Asset specificity and economic organization

Abstract This paper examines the optimization problem of firm and market organization in which both production cost and transaction cost differences are expressed as a function of asset specificity. In general, markets enjoy advantages by aggregating the demands of many buyers, thereby realizing economies of scale or scope. Such production cost savings need to be assessed in relation to the transaction cost advantages that internal organization sometimes enjoys over markets in adapting to changed circumstances. As it turns out, both production cost economies and the transaction cost differences between firm and market organization vary systematically with the characteristics of the investments. This paper employs a unified framework to assess the choice of organization form. The condition of asset specificity is featured.

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