All right, so we've discussed a lot of the risks of operating through the market. What limits firm scope? One might take the arguments we've had so far and say well, markets have all these problems. Why don't we just have one large organization run all of the economic activity within an economy? Well, you can imagine what some of the limits are. First, government. Government and Antitrust try to reduce monopoly powers and prevent the ability to such large organizations there for good policy reasons. Second, there's just mounting bureaucratic costs as you increase the firm's scope here. Coordinating between layers of management becomes more difficult here. Decision making often becomes slower and inflexible as organizations get larger. And you might be less able to adapt to market changes as you become larger and more bureaucratic here. So even though you might achieve some synergies when you diversify into a new business line. You also are often increasing bureaucracy costs as well, as you expand the firm scope. Last but not least, we also have these agency costs that could be created here. As you expand, not only do things get more bureaucratic, they can also get more political. More time is spent, maybe within the organization on influence games, trying to get resources for your business versus another. That might lead to opportunistic behavior of managers and employees. And ultimately, monitoring and sanctioning become more and more difficult as the scope of the firm increases. Ultimately, what we have with the theory of the firm is this idea of a horse race between the costs of doing a market transaction versus the cost of doing it within a firm. So what you see here on this graph is on the bottom axis, this idea of the complexity of the transaction. And by complexity, we're highlighting some of these uncertainties, these information asymmetries and the like that might make a transaction more complex. And on the y axis or the vertical axis, we talk about the these actual transaction costs. So think of something of low complexity. Going to the market and buying an apple. One can see the apple. You can feel it. You can observe it. You can assess whether the apple is ripe and fresh. And when you make the transaction, it's simply pay some money and you receive the apple. There's no risks or at least limited risks that you'll pay and not receive the good. Now think on the other extreme. Something as I mentioned before like paying for creativity or R&D. Again, this is a complex transaction. There's a lot of risk and uncertainty associated with it and it might be very hard to write a complete contract for R&D services and the like. In that situation, a market transaction might actually be more costly than a firm transaction. Where in fact, you can minimize some of these risks and fractions because of once again, of these residual rights of control. So one could imagine an inflexion point where at low complexity of transaction will favor the markets. And then eventually will reach a point where the increasing complexity of transaction drives things into the firm and we want to be diversified into multiple arenas. Think of an example as the following, Disney owns their own cruise line. Now why doesn't Disney just simply contract that out to an established cruise line provider? Well for Disney, they have a lot [INAUDIBLE] on their reputation. They have a lot of high expectations about the engagement of their employees with their clients, with their customers. And it's very hard to write a contract for someone to be happy for example. And have all the employees with a smile on their face. Therefore, it's easier if they manage it themselves and vertically integrate into the actual cruise line business. Then it would likely be if they contracted that out to a third party. So again, the theory of the firm begins to get us to understand the risks associated with both market transactions and encouraging things within the firm. And then trying to find the balance between the two.
