Lecture 1 - Introduction

Question 1

Benefits of specialization

Answer 1

1. Increased skill level
2. Greater possibilities of machanization
3. Shorter time wasted on switching between tasks
4. Prodoctivity gain

Question 2

Costs of specialization

Answer 2

People become interdepend
* Cooperation problems:
* Agency problems
* Coordination problems:

 * Sequence
 * Timing
 * Intensity level

Question 3

Who specializes in what?

Answer 3

The law of comparative advantages:
The total output of a group is largest when each good is produced by the person with the lowest opportunity cost, i.e., the comparative advantage.

Question 4

Coordination Problems

Results in:
Occurs when:
Addressed by:
Affected by:
Problems:

Answer 4

Results in:
- Confusion

Occurs when:
- lack of information regarding the decisions of other parties

Addressed by:
- Procedures
- Planning
- Culture
- Markets solve coordination problems by prices

Affected by:
- The level of specialization & interdependence
o Increased specialization & interdependence  increased coordination problems

Problems:
- Sequence & Timing of tasks
- Intensity level
- Division of labor
- Insufficient planning
- No procedures for reacting to disturbances
- Lack of communication
- Non-overlapping culture
- Incompatible activities
- Resource allocation

Question 5

Cooperation Problems

Motivation Problems

Results in:
Occurs when:
Addressed by:
Affected by:
Problems:

Answer 5

Results in:
- Conflicts
- Ending up in a bad equilibrium

Occurs when:
- information asymmetry
- diverging interests

Addressed by:
- designing incentives to reduce conflicts of interest
- Authority
- Performance incentives (stick & carrot)
- The right contracts
- Incentives
- Ownership arrangements
- Markets solve problems by incentives in the price system
o If you receive residual payments (profits, i.e., ownership) you are incentivized to work harder

Affected by:
- The level of specialization & interdependence
o Increased specialization & interdependence  increased coorperation problems

Problems:
- Agency problems
- Shirking
- Hold-up
- Undesired knowledge leaks
- Poaching of key employees
- Lack of trust

Question 6

Why is organizational efficiency at least as important as market efficiency?

Answer 6

An efficient organization is able to generate a considerable amount of surplus

In a competitive market the price if a product p is equal to the costs inkling slack.
* Slack is the result of unnecessary bureaucracy, negligence, conflicts, and misunderstandings. It is equal to p-c
* When organizations are efficient they can eliminate the waste so that total costs are only c. Hence, creating a surplus.

Question 7

Levels of institutional analysis

Answer 7

1. Embeddedness
2. Institutional environment
3. Governance
4. Resource allocation and employment

Question 8

The Big Idea of Coase’s Theory of the Firm

Answer 8

• Firms are alternatives to markets
• Whether firms or markets (make or buy) are used depends on transaction costs
• Authority is a mechanism for allocating resources

Question 9

Coase’s Theory of the Firm

What is the firm?

Answer 9

A firm is characterized by the employment contract, which implies authority

Question 10

Coase’s Theory of the Firm

Why does the firm exist?

Answer 10

• Costs of using the price mechanism (market)
  o Discovering relevant prices (coordination)
  o Negotiating and concluding a separate contract for each exchange (cooperation)
  o Coordinating when tasks are uncertain

Question 11

Coase’s Theory of the Firm

What determines the size of firms

Answer 11

• Increasing marginal costs
• Managers make more mistakes as the firm grows
  o E.g., because of loss of information due to increased hierarchy/layers
• Optimum: Marginal cost of firm = marginal cost of market