Thursday, March 1, 2012

Why do we require organization?

In the last blog we began our journey towards understanding the various organizational economic theories. In today's blog we initiate a discussion on "why organizations exist?"

For many this question would raise some odd feeling - Why even as such a question? We know organizations exist, so why did into this at all? It is important to understand this question - since in many ways this forms the starting point of organizational analysis and there by organizational economics.

We shall begin attempting to answer this question with Adam Smith's insight that - economy could be coordinated by a decentralized system of prices - "the invisible hand". Economics post this aimed at identifying the necessary conditions for the effective use of the invisible hand, and designing changes in these settings where the conditions are lacking. Continuing on the same lines, it would be interesting to ask - since the market is so effective in coordinating economic exchanges why would we ever need firms to manage this?

The answer to this question of the existence of firm was provided for the first time by Coase (1937) who suggested that sometimes the cost of managing economic exchanges across markets is greater than the cost of managing economic exchanges within the organizational boundaries. - This argument essentially placed "transaction costs" at the center of the analysis of the reason for firm's existence. In a way the theory put markets and organizations as alternatives to managing the same transaction.

Over the next few blogs we look at understanding the various theories that fall into this stream of organizational economics

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