Wednesday, March 18, 2015

Answers to the questions posted on March 12

Here I will give answers to the two questions asked in my preceding post, dated March 12, 2015.

Question 1: Why do people form firms?

Quick Answer: To exploit a resource pattern.

A “firm”, if you are not familiar with this usage, means a business firm. This term is used by economists to describe a business organized under a single ownership or control.

Our question “Why do people form firms?” is an important question for economists because the main models of neoclassical economics can not explain why people form firms. We see firms all around us. But neoclassical models of supply and demand in markets rest upon assumptions which seem to eliminate any possible need for firms.

This inadequacy of neoclassical models motivated Ronald Coase’s 1937 paper “The Nature of the Firm”. Coase called attention to transactions costs and suggested that people form firms to reduce transactions costs. His great work spawned a new sub-discipline in economics. Wikipedia tells more.

The Resource-Patterns Model of Life (RPM) offers another answer to our question “Why do people form firms?” People form a firm to exploit a resource pattern (RP). Figure 1 recalls our first example in which a population of critters exploits a RP which none of the critters acting alone could have exploited. We might call this population, which thrives by following a simple set of rules, a firm. The concepts which I am trying to build, at this stage in our development of RPM, overlap somewhat but not perfectly with the meanings we impute to our common terms "organization" and "firm".

Figure 1: A thriving community (exploiting a RP by following rules).

Let us consider two ways that critters might have formed this firm.

1. Spontaneously
When we think about it, it seems evident that a population of critters living in the vicinity of a resource pattern will eventually discover and exploit the pattern. Just random movement can explain the discovery, if we allow enough time. Furthermore, critters may be endowed with properties such as curiosity and civility which increase the speed with which they could be expected to discover the RP.

2. With forethought
First, remember two of our assumptions:
  • There are resource patterns in the universe.
  • Living Things survive by finding and imbibing resources.
In our thought experiments we will endow our critters with increasing abilities of calculation and perception. At the outset our critters do not know that the resources upon which they rely are distributed in patterns around them in their environment. But, given certain levels of intelligence and experience, our critters will recognize such patterns and they will focus their activities in order to minimize the effort they expend to gather their necessary resources from these patterns.

Later on, given more intelligence and experience, our critters might guess that there exist other RPs in the universe out beyond their community, as yet undiscovered by critters. That is, they will guess that there are patterns of RPs in the universe. Some fortunate critters in an established community may lend their surplus resources to a party of explorers. The explorers, upon traveling to a location that seems to promise viability, may succeed in establishing a new community. Such a community, we could claim, had been established with forethought, and not from time-consuming spontaneous discovery.

Question 2: When does planning for a new firm succeed?

Quick Answer: When the plan connects with a resource pattern.


Figure 2: A thriving population (center) ready to attempt colonization.
Consider Figure 2. We see an established population of critters exploiting a resource pattern in the center of this area. We also see an available resource pattern to the right of that established population. Recall that the dotted line around the RP means that we human modelers know about the RP, but the critters do not know about it yet.

We imagine, as we have just sketched above, some colonists are sent out from the established community, following hopeful plans to settle new RPs. In Figure 3, we see the results of two such plans, one plan being to establish a new colony to the right of the parent, the other being to establish a new colony to the left of the parent.

Figure 3: One plan destined to fail; another plan likely to succeed.
I hope it is obvious to my reader that one of these plans (to the right) has a good chance of succeeding, while the other plan (to the left) has no chance at all. Will you join me in supposing that, in order for a plan to form a new firm or organization to succeed, it is necessary that the plan connects with a RP?

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