On the Optimal Size of Economic Organizations: The Benefits and Costs of Centralization and Decentralization

Abstract

This paper considers the determinants of the optimal size of economic organizations and the benefits and costs of centralization and decentralization. After observing that this question arises with a broad class of organizations including regional and spacial ones, it focuses on an economic organization, the business firm. The paper first asks: why are factors of production, like managers, workers, and capital equipment, integrated into a firm for production? How is the boundary of the firm formed? In short, what is meant by the optimal size of the firm? It then proceeds to argue that the size of the firm is basically determined by the costs of operating it, and different costs of operating the firm are identified. New information technology affects the size of the firm by changing the relative magnitude of the costs. The paper attempts to assess the effects of new information technology on the degree of centralization and decentralization of the firm.