Escalona, James Adriane S.

4ECO1

Contract Theory of the Firm Summary

The author of the Contract theory of the Firm decided to write this article to answer various
questions regarding the true meaning of a firm, company and enterprise. The agenda of the paper was
not just to give the definite and correct answers to these words but to also study the broad concept of
economic literature. The aforementioned words are mentioned in our every day lives. However, few
people only knew what are the true meaning of these words. According to the article there are too many
major schools who had published their own opinion regarding the subject which led to some of them
winning Nobel prize. As I continue to read the article, we will be able to talk about what encompasses the
pure definition of Firm, in a Lawyer’s stand point firms are legal entities and sociologists uses sociological
point of view to determine firm and many more as this early in the paper I think that firms are views into
different perspective in different field, we will be able to answer that through the course of this paper.

In the field of economics there is an agreement in the theory of the firm and the theory is that firm
determines the effects and behaviors of firms on how they allocate and distribute scare resources.
Through time different theories were made and it had been difficult in comparing these theories towards
one another since it has different frame map on how that theory was created. In 1989, according to
Holmstrom and Tirole on the pioneer work of Coase the focused and answered three different questions.
They stated that the existence of firms must be examined since market and firms are interconnected
towards one another whereas they both perform transactions. However, they also stated that markets
can carry out transactions itself so why firms exist? Firms are dependent to its internal structure.
Furthermore, in the Neoclassical price theory transactions must be smooth to avoid independencies and
errors in the production process. There are two coordinating institutions that allows this to happen which
is the market and organization (firm) that being said, in the neoclassical theory organization can be
eradicated since market can already perform transactions smoothly.

Another theory from the article which is the principal-agent theory states that owners and
management of firms are not the same, the relationship of the two are said to be under a contract. Thus,
not answering how firm actually works if there are too many theories circulating around its meaning.
Theories of firm are full of uncertainties different authors and fields have opinions towards one another
not interconnecting or not being related at all.
 The Economic theory of the Firm as a foundation for international business theory summary

In multinational enterprise the economic theories of firms are a central structure to its theory.
However, it is only limited within the boundaries of the theory of economic firm itself. Through
neoclassical theory of firm, the production function and the institutional theory of the firm in its
imperfections was a step that paved way in the development of internalization theory. In this article it is
stated that economists only noticed the importance of production and firm in their relationship towards
one another. The internalization theory was created to explain why foreign direct investment was
concentrated in knowledge-intensive industries with the role of coordinating the transfer technology
within control. One of the purposes of the principal application of internalization theory is to serve an idea
and control for mode of entry decision for exporting and licensing and FDI.

In the comparison between Government and Firms it is stated that firms can exist in a socialist
economy in decision-making units. The internalization reduces the profits that could make the firm unable
to invest that it would fail, perfect market will not bring any help in the internalization as it cannot
contribute to the theory. The product of imperfect market will help the internalization theory benefit from
it which will avoid imperfects and errors. It is known that markets are uncompetitive making price
discrimination being impractical, products are heterogeneous and untrustworthiness of traders.

Imperfect competition and price discrimination, in the competition of different firms there will
always be opportunists, firms would set up to exploit different firms and the imperfection in the market,
if competition is based on freedom, then it would be free of exploitation of consumers. In the
heterogeneity of the market, the imperfections are the cost of seeking suitable suppliers or customers
that would allow them to compare prices from other competitions. The importance of economic theory
of the firm is important in creating different theories to discover different answers and discoveries that
would help professionals to further understand firms. Without Economic theory of firm, the IB theory will
never exist as the theory of firm is its foundation.
 Theories of Firm

The theories of firm are broad in different views and perspective from different fields and theories.
The foundation of these theories are the Neo-classical economics with its consumptions. It talks about the
in-depth analyzation of supply and demand. However, the deeper the lesson of this neo-classical
economics it can become more complicated than it ever was before. This article discusses how neo-
classical economics becomes one of the foundations of theories of firm.

In neo-classical microeconomics there are many assumptions revolving around the topic. It is
assumed that consumers are utilizing products at its limits, with different preferences on their own it
brings producers to be more competent when it comes to producing products for these consumers to
keep their competitive level from other firms. Consumers and producers as this interconnection between
them that helps them to understand the behavior and preferences towards what they want and the
products they plan to produce. Producers are practicing and studying every thing in the world and in the
future that might affect their decision making for their company. There is an equilibrium in the consumer
and producer, both are competent of their own understanding on how the market will flow and operate.
Furthermore, a critical contribution in the neo-classical economics from Adam Smith’s Wealth of Nations
that is known as the founding texts of knowledge for economics where it talks about the known two
observations from Adam Smith, the first being the economic self-interest. The self-interest has taken for
granted the moral sympathy of people in the community itself, although years of studies have already
been made where these different studies states that self-interest is not an issue regarding the economic
activity and its relationship to the community.

From three different articles there have been a lot of definitions of what is the meaning of a firm.
It will let you study the definition of this firms from different countries and economics of the world inviting
you to be curious in searching for its rightful meaning. It comes from different economist, from different
fields, it will bring you into the agency theory and corporate governance, the word firm is broad it has
tangible connections from different parts of things that operates the economy. Studies about how market
and firms are not related will also let you judge your own understanding regarding this topic. To conclude
this paper finding the meaning of the true foundations of the word firm will require men to go beyond
what they already know, men is limited by morality and laws that’s why answers are vague and it cannot
be discovered in the easiest way.