PRODUCTION,

INFORMATION COSTS,
AND ECONOMIC
ORGANIZATION

Armen
Alchian &
Harold
Demsetz 1972

ABOUT THE PAPER

Authored by:
Armen A. Alchian (University of California, Los Angeles)
Harold Demsetz (University of California, Los Angeles)

Published
1972 by The American Economic Review
1975 by Engineering Management Review
1997 in Readings in Microeconomic Theory (Manfredi La
Manna)

ARTICLE OVERVIEW
Resources are controlled by non-governmental
organizations (fi rms, households, markets)
Productivity increased through cooperation demand for
economic organizations

Questions for theory of economic organizations

Under what conditions can the organization or the market
provide greater gains from specialization and cooperative
production?
What is the structure of the organization?

CHARACTERIZATION OF THE FIRM

Firms posses the power to settle issues by fi at, by
authority, or by disciplinary action superior to that
available in the conventional market.
What separates an employer and an employee from
an employer and a customer?
The team and the centralized contractual agent in a team
productive process

Exactly what is a team process and why does it

induce the contractual form, called the fi rm?

THE TEAM
What makes a team?
The use of several resource types
The product does not equal a sum of individual
contributions
Not all resources used by the team belong to one person

Think about two people lifting a 100lb box

Does each person lift 50lbs?
Does one lift 75lb and the other 25lb?

How does a team lead to a fi rm?

THE FIRM
Shirking: A problem with the a team
Fixed by using a Monitor

Residual claimant
Observe input behavior
Central party common to all contracts
Ability to alter team membership
Ability to sell these rights (ownership)

Therefore, the fi rm arises when

It is possible to increase production through a team
It is economical to estimate marginal productivity via
observation

TYPES OF FIRMS
Profi t-Sharing Firms
Used for self-policing small teams

Socialist Firms
Employee-owned fi rms; found where government
restrictions exist

The Corporation
Sells promises of future returns for present fi nancial capital

Mutual and Nonprofi t Firms

Used for shirking duties

Partnerships
Favored for artistic / intellectual ventures

Employee Unions
Serve as monitors of employers for employees

SUMMARY
Individuals own resources
Teams are used to enhance effi cient use of inputs
The contractual structure arises as a means of
enhancing effi cient organization of team production.
Leads to the diff erent models of the fi rm

The fi rm takes on the characteristic of an effi cient

market in that information about the productive
characteristics of a large set of specifi c inputs is now
more cheaply available