Inside Organizations: Pricing, Politics, and Path Dependence

Abstract

When economists have considered organizations, much attention has focused on the boundary of the firm, rather than its internal structures and processes. In contrast, this essay sketches three approaches to the economic theory of internal organization— one substantially developed, another rapidly emerging, and a third on the horizon. The first approach (pricing) applies Pigou’s prescription: if markets get prices wrong then the economist’s job is to fix the prices. The second approach (politics) considers environments where important actions inside organizations simply cannot be priced, so power and control become central. Finally, the third approach (path-dependence) complements the first two by shifting attention from the “between” variance to the “within.” That is, rather than ask how organizations confronting different circumstances should choose different structures and processes, the focus here is on how path-dependence can cause persistent performance differences among seemingly similar enterprises.