ECON2410 Lecture Notes - Lecture 3: Bounded Rationality, Moral Hazard, Adverse Selection
3 Aug 2018
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Lecture 3: the vertical boundaries of the firm (part b) Reasons to make (vertically integrated: major costs associated with using market firms includes: Costs imposed by poor coordination between steps in the vertical chain. Unwillingness of trading partners to share private information. Transaction costs that can be avoided by performing the task in-house: costs associated with writing and enforcing contracts. As they are necessary to protect each party from opportunistic behaviour of others. The requirements for a complete contract are strict: one should be able to define and measure performance and must be enforceable. To enforce a contract an outside party like judge should be able to observe the contingency, the actions by the parties and impose the stated penalties for non-performance. Some factors that prevent complete contracting are: bounded rationality. Is the idea that in decision-making, rationality of individuals is limited by the information they have, the cognitive limitations of their minds: difficulties in specifying/measuring performance.
