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book cover The Theory of the Firm
An overview of the economic mainstream




Paul Walker
ISBN13: 9781138191532
ISBN10: 1138191531
Format: Hardback | 212 pages
Dimensions: 156 x 234mm
Illustrations note: 9 black & white illustrations,
1 black & white tables, 9 black & white line drawings

Published August 2016 by Routledge

The book is number 184 in the Routledge Studies in the History of Economics series.
Firms are an ubiquitous feature of the economic landscape, much of the activity undertaken within an economy takes place within their boundaries. Lafontaine and Slade (2007: 629), for example, state that the "[d]ata on value added [ ... ] reveal that, in the United States, transactions that occur in firms are roughly equal in value to those that occur in markets". Micklethwait and Wooldridge (2003: xv) underscore the importance of firms by arguing that "[t]he most important organization in the world is the company: the basis of the prosperity of the West and the best hope for the future of the rest of the world". Given the size of the contribution made by firms to economic activity, employment, innovation, growth, income and wellbeing, having a sophisticated theoretical understanding of the nature and structure of firms is an crucial component of a proper understanding of how an economy functions.

The theoretical literature on the firm is diverse and growing, albeit from a small base, and no overview of the length presented here could possibly encompass all the different approaches that have been taken, across both time and the spectrum of economic thought, to the analysis of production and/or the firm. We therefore restrict our survey to, in the main, the major 'mainstream' approaches to the firm, in both their 'past' (pre-1970) and 'present' (post-1970) incarnations. The concentration on the mainstream theory is because these theories are, obviously, those which dominate the literature and aspects of the pre-1970 mainstream theory is still the most common, often the only, 'theory of the firm' taught to students. Few of the post-1970 theoretical advancements have made it, as yet, into the standard (in particular undergraduate) economics textbooks.

While the intention here is to provide a concise, reasonably critical, yet readable survey primarily focussed on the contemporary advancements within the theoretical literature on the firm we also wish to help readers understand the evolution of the ideas that have resulted in these theories, to which end we consider, albeit briefly, the theoretical approaches of the pre-1970 literature as well as the approaches of the post-1970 period. Consideration of the history of the theory of the firm allows us to see the changes that have taken place with regard to economist's thinking on production and/or firms over the last 200 years or so. We will argue that over time a more sophisticated understanding of firms has begun to be developed, which has in turn led to the development of related areas such as the theory of privatisation, and we will look at some possible ways that the mainstream theory of the firm could evolve to continue this trend into the future.

Even for critics of the orthodoxy an appreciation of the mainstream theory is needed to understand the reasons for and the advantages/disadvantages of the non-standard approaches taken in the heterodox literature.

The unique aspects of the book include its discussions of 1) the post-1970 contributions to the theory of the firm - the book offers an intuitive introduction to the contemporary theories of the firm as well as simple formal models of the most important contributions to the literature; 2) the integration of the theory of the entrepreneur with the theory of the firm; and 3) the theory of privatisation. Such a combination of topics is not covered in most other texts.

An extensive bibliography is provided to guide readers to further reading on topics of interest and as a starting point for reading on material not covered directly in the text. See, for example, Chapter note 3, page 6, for information on other surveys of the mainstream theory and the pertinent empirical evidence, in addition to coverage of some applications and extensions of the mainstream approaches to the firm. For another example see Chapter note 6, page 7, for references that provide, along with their own bibliographies, a starting point for reading on the heterodox literature.

It has been assumed that reader will have been exposed to the standard introductory/intermediate 'textbook' treatment of the 'firm' and thus little time need be spent on a discussion of the details of this material.

In terms of the mathematics required we try to follow the advice of A. W. Zotoff: "In spite of the maxim, "Il ne s'agit pas de faire lire, mais de faire penser," we think that mathematical problems should not be given to economists to solve, and that mathematical economics should be treated as simply as possible, with all results worked out in detail" (Zotoff 1923: 115). We thus attempt to provide as much detail as is needed for a senior undergraduate to follow any mathematical argument relatively easily.

This book is of great interest to those who study history of economic thought, organisational economics and industrial economics.

  • Lafontaine, Francine and Margaret Slade (2007). 'Vertical Integration and Firm Boundaries: The Evidence', Journal of Economic Literature, 45(3) September: 629-85.
  • Micklethwait, John and Adrian Wooldridge (2003). The Company: A Short History of a Revolutionary Idea, New York: The Modern Library.
  • Zotoff, A. W. (1923). 'Notes on the Mathematical Theory of Production', Economic Journal, 33 no. 129 March: 115-21.
      A note on the numbering of equations and figures
      Preface and acknowledgments

1   Introduction (pdf)
               Chapter notes

2   The past
         2.1 Background
         2.2 Neoclassical
            2.2.1 Summary
         2.3 Behavioural and managerial models
            2.3.1 Behavioural models
            2.3.2 Managerial models
            2.3.3 Summary
         2.4 Demsetz and the neoclassical model
         2.5 Conclusion
               Chapter notes

3   The founding works
         3.1 Knight - Risk, Uncertainty and Profit
         3.2 Coase - The Nature of the Firm
         3.3 Conclusion
               Chapter notes

4   The ‘present’
         4.1 The post-1970 theories of the firm
            4.1.1 Mainstream theories
      Principal-agent type models
      Incomplete contracts models
      General criticisms
            4.1.2 Recent developments within the mainstream
      The reference point approach
      Spulber 2009
      Foss and Klein 2012
            4.1.3 Summary
         4.2 Reference points, property rights and transaction costs
         4.3 The theory of privatisation
            4.3.1 Background
            4.3.2 Definitions of privatisation
            4.3.3 The post-1980 theories of privatisation
            4.3.4 Summary
         4.4 Conclusion
               Chapter notes

5   Partial versus general equilibrium
               Chapter notes

6   Conclusion
               Chapter notes

      Appendix 1: the particular expenses curve
      Appendix 2: Simon (1951)
      Appendix 3: monotone comparative statics
      Appendix 4: examples of poor SOE performance


The book is available for order from most booksellers including
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The Amazon Kindle page.

If you find a new error let me know via this form. Thanks.

Errors so far:

The numbering of equations is wrong. The numbering system should be "page number.equation number". This mean that equation 65.2 should be the second equation on page 65. But it is not. For most equations in the book the numbering system turns out to be "page number −1.equation number" so that equation 65.2 actually appears on page 66. In addition there are some pages with equations numbered by two different page numbers included on them. Page 82 has numbers equation numbers 81.1, 82.1, 82.2 and 82.3 on it. Page 86 contains equations 85.1 and 86.1.

p. 5 footnote 1: Quotes around the first appearance of firm should be single quote marks while the quotes around the second use of firm should be double quotes.

p. 7 footnote 6: add, as its own paragraph, `Boulding (1950) offers an ``ecological framework" for modelling the economy with the firm being one of the ``economic organisms" making up the economy' after `and Jacobides and Winter (2005)' and before `The most'.

p. 7 footnote 6: replace Foss (1994, 1997) with Foss (1994a, 1997).

p. 8 footnote 7: the quote marks around entrepreneur and undertaker in the sentence beginning “In his 1931 …” should be single quote.

p. 8 footnote 8: the quotes around uncertainty and risk in the sentence beginning “On the nature of …” should be single quotes.

p. 24: replace (Foss 1994a: 1121) with (Foss 1994b: 1121).

p. 38 footnote 1: after "... Sreni on pages 10–11." place "For more on the development of the corporate form see Dari-Mattiacci, Gelderblom, Jonker and Perotti (2017)."

p. 47 footnote 40: replace Foss (1994a: 1119) with Foss (1994b: 1119).

p. 47 footnote 41: replace (Foss 1994a: 1120-1) with (Foss 1994b: 1120-1).

p. 53: section heading 3.2: delete single quotes around The Nature of the firm.

p.73: reference to Holmstrom and Tirole (1989) should be Holmstrom and Tirole (1991).

p. 85: second line from the top "vale" should be "value".

p. 96: Math aside: reu_B(z,G; rho) should be replaced by u_B(z,G; rho).

p. 131: last line on the page "nothelp" should be replaced by "not help".

p. 135: 5th line from the top "plus revenue" should be replaced by "plus revenue $(p\times q)$". (This is the tex code that gives the desired result, which is roughly (p x q))

p. 135: Figure 135.1: "Firm's revenue" should be replaced by "Payment to firm". On the vertical axis "p" should be added opposite where the horizontal dashed line ends at the vertical axis.

p. 146: replace footnote 12 with See, for example, Bolton and Dewatripont (2005: 37) and Buhai (2003: 3). Gibbons and Roberts (2013: 2) write, ``Herbert Simon (1951) offered perhaps the first formal model in organizational economics, [...]" while McLeod (2016: 107) says ``The first formal model of incomplete contracts is due to Simon (1951)".

p. 153: chapter note 53: Gupta, Shiller, Ma and Tiongson (2001) should be Gupta, Schiller, Ma and Tiongson (2001).

p. 158: lines 29 and 30 from the top remove the two dashes around the expression "How does a producer act in its factor and product markets?". Add a comma after the ? at the end of the expression just given.

p. 178: replace reference Aghion, Philippe, Mathias Dewatripont, Patrick Legros, and Luigi Zingales (eds.) (2014a). ‘Grossman & Hart at 25’, Journal of Law, Economics, and Organization, 30(suppl. 1) May: i1–i175.
Aghion, Philippe, Mathias Dewatripont, Patrick Legros, and Luigi Zingales (eds.) (2014a). ‘Grossman & Hart at 25’, Journal of Law, Economics, and Organization, 30(suppl. 1) May: i1–i175. The papers from this special issue of the journal have been reprinted in Aghion, Dewatripont, Legros, and Zingales (2016).

p. 178: add reference Aghion, Philippe, Mathias Dewatripont, Patrick Legros, and Luigi Zingales (eds.) (2016). The Impact of Incomplete Contracts on Economics, Oxford: Oxford University Press.

p. 181: add reference Boulding, Kenneth E. (1950). A Reconstruction of Economics, New York: John Wiley and Sons, Inc.

p. 184: add reference Dari-Mattiacci, Giuseppe, Oscar Gelderblom, Joost Jonker and Enrico C. Perotti (2017). ``The Emergence of the Corporate Form", Journal of Law, Economics and Organisation, 33(2) May: 193-36.

p. 186: replace Foss, Nicolai J. (1994) with Foss, Nicolai J. (1994a)

p. 186: replace Foss, Nicolai J. (1994a) with Foss, Nicolai J. (1994b)

p. 188: the reference Gupta, Sanjeev, Christian Shiller, Henry Ma and Erwin Tiongson (2001) should be Gupta, Sanjeev, Christian Schiller, Henry Ma and Erwin Tiongson (2001).

p. 191: add reference for Holmstrom, Bengt and Jean Tirole (1991). ‘Transfer Pricing and Organizational Form’, Journal of Law, Economics, and Organization, 7(2) Fall: 201-28.

p. 193: add reference for MacLeod, W. Bentley (2016). 'The Empirical Implications of the Grossman-Hart Model: Comments on ``Incomplete Contracts and the Internal Organization of Firm" by P. Aghion, N. Bloom and J. Van Reenen'. In Philippe Aghion, Mathias Dewatripont, Patrick Legros, and Luigi Zingales (eds.), The Impact of Incomplete Contracts on Economics (pp. 106-15), Oxford: Oxford University Press.

p. 209: the index entry “NEXUS OF CONTRACTS 63” should be deleted.

p. 211: the index entry Tiongso, E. 153 should be Tiongson, E. 153