2. Theoretical Framework

Safe Project: E(V) = $105M (low risk)
Risky Project: E(V) = $100M but high variance (50% chance V = $150M, 50% chance V = $50M)

Coase develops a transaction cost theory of the firm. He argues that markets, despite their theoretical elegance in neoclassical models, involve substantial costs that have been systematically ignored: search costs (discovering relevant prices and trading partners), negotiation costs (haggling over terms), contracting costs (specifying and documenting agreements), and enforcement costs (ensuring compliance and resolving disputes). The firm emerges as an alternative governance mechanism that replaces the decentralized price system with centralized direction via the entrepreneur or manager exercising authority over resources. The boundary of the firm—what activities are organized internally versus contracted externally—is determined by the point where the marginal costs of internal organization equal the marginal costs of relying on market transactions.

3. Argumentative Structure & Key Concepts

Coase structures his argument around three foundational concepts: (1) The nature of the firm as a contracting mechanism: rather than a