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Flashcards in Term 2 Deck (100):
1

What are the flows in neoclassical theory

Physical
Inputs - Production - Outputs

Monetary Flow
Revenue - Profit - Cost

2

What are the assumptions of Neoclassical Theory?

1 plant, 1 Product
PC Market
Owner = Entrepreneur
Max Profit

3

How do you max profit>

Set P=MC and find quantity

4

What are the criticisms of neoclassical theory?

Do firms really profit max?
Do we have perfect information
Is the entrepreneur the only actor

5

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

6

What assumptions does Coase challenge?

Perfect Information
Global Rational

7

What determines if a firm exists?

If transaction costs are greater than management costs, use firm

8

What determines the size of the firm

Managerial Dis economies
Misallocation of resources
Dissimilarity of Transactions

Expand until Management Costs = Transaction Costs

9

What are Williamsons Critiques of Coase?

No quantification of transaction cost
Multiple governance structures available

10

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

11

How does williamson define a firm?

A governance structure

12

How do we consider a transaction

Identify the Attributes: Frequency, uncertainty, idiosyncratic investments

Choose the best structure: Market, Hybrid, Hierarchy

13

What are the attributes we use to consider governance structures, how does each type perform?

Incentive Intensity
Admin Controls
Adaptation via Autonamy
Adaptation via Coordination
Contract Law

Market = Alternating, Strong First
Hybrid - Semi
Hierarchy - Alternating, Weak First

14

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

15

What is market governance?

Classical Contract Law
Legally Binding

16

What is Unified Governance

Internal to a firm
issues sorted by entrepreneur

17

What is bilateral governance?

Autonomy of parties is maintained?

18

What is trilateral governance?

Neoclassical Contract Law

19

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

20

Define Vertical Boundaries?

What activities are performed internally v externally

21

What are the reasons for buying v Make?

Buy:
Economies of Scale and Learning
Bureaucracy

Make
Incomplete Contracts
Opportunism
Idiosyncratic Investments

22

Discuss economies of scale and learning?

Firms can aggregate the demand of buyers, reducing AC

23

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

24

Discuss Contracts

A contract reduces the opportunity for opportunistic behaviour and protects against it
Effectiveness depedends on completeness and contract law

25

Discuss a complete contract?

Protects 100% against opportunistic behaviour by specifying every possible contingency

Fails in Practice due to bounded rationality and asymmetric information

26

What are the consequences of asymmetric contracts?

Problems in coordination of production flows
Possible leak of private information
Transaction costs

27

Discuss co-ordination problems?

Co-ordination rises costs
Solved by Penalties and Bonuses

If problem is that bad, vertically integrate

28

Discuss information leakage problems?

Using markets to source suppies can leak information

Solved by patents

If problem is that bad, vertically integrate

29

Why are incomplete contracts a problem?

Not in isolation, due to opportunistic behaviour

However, if one party cheats, the other can leave

30

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

31

Define a relationship specific asset

Idiosyncratic investments made to support a trasaction

If redeployed
Loose some productivity and a cost

32

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

33

What are the consequences of asset specificity?

Fundemental Transofmraiton: Locked into relationship

Rent and Quasi-Rent

34

What is Quasi rent?

Profit earned from deploying an asset in its intended use - Its next best

35

How do you calculate rent, Quasi-Rent and Relationship specific investments

Rent:
X∗(P∗−C)−I

Quasi-Rent:
X∗(P∗−Pm)

Relationship:
I−X*(Pm−C)

P*: price of the good
X*: quantity
Pm: next best price
C: variable cost
I: cost of the specific investment

36

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

37

What is the difference between the neoclassical and TC apprach

Neoclassical Emphasise production costs
Views the firm as a transaction

TC Approach
Focuses on TC
Firm is viewed as one governance structure

38

What are the two major efficiency that make up a decision?

Technical and Agency

39

Discuss Technical Efficiency?

Efficiency in the physical produciton of the good
Effected by economies of scale

40

Discuss Agency Efficecy?

Efficiency of transacting - Choosing the best governance structure

Effected by vertical integration

41

Discuss the heuristic model graph

Y Axis: Difference between cost of internal organisation v market
X Degree of asset specificity

42

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

43

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

44

Discuss total efficiency in the heuristic model

Overall difference between VI and the Market

To left of vertical intercept, use market

45

Discuss the effect on an increase in the market size?

Delta T moves ight
Delta A pivots anti clock

Delta C pivots clockwise

46

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

47

Discuss VI under neoclassical theory?

Firms either remove market power or create market power through VI

48

Discuss Successive Monopolies

Upstream monopoly manufacturer and downstream monopoly retailer

Without VI both firms have to make a profit

49

What is the double markup problem?

Both firms have to make a profit

50

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

51

Discuss monopolisation?

VI as a method of creating market power in downstream competetive markets

52

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

53

Discuss VI for price discrimination?

A firm integrates to segment the downstream firms

A method of preventing arbitrage

Buy the most elastic firm

54

Discuss VI for free Riding

Horizontal externalitys created as retailers must provide a service that the manufacturer did not account

Thus under invest

55

Define vertical restraints?

Contractual limitations placed by the manufacturer on the

56

Give some example of Vertical Restraints

Resale Price Maintenance
Exclusive Dealing
Exclusive Territories
Quantity Fixing
Two Part Tariff

57

What is the purpose of Vertical Restraints

Alternative of VI when
Double markup problem
Free Riding Distributors / Manufacturers

58

How can Vertical Restraints remove the double markup problem?

Price ceiling to remove the retailers profit
Quantity fixing in a similar fashion

59

How can vertical restraints fix free riding

Exclusive Territores to promote advertising

RPM price floor to force them to compete on other aspects

60

What are the bad points of vertical restraints?

Limits competition by:
Cartelizing an Industry - Causing Collusion

Prevent Entrance

61

What are the good points of vertical restraints

Improve Competition
Lower prices
Fix any issues its designed to (elaborate)

62

Evaluate Vertical Restraints RPM

Removes Spill Over Effects of Retailers Decisions

63

What are horizontal boundaries and how can they change?

How much of the market a firm will serve

Changed by:
Organic growth
Mergers

64

What are the determinants of horizontal boundaries?

Economies of Scale
Economies of Scope
Learning economies

65

What are economies of scale?

Reduction of AC as unit produced increases
To occur: LRMC < LRAC

66

How do you measure economies of scale?

MC/AC
S<1: Economies of Scale
S=1, no more economies
S>1: Expansion involves diseconomies

67

What are economies of scope?

Reduction in TC if a firm produces a greater variety of goods

68

How do you calculate economies of scope?

TCA+TCB-TCA,B / TCA,B

Economies of scope >0
Diseconomies of scope <0

69

What are learning economies?

A reduction in AC due to know how

Greater Speed
Less Waste
LEss Supervision

70

How do you measure learning economies?

AC2/AC1

Slope of 0.80 indicates AC falls by 20% if output doubles

71

What is the learning curve strategy?

Expand output rapidly to benefit from learning economies

72

What are the differences between economies of scale and learning economies?

Economies of scale are reversable
Dependant on time
Dependant on capital

73

What are the sources of economies of scale?

Production
Purchasing
Advertising
RandD

74

Discuss production as a source of economies of scale

Short Run: Moving down AC
Long run: Moving to a lower AC

75

Discuss Specalisation as a source of economies of scale?

As market size grows, firms can employ specialised resources that would otherwise no be available

76

Discuss Inventories as a source of economies of scale?

Ratio : I/S
The goal is to keep the ratio low

77

Discuss Physical properties as a source of production economies?

Squared Cubed Law

78

Disucss economices of scale in purchasing?

Bulk discounts

79

Discuss economies of scale in advertising

Larger firms have a lower cost per potential consumer

80

Discuss economies of scale in R and D

Minimum feasible size of R and D projects

81

Discuss dis economies of scale

Example:
Wages are higher in larger firms, as compensation for the preference of small firms

Conflicts of Interest

82

Discuss economies of scope?

Shared inputs
R and D spillovers
Adverisitng

83

Discuss diseconomies of scope?

Conflicting brand images

84

What are the managers objectives?

Sales Max
Utility Max
Growth Max
A Quiet life

85

Discuss Baumols Model?

A Sales max model
Managers will max sales subject to profit constraint

86

What determins the profit constraint

Earnings to finance expansion
Dividends

87

What are the applications of Baumols model?

Overhead costs
Non-Price competition

88

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

89

How can Baumols model explain non-price competition

Effect of price reduction depends on elasticity of demand
Not considered in neoclassical

90

What is the main point of Williamsons model?

The manager maximises his own utiltiy
Salary
Power and Prestige
Job Securirty

91

What will the manager prefer under Williamsons model?

Expansion of Staff
Emoluments - Cars
Discretionary Investments - Investments he controsl

92

Discuss the Model:

Representend Price as:
Quantity produced, staff and epsilon

93

What are the methods of controlling manager behaviour

Internal
Shareholders
Incentive Contracts
Internal organisation

External
Takeover Threat
Insolvency Threat
Competition
Managerial Labour Market

94

Discuss shareholders as an internal constraint?

Manager is responsible to board of directors - financial reports

Independant Auditors

Can remove a bad manager

95

Discuss Incentive Contracts

Linking Pay to performance

Must be a good performance measure

96

What are the components of a good performance measure

No random component
Should encourage good activitiies
Relative and narrow

97

Discuss a takeover threat

Either:
Dissatisfied shareholder sell shares and firm gets taken over
Bad use of resources causes value to fall

98

What are the problems with the takeover threat

Information Asymmetries
Free riding
Short Termism

99

What defences are available against takeovers

Green mail: buy shares of attempted takeover
Poison Pills: give rights of cheap shares to current owners

100

Discuss Bankruptcy, Product Market Competition and Managerial Labour Markets?

Threat of liquidation encourages manageers

Can use other firms to see how your manager is doing

Being fired will stop them getting another job