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.
- Design stage
- Testing stage
- Prototype stage
- Marketing stage
- Commercialization stage
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