structural:reformatting, structural:scholar_edition
Definition

In economics, a market is a coordinating mechanism that uses prices to convey information among economic entities (such as firms, households and individuals) to regulate production and distribution. In his seminal 1937 article " The Nature of the Firm ", Ronald Coase wrote: "An economist thinks of the economic system as being coordinated by the price mechanism....in economic theory we find that the allocation of factors of production between different uses is determined by the price mechanism". Thus the usage of the price mechanism to convey information is the defining feature of the market. This is in contrast to a firm, which as Coase put it, "the distinguishing mark of the firm is the super-session of the price mechanism".

Thus, Firms and Markets are two opposite forms of organizing production; Coase wrote:

Outside the firm, price movements direct production, which is co-ordinated through a series of exchange transactions on the market. Within a firm, these market transactions are eliminated and in place of the complicated market structure with exchange transactions is substituted the entrepreneur-co-ordinator, who directs production.

There are also other hybrid forms of coordinating mechanisms, in between the hierarchical firm and price-coordinating market(e.g. global value chains, Business Ventures, Joint Venture, and strategic alliances).

The reasons for the existence of firms or other forms of co-ordinating mechanisms of production and distribution alongside the market are studied in "The Theory of the Firm" literature, with various complete and incomplete contract theories trying to explain the existence of the firm. Incomplete contract theories that are explicitly based on bounded rationality lead to the costs of writing complete contracts. Such theories include: Transaction Cost Economies by Oliver Williamson and Residual Rights Theory by Groomsman, Hart, and Moore.

The market/firm distinction can be contrasted with the relationship between the agents transacting. While in a market the relationship is short term and restricted to the contract, in the case of firms and other co-ordinating mechanisms it is for a longer duration.

In the modern world much economic activity takes place through fiat and not the market. Lafontaine and Slade (2007) estimates, in the US, that the total value added in transactions inside the firms equal the total value added of all market transactions. Similarly, 80% of all World Trade is conducted under Global Value Chains (2012 estimate), while 33% (1996 estimate) is intra-firm trade. Nearly 50% of US imports and 30% of exports take place within firms. While Rajan and Zingales (1998) have found that in 43 countries two-thirds of the growth in value added between 1980 and 1990 came from increase in firm size.