Only one task now remains ; and that is, to see whether
the concept of a firm which has been developed fits in with
that existing in the real world. We can best approach the
question of what constitutes a firm in practice by considering
the legal relationship normally called that of “ master and
servant” or “employer and employee?’ The essentials
of this relationship have been given as follows:
“ the servant must be under the duty of rendering
personal services to the master or to others on behalf
of the master, otherwise the contract is a contract for
sale of goods or the like.
The master must have the right to control the
servant’s work, either personally or by another servant
or agent. It is this right of control or interference, of
being entitled to tell the servant when to work (within
the hours of service) and when not to work, and what
work to do and how to do it (within the terms of such
service) which is the dominant characteristic in this
relation and marks off the servant from an independent
contractor, or from one employed merely to give to his
employer the fruits of his labour. In the latter case,
the contractor or performer is not under the employer’s
control in doing the work or effecting the service; he
has to shape and manage his work so as to give the result
he has contracted to effect“
We thus see that it is the fact of direction which is the
essence of the legal concept of “ employer and employee,”
just as it was in the economic concept which was developed
above. It is interesting to note that Professor Batt says
further
“That which distinguishes an agent from a servant is
not the absence or presence of a fixed wage or the payment
only of commission on business done, but rather the
freedom with which an agent may carry out his employ-
ment.““
We can therefore conclude that the definition we have given
is one which approximates closely to the firm as it is considered
in the real world.
Our definition is, therefore, realistic. Is it manageable ?
This ought to be clear. When we are considering how
large a firrn will be the principle of marginalisrn works
smoothly. The question always is, will it pay to bring an
extra exchange transaction under the organising authority ?
At the margin, the costs of organising within the firrn
will be equal either to the costs of organising in another
firm or to the costs involved in leaving the transaction to
be “organised.” by the price mechanism. Business men
will be constantly experimenting, controlling more or less,
and in this Way, equilibrium will be maintained, This
gives the position of equilibrium for static analysis. But
it is clear that the dynamic factors are also of considerable
importance, and an investigation of the effect changes have
on the cost of organising within the firm and on marketing
costs generally will enable one to explain why firms get
larger and smaller. We thus have a theory of moving
equilibrium. The above analysis would also appear to have
clarified the relationship between initiative or enterprise
and management. Initiative means forecasting and operates
through the price mechanism by the making of new contracts.
Management proper merely reacts to price changes, rearranging the factors of production under its control. That the
business man normally combines both functions is an obvious
result of the marketing costs which were discussed above.
Finally, this analysis enables us to state more exactly what
is meant by the “ marginal product ” of the entrepreneur.
But an elaboration of this point would take us far from
our comparatively simple task of definition and clarification.