According to one theory, firms exist because there are costs to the operation of

Question

According to one theory, firms exist because there are costs to the operation of the price mechanism. Inside firms, price mechanism does not operate, resources are allocated by administrative decisions, and the costs of operating price mechanism are avoided. On this logic, why not do away with the market completely, and allocate all resources in the economy by managerial commands, running the whole economy as one firm? Would not it further reduce transaction costs? What does this theory say about this possibility?

Explanation / Answer

Basically allocating all resources in the economy by managerial commands, running the whole economy as one firm means the government is controlling the economy Government can affect markets either through
direct participation (as a market maker or as a buyer or supplier of goods and services), or through indirect participation in private markets (for example, through regulation, taxation, subsidy or other influence). Government frequently has a choice between traditional instruments and market-based approaches. There are pros and cons associated with all types of Government intervention. Many, if not most, intervention can have unforeseen consequences. Failure to address indirect costs and possiblespillovers can result in a less effective policy and impose unnecessary economic costs.

So this question is mainly talking about command system.A system where the government, rather than the free market, determines what goods should be produced, how much should be produced and the price at which the goods will be offered for sale. The command economy is a key feature of any communist society. China, Cuba, North Korea and the former Soviet Union are examples of countries that have command economies.Also known as a planned economy, command economies are unable to efficiently allocate goods because of the knowledge problem - the central planner's inability to discern how much of a good should be produced. Shortages and surpluses are a common consequence of command economies. A free-market price system, on the other hand, signals to producers what they should be creating and in what quantities, resulting in a much more efficient allocation of goods.

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