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Division of Labor, Transaction Cost, Emergence of the Firm and Firm Size


  • Pak-Wai Liu
  • Xiaokai Yang


In this paper a general equilibrium model is constructed to explain the emergence of firms and change in firm size by the tradeoff between economies of specialization and transaction cost. We show that firms emerge from the development of division of labor if the transaction efficiency for labor is smaller than that for intermediate goods. Given the emergence of firms, change in the average size of firms (average employment) will depend on the change in transaction efficiency for intermediate goods relative to that for labor. If the transaction efficiency is improved in such a way that the transaction efficiency for intermediate goods becomes higher than that for labor, average employment will decrease. We present evidence showing that it is not uncommon that average employment declines as the economy develops. The general equilibrium model provides an explanation for the concurrent increase of productivity and decrease in average employment which is observed in a number of countries. Models based on economies of scale instead of economies of specialization would have yielded the opposite prediction.

Suggested Citation

  • Pak-Wai Liu & Xiaokai Yang, 1999. "Division of Labor, Transaction Cost, Emergence of the Firm and Firm Size," CID Working Papers 10, Center for International Development at Harvard University.
  • Handle: RePEc:wop:cidhav:10

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    References listed on IDEAS

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    5. Xiaokai Yang & Yew-Kwang Ng, 2006. "Theory Of The Firm And Structure Of Residual Rights," World Scientific Book Chapters,in: Inframarginal Contributions To Development Economics, chapter 10, pages 231-258 World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Sachs, J.D. & Yang, X., 1999. "Graduate Spread of Market-Led Industrialization," Papers 11, Chicago - Graduate School of Business.

    More about this item


    irrelevance of size of the firm; division of labor; theory of the firm;

    JEL classification:

    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure
    • L23 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Organization of Production
    • L33 - Industrial Organization - - Nonprofit Organizations and Public Enterprise - - - Comparison of Public and Private Enterprise and Nonprofit Institutions; Privatization; Contracting Out


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