mechanism is superseded varies greatly.

In a department store
In the Lancashire cotton industry


This co-ordination of the various factors of production is, however, normally carried out without the intervention of the price mechanism. As is evident, the amount of "vertical " integration, involving as it does the supersession of the price mechanism, varies greatly from industry to industry and from firm to firm.

It can, I think, be assumed that the distinguishing mark of the firm is the supersession of the price mechanism.

The purpose of this paper is to bridge what appears to be a gap in economic theory between the assumption (made for some purposes) that resources are allocated by means of the price mechanism and the assumption (made for other purposes) that this allocation is dependent on the entrepreneur-co-ordinator. We have to explain the basis on which, in practice, this choice between alternatives is effected.