What do you mean by theory of firm, Managerial Economics

Q. What do you mean by Theory of Firm?

Microeconomics especially the theory of firm, assumed importance and attracted considerable attention in the early 20thcentury. This shift ensued after the growing realisation that perfect competition assumption of the classical economists wasn't a ground reality. This realisation resulted in a spate of efforts to analyse and understand the behaviour of individual firms. In perfect competition, all firms are presumed to be price takers and consequently studies into the behaviour of individual firms weren't called for. Because the reality was far different, the urgency to study the behaviour of firms of all sizes was obvious. Naturally theory of the firm, rather how firms, small andbig, behave under different circumstances began to attract wide attention, especially in the aftermath of World War I.

The need for a revised theory of the firm was emphasised by empirical studies undertaken by Berle and Means that made it clear that ownership of a typical American corporation is spread over a wide number of shareholders, leaving control in the hands of managers who own very little equity themselves. Hitch and Hall found that executives made decisions by rule of thumb rather than in accordance to marginal analyses. Firms exist as an alternative system to market mechanism when it's more efficient to produce in a non-price environment. For illustration in a labour market, it may be very costly or difficult for firms or organisation to involve in production when they have to fire and hire their workers depending on supply/demand conditions. It may also be expensive for employees to shift companies everyday looking for better alternatives. So firms engage in a long-term contract with their employees to minimise the cost.

Klein (1983) asserts that 'Economists now recognise that such a sharp distinction [between inter- and intra-firm transactions] doesn't exist and that it's useful to consider also transactions occurring within the firm as representing market (contractual) relationships'. The costs involved in such transactions which are within a firm or even between the firms are transaction costs.

According to Putterman, this is an exaggeration-most economists accept a distinction between the two forms though also that two merge into each other; extent of a firm isn't simply defined by its capital stock. Richardson for illustration, notes that a rigid distinction fails because of existence of intermediate forms between market and firm such as inter-firm co-operation. 

Eventually whether the firm constitutes a domain of bureaucratic direction which is shielded from market forces or simply 'a legal fiction', 'a nexus for a set of contracting relationships among individuals' (Meckling andJensen) is 'a function of the completeness ofmarkets and ability of market forces to penetrate intra-firm relationships'.

Posted Date: 8/12/2013 2:35:50 AM | Location : United States

Related Discussions:- What do you mean by theory of firm, Assignment Help, Ask Question on What do you mean by theory of firm, Get Answer, Expert's Help, What do you mean by theory of firm Discussions

Write discussion on What do you mean by theory of firm
Your posts are moderated
Related Questions
define scarcity and oppurtunity cost.show how these concepts are useful in managerial decision making

The International Monetary Fund The International Monetary Fund is a kind of an embryo World Central Bank.  Its objectives are: i.    To work towards the full convertibilit

a.  A major freeze destroys a large number of orange trees in Florida Ans- Since the freeze destroyed a large number of orange trees in Florida the number of oranges the selle

Individual firm and market supply curves The quantities and prices in the supply schedule can be plotted on a graph. Such a graph is called the firm supply curve. A fir

Dumping If goods are sold on a foreign market below their cost of production this is referred to as dumping.  This may be undertaken either by a foreign monopolist, using high

What is Cyert and March's behavior theory? What are the demerits.

how realistic is the sales maximisation model from your experience with business objectives as persued by firms

If a firm's organisational characteristics have not any implications for its behaviour or more possibly have implications that can be taken into account without adopting a behaviou

income generation process through investment multiplier

What is the Permanent Income Hypothesis? What is the theory's potential relevance for assessing the effects of temporary tax cuts for the purpose of fiscal stimulus? If you were