Barry Haworth
University of Louisville
Department of Economics
Economics 201

Why do firms exist?

What kind of firms are there?

Firms organize in one of three general ways:
1) Sole proprietorship - directly owner-operated
2) Partnership - joining of two or more individuals
3) Corporation - "owned" by investors, run by managers

These forms also differ in terms of their liability to potential creditors

  • most partnerships have unlimited liability
  • corporations have limited liability

Why do firms exist?

1. Transactions costs occur as goods and services are provided
Definition: cost of "doing business" (costs other than production and distribution costs)

2. Firms minimize costs
Cost minimization => Profit maximization

Example of various types of transaction costs:

Suppose Ford wants to design and sell a new automobile.
There are various stages that Ford follows, in order to produce a commercially viable product.

What problems may arise?

1. Organizing the project: internal product development or external?
internal commitment of specialized resources => switching costs

2. Securing/appropriating a return on the investment into the project
safeguarding against opportunistic behavior => monitoring costs

3. Adapting to future problems - developing contingencies
"bounded rationality" and costly information => information costs