Hold-Up Problem

Topics: Economics, Costs, Transaction cost Pages: 12 (4420 words) Published: April 3, 2013
Economists have a very well-established theory of market trading and are on the way to processing a similarly well-developed other theories of the firms (Hart, 1995). Particularly, neoclassical theory of the firm, the dominant economics paradigm, has influenced and been influenced by developments in regulated industries can be the foundation to explain many other theories. Whether a company should expand the scale and scope of their business or not still is the controversial question. It is believed that this action brings many benefits for companies such as manufacturing at lower costs. However in some cases they also have their own disadvantages. To understand more deeply and address this problem we base on the neo-classical theory of the firm and the result in analysis “hold-up problem” This paper begins by analysing the success of neo-classical in explaining scale and scope of firms. It will then go on to analyse imperfect contracts and specific investments in the transaction cost theories. Next, the effects of the property right approach on economies of scale and scope are evaluated through method to solve this problem. In accordance with the explanations, the example of General Motors and Fisher Bodies bring the deeper insight into this theory.

1. The success (strengths) of neo-classical in explaining scale and scope of firms. As can be seen from neo classical theory, this theory stress on technology in general and return to scale in particular. Thanks to this, a firm can draw the determinants of size of firm. Furthermore, this theory also is very useful for analysing how the firm’s optimal production choice varies with input and output prices and for understanding the aggregate behaviour of an industry and for studying the consequences of strategic interaction between firms. To be more specify, it is believed that economies of scale are simply properties of the firm’s production and cost functions except overhead costs (Joseph Stiglitz, 1997). According to the some recently innovative ideas, economies of scale and scope appeared in neo-classical theory as technical relationships. It simple means that the higher rates of output lead to the lower unit costs. It is, in fact, higher outputs generate lower unit costs due to the improvement of knowledge such as scale enables. Next, regarding to neo-classical theory plan size, it seems that there are many choices of plan size, each of which has a short-run average cost curve that has its minimum. The long-run cost curve is the envelope of the short-run cost curve. No matter what firms produce, they should choose the plan size that have the output at the minimum average cost. The simplest explanation of scale is as the lowest point on a ‘U’ shaped long run average cost function which shows as below:

Long Run
Long Run

From the diagram, it can be seen that if remaining return to scale, the size of the firm is undetermined. If increasing returns, the firm ends up as a monopoly or limited by monopolistic competition. If decreasing returns, the firm could make more profit by continually splitting itself into smaller sizes. Moreover, average cost is constant, declining or rising according to returns to scale, but there is no lowest point. However, this is a problem with all homogeneous production function, which cannot thus be a basic for technological explanations of scale. Secondly, theoretical work is a useful indicator for evaluating how the firm’s optimal production choice varies with input and output prices, for understanding the aggregate behaviour of an industry. Besides, according to neoclassical microeconomic theory, the minimum cost function is the result of a profit maximizing process. The minimum cost function assumes that for a given state of technology as embedded in an underlying production function, and a given vector of factor prices, the minimum cost for any given level of output can be expressed as a function...

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