Firms and

Markets
 How is production organised?
• Markets
work on one’s own-account and sell directly to others (e.g., farmers)
work by service-contractors (e.g., plumbers, tailors)
• Firms with differing ownership structures:
individual proprietorships
partnerships (including share-tenancy)
corporations (especially joint-stock)
 Markets and firms
• (Firms) employment or wage-relationship
involves an authority relationship
pay an amount (wage or salary) in exchange for worker’s agreement
to do the employer’s bidding within certain bounds
• (Markets) sale or contract work
payment of a contracted price to perform a pre-determined piece of
work (like paying a definite price for a given good).
 A world with markets but without firms?
Cotton farm

Spinner

Weaver

Dyer

Sastre/tailor final customer

Cotton farm

Textile firms

garment firm retail firm/final customer

 Why do firms exist at all?
 transactions costs of using only the market (Coase 1938)
need to draw up and enforce lengthy contracts
slow uptake of new technology; risk of loss of control over
innovations
 technology: taking advantage of economies of large-scale
production
 expansion: superiority of some types of firms in raising funds
for expansion
 Labour force by class of worker (%)
Philippines

2002 2021
Wage and salary workers 48.3 62.2
Self-employed 38.5 28.1
Unpaid family workers 13.1 7.3

There is a long-term shift towards wage employment reflecting a decline in

informal-sector employment, independent crafts, and self-employment in agriculture.
 Why do firms exist at all?
Disadvantages from owners’ viewpoint
 monitoring costs
– incentives (e.g., fixed wage) not directly related to output
– inherent opportunism among employees (so-called “principal-agent”
problem)
 obligations imposed by social legislation
– standards on pay and benefits (social insurance)
– legal procedures for hiring, training, and firing
 Summary
Markets/contracting
 no incentives problem
 less encumbered by social rules
 costly contracting and enforcement
 slow response to or loss of control of
new technology
Firms
 adaptability to new technologies and
changing demand
 accommodates large-scale production
 advantage in financing
 costly monitoring of effort
 covered by rigid social legislation
 Types of firms
 Sole proprietorship (single owner)
– affords greatest degree of control
– but limited ability to attract outside funds
– expansion based on owner’s ability to borrow on his own account
– potentially puts owner’s entire wealth at risk
– less regulation, e.g., does not have to be registered with the SEC
 Types of firms
 Partnerships
– a middle form permitting sharing of costs and talents
– difficult to raise outside funds beyond wealth and creditworthiness of
partners
– unlimited liability: partners jointly and individually liable for debts
when bankruptcy occurs
 Types of firms
 Joint-stock corporations
– In its modern form, mainly a Western invention (17. C) to spread risk among
many owners in overseas projects (e.g., discoveries, settlements)
– a legal personality independent of owners; “immortal” in principle
– “limited liability”: in case of bankruptcy, owners liable only for the
amount they originally contributed to the firm
– attractive for outsiders to own shares of the firm, providing funds for expansion
– but it may dilute control by original owners; (in modern corporations, true
control is with managers, not the many shareholders)
 Summary
Liability Financing Owner
potential Control
Sole proprietor Full Low High

Partnership Full Low Shared

Corporation Limited High Limited