Why so much of the economy happens inside firms, not markets
We picture the economy as one giant marketplace, prices shuffling goods from seller to buyer. Yet in the United States, the value added by transactions inside companies roughly equals everything added by open-market deals. Economists have spent nearly a century asking why so much activity escapes the price mechanism altogether, and what markets really are.
At its simplest, a market is any arrangement that lets buyers and sellers swap goods, services or information, with or without money. Its defining trick is that prices carry information: when something grows scarce, a rising price tells producers to make more and consumers to use less, with nobody giving orders. Such arrangements pop up wherever one party wants what another can supply, which is why prisons develop trade in cigarettes and playgrounds in chewing gum.
In 1937 the economist Ronald Coase pointed out an awkward fact. Inside a company, prices stop steering anything. A manager simply tells workers what to do. Coase saw firms and markets as opposite ways of organising production, one run by command and the other by exchange. Later thinkers, including Oliver Williamson, explained the choice through the cost of writing contracts. Because people cannot foresee every contingency, spelling out every deal in advance is expensive, and it can be cheaper to bring the work in-house under a boss.
The numbers show how much happens by fiat. A 2012 estimate put 80 percent of world trade within global value chains, and around half of American imports and 30 percent of exports move between branches of the same firm. One study of 43 countries found that two-thirds of the growth in value added during the 1980s came from companies getting bigger.
Markets still come in bewildering variety, from fish stalls and bazaars to auctions, commodity futures and online exchanges where buyers and sellers never meet. When a market settles at an outcome that wastes resources, economists call it market failure, though fixing it is tricky, since government intervention can fail too.
Source: Market (economics)
