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Lecture 4

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University of Guelph
ECON 2720
B Ferguson

Lecture 10 January 27, 2014 10:28 AM Ronald Coase and Adam Smith - He is known for writing on "the nature of the firm" and explained why firms act in certain ways - Adam Smith explains the number of steps in production in the Wealth of Nations - During the time this book was written there were no factories, a woman would be in her home spinning whole into cloth - A merchant would come to the village and buy the whole from this woman and then sell it to someone else he knew who knit cloth - At the end of this manufacturing process the guy who made and sold the coat often didn't have the money to buy the cloth until after he sold the finished product - The merchant often had to extend credit to the guy at the top of the chain otherwise the merchant wouldn't be able to do anything with the cloth - These producers along the way didn't exclusively produce what they did, their main priority was to survive since everyone lived in subsistence - If one woman didn't have a chance to die the cloth the whole production chain could break - Merchants began to start paying these woman to do what they do full time so the production chain doesn't break down - This system evolved over time to where the merchant paid everyone in the chain to do what they did so the flow of materials and money would be constant - Because these woman were now being paid woman were no longer living on subsistence - The merchants risk is much lower because people have a higher incentive to produce full time - These merchants were now known as merchant manufacturers because they controlled production - This is known as the "putting-out system" - Eventually they started setting up workshops in towns because then they wouldn't have to spend so much time delivering materials across a region - This is system is known as the factory system, but now in the sense we think of today - This wasn't done because merchants thought specialization would make production more efficient, but because the merchant himself didn't want to travel as much - Transportation was extremely expensive, especially land transportation - This led to a dramatic reduction in transaction cost, and led to specialization - Towns began to be known for doing one thing and the effects of economies to scale began to be seen - Life in towns were generally much better in towns, mostly because people didn't rely on subsistence - Now that there are so many spinners in one town the merchant manufacturers can go to another spinner if one is running low, and this worked the other way around as well - Merchants no longer needed to control the chai of production because everything was in one town and less coordination was needed - Spinners in a town would get together and create a guild - The guilds set quality standards for cloth in that town so producers would know quality from that town would be guaranteed - Weavers and spinners started to set higher prices for their cloth because it was higher quality - Price elasticity for the low end market is much higher than for the high end market - Merchants began to look for places where lower quality and cheaper materials could be made Lecture 11 January 29, 2014 10:30 AM The Factory System - The prices merchants were willing to pay were based on the quality of the cloth, and cloth from different towns were tested, and they would develop a reputation based on that quality - Once a t
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