A Statistical Mechanics Approach to Coase's Theory of the Firm

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The project uses modeling techniques originally developed in physics to understand the growth of business firms. Physicists have analyzed systems in which the behavior of one "unit" (an atom, perhaps) is affected by the behavior of a large number of other units. The effect of each individual interaction may be small, but the aggregate effect is not. By analogy, the growth of each business firm is affected by a large number of other firms: competitors, customers, suppliers, and the producers of related products. In 1939, Coase published a seminal article in which he argued that firms exist to minimize transaction costs. This article provided the framework that economists still use to try to understand the size and growth of firms. Even though the logic of this framework is widely accepted, it has not yielded testable predictions about the size and growth of individual firms that have been verified empirically. In other words, it has not passed the fundamental test of a successful scientific theory. The results in models of physical systems with large numbers of interacting units are that while the behavior of any one unit is inherently unpredictable, the statistical properties of the entire system are predictable. This project develops models that are consistent with the framework suggested by Coase, that explain well-documented regularities about the distribution of firm size and growth, and that explain why the growth, size, and composition of individual firms are inherently unpredictable. While this project is basic research, the results could ultimately affect antitrust and other aspects of industrial policy.