Differences in optimal firm size can only be explained by heterogeneity amongst enterprises and the markets in which they operate. Therefore, the concept of the representative enterprise from the traditional theory of the firm is not helpful in explaining size differences.

Differences in firm size may better be explained using recent developments in labour economics that stress the heterogeneity of workers and enterprises. In this paper, we exploit these new developments in labour economics by building a simulation model of the firm, which explicitly considers the link between internal and external labour markets and the resulting worker flows. Simulations with the model show how factors that account for differences in transaction costs and for heterogeneity of workers generate enterprises of different sizes.