Flashcards in Term 2 Deck (100):
What are the flows in neoclassical theory
Inputs - Production - Outputs
Revenue - Profit - Cost
What are the assumptions of Neoclassical Theory?
1 plant, 1 Product
Owner = Entrepreneur
How do you max profit>
Set P=MC and find quantity
What are the criticisms of neoclassical theory?
Do firms really profit max?
Do we have perfect information
Is the entrepreneur the only actor
What is did Ronald Harry Coases theory consider?
Intra firm v Free market transactions
The Puzzle: if markets exist, how do we explain the existence of the firm
What assumptions does Coase challenge?
What determines if a firm exists?
If transaction costs are greater than management costs, use firm
What determines the size of the firm
Managerial Dis economies
Misallocation of resources
Dissimilarity of Transactions
Expand until Management Costs = Transaction Costs
What are Williamsons Critiques of Coase?
No quantification of transaction cost
Multiple governance structures available
What assumptions does Williamson have and what are their implications?
Bounded Rationalisation: Satisfying instead of maximising and contracts insufficient
Opportunistic Behaviour: People are dishonest thus contracts need safeguards
How does williamson define a firm?
A governance structure
How do we consider a transaction
Identify the Attributes: Frequency, uncertainty, idiosyncratic investments
Choose the best structure: Market, Hybrid, Hierarchy
What are the attributes we use to consider governance structures, how does each type perform?
Adaptation via Autonamy
Adaptation via Coordination
Market = Alternating, Strong First
Hybrid - Semi
Hierarchy - Alternating, Weak First
What governance structures goes best with each type of transaction?
Occasional and Nonspecific - Market Governance
Reccurent and Nonspecific - Market governance
Recurrent and Idiosyncratic - Unified Governance
What is market governance?
Classical Contract Law
What is Unified Governance
Internal to a firm
issues sorted by entrepreneur
What is bilateral governance?
Autonomy of parties is maintained?
What is trilateral governance?
Neoclassical Contract Law
What are the criticisms of williamson?
Identification of transaction costs
Opportunism as a universal phenomenon
Reputation and prior cooperation as mechanisms to reduce opportunism
Limited predictable power
Define Vertical Boundaries?
What activities are performed internally v externally
What are the reasons for buying v Make?
Economies of Scale and Learning
Discuss economies of scale and learning?
Firms can aggregate the demand of buyers, reducing AC
Discuss the reduction of bureaucracy?
Agency Costs: Slack effort and admin controls designed to stop it
Influence Costs: The costs generated by internal resource lobbying and bad decisions
A contract reduces the opportunity for opportunistic behaviour and protects against it
Effectiveness depedends on completeness and contract law
Discuss a complete contract?
Protects 100% against opportunistic behaviour by specifying every possible contingency
Fails in Practice due to bounded rationality and asymmetric information
What are the consequences of asymmetric contracts?
Problems in coordination of production flows
Possible leak of private information
Discuss co-ordination problems?
Co-ordination rises costs
Solved by Penalties and Bonuses
If problem is that bad, vertically integrate
Discuss information leakage problems?
Using markets to source suppies can leak information
Solved by patents
If problem is that bad, vertically integrate
Why are incomplete contracts a problem?
Not in isolation, due to opportunistic behaviour
However, if one party cheats, the other can leave
What is the implied contracting process
If no bounded rationality: Planning
If no Opportunism: Promise
If no Asset Specificity: Competition
If all issues, Create a firm
Define a relationship specific asset
Idiosyncratic investments made to support a trasaction
Loose some productivity and a cost
What are the types of asset specificity?
Site: Side by side location
Physical Asset: Design characteristics specific to a transaction
Dedicated: Made based on a relationship, if fail spare capacity
Human Asset: Employees gain skills dealing with a customer
What are the consequences of asset specificity?
Fundemental Transofmraiton: Locked into relationship
Rent and Quasi-Rent
What is Quasi rent?
Profit earned from deploying an asset in its intended use - Its next best
How do you calculate rent, Quasi-Rent and Relationship specific investments
P*: price of the good
Pm: next best price
C: variable cost
I: cost of the specific investment
What is the hold up problem
If a good has a large quasi rent, their is the possibility of falling victim to opportunistic behaviour -renegotiating
What is the difference between the neoclassical and TC apprach
Neoclassical Emphasise production costs
Views the firm as a transaction
Focuses on TC
Firm is viewed as one governance structure
What are the two major efficiency that make up a decision?
Technical and Agency
Discuss Technical Efficiency?
Efficiency in the physical produciton of the good
Effected by economies of scale
Discuss Agency Efficecy?
Efficiency of transacting - Choosing the best governance structure
Effected by vertical integration
Discuss the heuristic model graph
Y Axis: Difference between cost of internal organisation v market
X Degree of asset specificity
Discuss Technical Efficiency in the heuristic model
In house production - Market Production
As asset specificity increases, markets economies of scale fall
Downwards sloping but also positive
Discuss Agency Efficiency in the heuristic model
Transaction costs when firm is VI
As asset specificity increases, the market becomes worse as there is less competition
Discuss total efficiency in the heuristic model
Overall difference between VI and the Market
To left of vertical intercept, use market
Discuss the effect on an increase in the market size?
Delta T moves ight
Delta A pivots anti clock
Delta C pivots clockwise
What are the implications of heuristic model
Market provision with low AS
Pay attention to economies of scale
If firm is large VI
If high coordination VI
If market is competetive VI
Discuss VI under neoclassical theory?
Firms either remove market power or create market power through VI
Discuss Successive Monopolies
Upstream monopoly manufacturer and downstream monopoly retailer
Without VI both firms have to make a profit
What is the double markup problem?
Both firms have to make a profit
What are the consequences of successive monopolies
The MR of the retailer is the demand for the supplyer
The price sold is the MC
This creates a vertical externality
VI results in higher Q, lower P, more surplus
VI as a method of creating market power in downstream competetive markets
Discuss the effectiveness of VI under monopolisation?
If inputs are used in fixed proportions, no incentive to VI as monopolist can already fully control the market
If not fixed, downstream can substitute
Discuss VI for price discrimination?
A firm integrates to segment the downstream firms
A method of preventing arbitrage
Buy the most elastic firm
Discuss VI for free Riding
Horizontal externalitys created as retailers must provide a service that the manufacturer did not account
Thus under invest
Define vertical restraints?
Contractual limitations placed by the manufacturer on the
Give some example of Vertical Restraints
Resale Price Maintenance
Two Part Tariff
What is the purpose of Vertical Restraints
Alternative of VI when
Double markup problem
Free Riding Distributors / Manufacturers
How can Vertical Restraints remove the double markup problem?
Price ceiling to remove the retailers profit
Quantity fixing in a similar fashion
How can vertical restraints fix free riding
Exclusive Territores to promote advertising
RPM price floor to force them to compete on other aspects
What are the bad points of vertical restraints?
Limits competition by:
Cartelizing an Industry - Causing Collusion
What are the good points of vertical restraints
Fix any issues its designed to (elaborate)
Evaluate Vertical Restraints RPM
Removes Spill Over Effects of Retailers Decisions
What are horizontal boundaries and how can they change?
How much of the market a firm will serve
What are the determinants of horizontal boundaries?
Economies of Scale
Economies of Scope
What are economies of scale?
Reduction of AC as unit produced increases
To occur: LRMC < LRAC
How do you measure economies of scale?
S<1: Economies of Scale
S=1, no more economies
S>1: Expansion involves diseconomies
What are economies of scope?
Reduction in TC if a firm produces a greater variety of goods
How do you calculate economies of scope?
TCA+TCB-TCA,B / TCA,B
Economies of scope >0
Diseconomies of scope <0
What are learning economies?
A reduction in AC due to know how
How do you measure learning economies?
Slope of 0.80 indicates AC falls by 20% if output doubles
What is the learning curve strategy?
Expand output rapidly to benefit from learning economies
What are the differences between economies of scale and learning economies?
Economies of scale are reversable
Dependant on time
Dependant on capital
What are the sources of economies of scale?
Discuss production as a source of economies of scale
Short Run: Moving down AC
Long run: Moving to a lower AC
Discuss Specalisation as a source of economies of scale?
As market size grows, firms can employ specialised resources that would otherwise no be available
Discuss Inventories as a source of economies of scale?
Ratio : I/S
The goal is to keep the ratio low
Discuss Physical properties as a source of production economies?
Squared Cubed Law
Disucss economices of scale in purchasing?
Discuss economies of scale in advertising
Larger firms have a lower cost per potential consumer
Discuss economies of scale in R and D
Minimum feasible size of R and D projects
Discuss dis economies of scale
Wages are higher in larger firms, as compensation for the preference of small firms
Conflicts of Interest
Discuss economies of scope?
R and D spillovers
Discuss diseconomies of scope?
Conflicting brand images
What are the managers objectives?
A Quiet life
Discuss Baumols Model?
A Sales max model
Managers will max sales subject to profit constraint
What determins the profit constraint
Earnings to finance expansion
What are the applications of Baumols model?
How can Baumols model explain Overhead Costs?
Normally an increase in FC leads to a raise in price
This will not occur in neoclassical as we only consider MC
Under Baumol, shifts curve down, increasing price
How can Baumols model explain non-price competition
Effect of price reduction depends on elasticity of demand
Not considered in neoclassical
What is the main point of Williamsons model?
The manager maximises his own utiltiy
Power and Prestige
What will the manager prefer under Williamsons model?
Expansion of Staff
Emoluments - Cars
Discretionary Investments - Investments he controsl
Discuss the Model:
Representend Price as:
Quantity produced, staff and epsilon
What are the methods of controlling manager behaviour
Managerial Labour Market
Discuss shareholders as an internal constraint?
Manager is responsible to board of directors - financial reports
Can remove a bad manager
Discuss Incentive Contracts
Linking Pay to performance
Must be a good performance measure
What are the components of a good performance measure
No random component
Should encourage good activitiies
Relative and narrow
Discuss a takeover threat
Dissatisfied shareholder sell shares and firm gets taken over
Bad use of resources causes value to fall
What are the problems with the takeover threat
What defences are available against takeovers
Green mail: buy shares of attempted takeover
Poison Pills: give rights of cheap shares to current owners