Knowledge And Decisions

From this it is clear that one reason for the existence of a business firm is to economize on the production or application of knowledge. Any user of an “Instamatic” camera could acquire as much knowledge as is used in presetting the lens and shutter by purchasing an elementary book on photography and investing a few hours in reading it. Since the consumer sees people all around him with adjustable cameras, he knows that it is neither impossible nor probably very difficult to acquire such knowledge. His is therefore an informed choice to purchase the knowledge from the camera manufacturer, rather than produce this knowledge himself from a book. This is a perfectly rational choice where the camera firm can produce the quantity of knowledge needed (for casual snapshots) at a lower cost than the consumer. From the point of view of society at large, fewer resources are used to produce a given product or to achieve a given end result.

One of the reasons the firm has lower costs than the consumer would have is that it engages in fewer transactions in proportion to its volume of output. A consumer who wished to hire a photographic expert to tell him at what distance to focus his lens would have to determine the likely sources of such experts and the means of determining their expertise, as well as not buying more expertise than he needed, and other such problems. The cost of hiring the expert, spread over one or two cameras would be much higher per camera (or per picture) than when a camera manufacturer hires experts to guide its decisions on thousands of cameras. Similar considerations apply to the hiring of many kinds of workers (including management) and to the hire or purchase of specialized equipment.

In the theoretical extreme, each worker could hire various fractions of his time to various employers, as some workers do in practice to some extent. But theoretically the worker would be ready to sell the tiniest fraction of his time to different employers or to change employers at any given instant of the working day when the fluctuations of the labor market might offer a marginally higher wage rate somewhere else. Such behavior would, of course, involve very high transactions costs to the worker — and to the employer, who would have to be constantly prepared to fill vacancies at a moment’s notice. Contractual and semicontractual arrangements, including “adequate notice” customs, reduce these transactions costs, at the cost of reduced institutional flexibility in the quantity and quality of labor employed, and in the quantity and quality of work obtainable from given workers in a situation where “instant firing” is often not a feasible option. That many firms voluntarily chose to accept such costs of institutional rigidity implied in having “regular employees” — even before union or legal pressures for job security — suggests that transactions costs would be substantial otherwise. That other firms had to wait for such outside pressures suggests that the relative weights of those costs and benefits vary from situation to situation.

As in the general question of the relative advantages of formal versus informal procedures, the point here is not to determine which is better categorically. On the contrary, the point is to suggest why there is a trade-off. The particular terms of that trade-off, and the way those terms vary incrementally, is likely to be far better known to those directly involved than to others operating on general principles.

Even after acquiring the formal institutional structures implied where firms sell to consumers, economic processes still retain substantial elements of incremental rather than categorical decision making. The consumer, by choosing among firms to patronize, implicitly weighs the effectiveness of different sets of workers and managers, rewarding some with fuller, more sustained employment, and forcing others to work less or not at all — despite any institutional guarantees — for lack of consumer demand can force the institution itself out of business. Even where the consumer chooses to buy prepackaged products, his range of choice among such products and retailers of products usually prevents his being forced into the kind of take-it-or-leave-it “package deal” choices common in such fields as politics, where he must vote for one candidate’s whole “package” of positions on foreign policy, civil liberties, ecology, race relations, monetary policy, etc. The almost continuous revision of most economic decisions adds a temporal flexibility not found in political systems with fixed terms of office, where recall and impeachment are costly options.