Why Do Firms Exist in Market Economy

I think that Fridrich Hayek was one of the greatest economic and political thinkers in the twentieth century, who insisted that the collective intelligence of general public was better than the wisdom of elites. He supported market economy and criticized planned economy.

Basically I also believe that market economy works far much better than governments and governments should play just accessory roles, because market economy reflects the collective intelligence of general public and governments are based on the "wisdom" of elites.

But if market mechanism is more effective than any organization, why do firms or governments exist in market economy? Why do firms work better than market economy?

Ronald Coase answered this question in his book "the Firm, the Market, and the Law." His answer is "transaction cost."

In order to explain why firms exist and what activities they undertake, I found it necessary to introduce a concept which I termed in that article "the cost of using the price mechanism," "the cost of carrying out a transaction by means of an exchange on the open market," or simply "marketing costs." To express the same idea in my article on "The Problem of Social Cost," I used the phrase "the costs of market transactions." These have come to be known in the economic literature as "transaction cost." I have described what I had in mind in the following terms: "In order to carry out a market transaction it is necessary to discover who it is that one wishes to deal with, to inform people that one wishes to deal and on what terms, to conduct negotiations leading up to a bargain, to draw up the contract, to undertake the inspection need to make sure that the terms of the contract are being observed, and so on." Dahlman crystallized the concept of transaction costs by describing them as "search and information costs, bargaining and decision costs, policing and enforcement costs."

The Internet gave a great impact on the structure of transaction costs and firms should adjust themselves to it. This change brought the rise and fall of Apple and Sony. Now that Apple successfully adjusted to the new structure of transaction costs, but Sony failed it.

Drucker pointed out that the role of enterprise as follows.

Because it is the purpose to create a customer, any business enterprise has two ― and only two ― basic function: marketing and innovation. These are the entrepreneurial function.

In a sense, it's true. Apple has succeeded, because they concentrated in marketing and innovation. But at the same time, Foxconn also has succeeded, because they got the order of fabrication from Apple.

The key factor of success is to clear up their own position in the new structure of transaction costs. Any organization should identify that what cost they can save in the market economy.