ECMC40 - Midterm Review

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Economics for Management Studies
Majid Aramand

Study Guide 1) The Nature of the Firm, by Coase Firm: what is it? - A firm is an economic system that works by itself. Price is the central mechanism and entrepreneur as the coordinating factor. - supply-demand, production-consumption Existence of firm: why firms emerge? - Firms emerge to control other people. Motivation to be one’s own master and earn money/profit. - A contract is to limit entrepreneurship. The firm governs the direction of resources within the limits of these contracts Firm and size: why firms become larger? - Firms become larger to gain monopoly, economics of scale, to rise supply prices Cost curve slope and the size of the firm: what is the relationship? - When the cost of production goes down and the volume of production goes up, there are economies of scale. 2) An economist’s perspective on the theory of the firm, by Hart What roles firms play in capitalism? - Firms create growth (macroeconomy) Neoclassical theories - The firm is a means of production - It is meant for maximizing the profit/welfare of the owner - Changes in the environment are exogenous to the firm Principal-agent theory - Conflicts of interests between two parties - information asymmetry, unobservability, risk aversion (by agents) - Whenever the ‘principal’ (owner) has another ‘agent’ (manager) performs a service on his behalf and cannot fully observe the agent’s action. - So in order to make sure that the agent does what is in the principals’ interests and not in the agent’s interests, incentives will be offered like salary + perks (bonuses) Transaction cost theory - Costs like thinking, planning, contracting are lower in some situation if the transaction is carried out within the firm rather than in the market - Contracting costs - The main cost of transacting in the market is learning the terms of trade. These can be reduced by given one party authority over the terms of trade. - So the firm acts as a nexus of contracts - The firm arises to economize transactions Property rights approach to the firm - ownership of assets - possession of residual rights of control of assets - shareholders control management 3) Production, information costs, and economic organization, by Alchian and Demsetz Organization and firm - Resource owners increase productivity through cooperative specialization and this leads to the demand for economic organizations which facilitate cooperation. Organization’s performance - measured by the inputs (what you put in) and what comes out (outputs), productivity - efficiency Team productivity - joint activity yields high productivity, market can monitor team productivity Vertical integration - A style of management control. The combination in one company of two or more stages of production normally operated by separate companies Types of firms - profit shares - corporation, future returns -> stock owners, shareholders, voting power - mutual/non profit firms - partnership unions Homogeneous resources - something resource that all firms share Heterogeneous resources - something unique that only a particular firm has and that other firms don’t 4) Organization and markets, by Simon Objectives of firm creation in capitalism - Profits are the sole objection Firm’s boundaries - The firms boundaries are the contracts, authority and employee utilities Organizational efficiency and motivation - accepting the authority of the firm - profit is a motive for the principal Rewards and motivation - rewards is a motive for the agent - depending on the culture, different agents want to be rewarded in different ways Loyalty and efficiency - nepotism, those in power favouring relatives or close friends for positions - organizational citizenship – behaviours that extend beyond the employees normal job duties that contributes to the organization’s success Coordination - individual and group activities - activities within and between firms Authority
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