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The purpose of companies is to reduce transaction costs
The purpose of companies is to reduce transaction costs. Suppose that the costs of market transaction go up, everything else held constant, firms will
(a) increase their size because they are needed more than ever.
(b) decrease their size because they are not fulfilling their purpose.
(c) remain the same because companies no longer care about transaction costs.
(d) Unknown; not enough information to say.
Expert Solution
The correct answer is (b) decrease their size because they are not fulfilling their purpose.
This is the correct answer because with the increase in transaction cost and keeping the remaining variables fixed, there will be an increase in the variable cost for the firm. It will lead to an increase in the per-unit cost of production and thus a reduction in firm profits. Thus the firm will reduce its size to cover the increased transactional cost and in an attempt to reduce the overall cost per unit of production.
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