Coase

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The Suntory and Toyota International Centres for Economics and Related Disciplines

The Nature of the Firm Author(s): R. H. Coase Reviewed work(s): Source: Economica, New Series, Vol. 4, No. 16 (Nov., 1937), pp. 386-405 Published by: Blackwell Publishing on behalf of The London School of Economics and Political Science and The Suntory and Toyota International Centres for Economics and RelatedDisciplines Stable URL: http://www.jstor.org/stable/2626876 . Accessed: 13/02/2012 05:20
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ENOVEMBER

The Nature of the Firm
By R. H. COASE
ECONOMIC theory has suffered in the past from a failure to state clearly its assumptions. Economists in building up a theory have often omitted to examine the foundations on which it was erected. This examination is, however, essential not only to prevent the misunderstanding andneedless controversy which arise from a lack of knowledge of the assumptions on which a theory is based, but also because of the extreme importance for economics of good judgment in choosing between rival sets of assumptions. For instance, it is suggested that the use of the word " firm " in economics may be different from the use of the term by the "plain man."'' Since there is apparently a trend ineconomic theory towards starting analysis with the individual firm and not with the industry,2 it is all the more necessary not only that a clear definition of the word " firm " should be given but that its difference from a firm in the " real world," if it exists, should be made clear. Mrs. Robinson has said that "the two questions to be asked of a set of assumptions in economics are: Are theytractable ? and: Do they correspondwith the real world ? "3 Though, as Mrs. Robinson points out, " more often one set will be manageable and, the other realistic," yet there may well be branches of theory where assumptions may be both maniageableand realistic. It is hoped to show in the followingpaperthat a definitionof a firm may be obtained which is not only realistic in that it corresponds towhat 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
1 Joan Robinson, Economics is a Serious Subject, p.
2 12.

See N. Kaldor, "The Equilibrium of the Firm," Economic _ournal, Mllarch, 1934. 8 Op. cit., p. 6. 386 1937]

THE

NATURE

OF

THE

FIRM

387

the margin., Our definition must, of course, "relate to formal relations which are capable of being conceived
exactly."2

It is convenient if, in searching for a definition of a firm, we first consider the economic system as it is normally treated by the economist. Let us consider the description of the economic system given by Sir ArthurSalter.3 " 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...
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