This chapter is concerned with the economics of organization and management, a relatively new area of study that seeks to analyze the internal structure and workings of economic organizations, the division of activity among these organizations, and the management of relations between them through markets or other higher-level, encompassing organizations.

The dominant approach to this subject is transaction-cost economics, as introduced by Coase (1937, 1960) and developed by several others since, most notably Williamson (1975, 1985). The main tenet of Coase's theory is that economic activities tend to be organized efficiently – that is, so as to maximize the expected total wealth of the parties affected. In this context, two sorts of costs are customarily identified – those of physical production and distribution and those of carrying out necessary exchanges. Because these are typically treated as distinct and separable, the efficiency hypothesis becomes one of transaction-cost minimization: The division of activities among firms and between a firm and the market is determined by whether a particular transaction is most efficiently conducted in a market setting or under centralized authority within a firm.

This approach has two conceptual problems. First, the total costs a firm incurs cannot generally be expressed as the sum of production costs – depending only on the technology and the inputs used – and transaction costs – depending only on the way transactions are organized. In general, these two kinds of costs must be considered together; efficient organization is not simply a matter of minimizing transaction costs.