Basic Concepts in Economics of Firms

Topics: Property, Contract, Transaction cost Pages: 18 (4989 words) Published: March 17, 2013
Basic Concepts
The economics of business enterprise, an introduction to economic organisation and the theory of the firm Martin Ricketts (chp. 1-5) …and more… Aida Isabel Tavares Economia da Empresa 1

Quick review about the basics of theory of the firm
Firms under the neoclassic view are treated as a production black-box: input → firm → output Fundamental issues about firms:  Why do firms exist? How different are firms versus markets?  What determines firm’s scope or boundaries? M&As; Spin-offs; Alliances  What determines firm’s organizational forms? Corporations, partnership, proprietary Chain stores, franchises, alliances MNEs: Subsidiaries vs. joint-ventures; horizontal vs. vertical FDIs; why R&D is mostly done at headquarters

Aida Isabel Tavares Economia da Empresa


Short review of the theoretical progress
¤ Ronald Coase (1937), The Nature of the Firm ¤Principal-agent theory (Alchian and Demsetz; Holmstrom) ¤ Transaction cost economics (Oliver Williamson) ¤ Property rights theory (Oliver Hart and Grossman) Incomplete contracts

Aida Isabel Tavares Economia da Empresa


Summary I) II) III) IV) V) VI) Gains from trade Transaction costs The entrepreneur Property rights Principal and agent Vertical integration

Aida Isabel Tavares Economia da Empresa


firm – legal concept ∫ economic concept neoclassic definition – microeconomic unit: inputs ö outputs nature of the firm – process of production that involves coordination (individuals and activities) without explicit bilateral contracts that bind individuals together scarcity – the best use of resources involve agreements between individuals - how do this agreements are formulated information – is not perfect nor complete nor observable nor verifiable coordination mechanisms – specialization and bargaining; price system

Aida Isabel Tavares Economia da Empresa


Firms – in a world of costly knowledge and relationships – firms are a mechanism for reducing costs – market process vs planning process (contracts – imperfect) Firms – ripe the advantage of cooperative effort through division of labour and exchange Contracts – imperfect - trust; the “tit for tat strategy”; reputation; monitoring The gains from trade come from differences in preferences and differences in technology, so there are incentives to promote efficiency in resource allocation. However, the free market is not so “free” as is seems…

Conclusion Firms generate advantage outside the market system by exploring labour division and exchange Aida Isabel Tavares Economia da Empresa 6

Why aren’t all economic transactions conducted through markets? “The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism”. Coase, 1937 The foundation – Coase: in the absence of transaction costs, property rights and organizational form do not matter for achieving efficient economic outcomes The concept of transaction costs helps explain why the firm exists (to offset the cost of using price mechanism), and what activities the firm will undertake

Aida Isabel Tavares Economia da Empresa


The costs other than the money price that are incurred in (before, during and after) trading goods or services: search and information costs, bargaining and decision costs, policing and enforcement costs. Sources: uncertainty (characteristics partners, quality, availability, prices…) bounded rationality (limited ability to process information, incomplete contracts, asymmetric information) opportunism (self interest, imperfect commitment) (asset specificity)

Aida Isabel Tavares Economia da Empresa


Transactions: frequency, degree of complexity, informational specialization, asset specificity (site (location), physical, human and dedicated(directed)) Given that there are TC, why isn’t the economy one big firm? Production requires contracts and assets. Reasons - diminishing...
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