Week 11

Question 1

The firm

Answer 1

A planning unit which produces goods (outputs) using factors of production (inputs) for financial return

Question 2

The economics of organisation looks inside the “black box” of the firm.

Answer 2

6/10

Question 3

Problems with the traditional approach

Answer 3

why do firms exist at all?

How are they internally organised?

What determines their boundary ?

Question 4

5 Assumptions of traditional economics

Answer 4

Perfect rationality and information

Profit maximisation

Identical costs and profits

One single and identical product

Zero transaction cost

Question 5

Reality of Perfect rationality and information

Answer 5

Firms are evolving hierarchies of procedures to process information

Question 6

Reality of Profit maximisation

Answer 6

Firms are coalition of stakeholders with different, conflicting objectives

Question 7

Reality of Identical costs and profits

Answer 7

Firms are bundles of resources of different quality which determine their success which differs between firms and over time

Question 8

Reality of One single and identical product

Answer 8

Firms make a number of products at different stages of the production process.

Question 9

Reality of Zero transaction cost

Answer 9

Firms are command and control mechanisms that internalise market transactions

Question 10

The firms boundary

Answer 10

6/10

Question 11

The firms boundary definition

Answer 11

Defines what the firm does

Question 12

Vertical chain

Answer 12

All steps that need to be carried out in order to produce a good or service

Question 13

Vertical Boundary

Answer 13

identifies the activities on the vertical chain which the firm carries out itself internally, instead of acquiring from the market (the make or buy decision)

Question 14

Horizontal boundary

Answer 14

identifies how much of the product market the firm serves (the quantities and varieties of its products and services) - essentially, its size

Question 15

Transaction costs

Answer 15

The costs of using the market i.e. the costs that parties incur in the process of agreeing and following through on an exchange.

Question 16

Transactions involve

Answer 16

Identifying trading partners

Negotiating contracts

Monitoring compliance

Enforcing fulfilment

Question 17

Transactions are costly due to

Answer 17

Bounded rationality

Opportunism/moral hazard

Question 18

Firms are command-and-control mechanisms

Answer 18

Firms are command-and-control mechanisms that can internalise transactions when carrying them out within the firm is cheaper than in the market.

Question 19

Firm integration

Answer 19

6/10

Question 20

Vertical integration

Answer 20

When the firm expands its vertical boundary. The firm decides whether to carry out a transaction along the vertical chain in inhouse (backward or forward integration) or in the market (outsourcing) based on where it can be done at lower transaction cost (make or buy decision).

Question 21

Make or buy decision

Answer 21

a list of factors to consider – they may not always point in the same direction – need to balance them out

Question 22

a list of factors to consider – they may not always point in the same direction – need to balance them out

Answer 22

Economies of scale and scope

Number of firms

Asset specificity

Firm specific knowledge

Uncertainty

Scope for opportunism

Monitoring/governance costs

Complexity of production

Question 23

Make or buy decision

Starbucks example

Answer 23

6/10

Question 24

Horizontal integration

Answer 24

When the firm expands its horizontal boundary. The firm decides how much of the product market to serve in terms of quantity and variety based on economies of scale and scope as well as strategic reasons.

Question 25

Economies of scale Horizontal integration

Answer 25

Cost per unit of output falls as scale (quantity) of production increases. 6/10

Question 26

Real economies Horizontal integration

Answer 26

changes in input quantities as a result of volume Indivisibilities of fixed assets Alternative production techniques Specialisation Inventories

Question 27

Pecuniary economies Horizontal integration

Answer 27

changes in prices paid by the firm for inputs Purchasing power Advertising R & D

Question 28

Diseconomies Horizontal integration

Answer 28

Higher wages and unionisation Incentivisation and monitoring Red tape: communication and coordination difficulties Specialised resources spread too thin

Question 29

Horizontal integration Learning economies

Answer 29

Cost per unit of output falls due to accumulating experience and know how over time

Question 30

Learning economies vs. economies of scale

Answer 30

Can be substantial when economies of scale are minimal, absent (e.g., in complex, labour intensive industries) and vice versa (e.g., in simple, capital intensive industries) Failure to recognise the difference may lead to incorrect judgment about the benefits of size

Question 31

Horizontal integration Economies of scope

Answer 31

Cost per unit of output falls as variety of production increases. The combined production of two or more separate products costs less than the total of their individual production.

Question 32

Sources of economies of scope

Answer 32

Indivisibilities: under-utilised fixed assets Core competences: firm-specific assets Networks: customers, suppliers, contacts with banks, government Brand name: exploit customer loyalty

Question 33

The factors of production

Answer 33

FOP are the inputs used by the firm to produce outputs (goods and services).

Question 34

The 3 FOP categories

Answer 34

Labour - the FOP which comprises the human input; Land – the FOP that are created by nature; Capital - the FOP that are man made, i.e. have themselves been produced

Question 35

The factors market - Introduction

Answer 35

The prices paid by firms to households for these FOPs are wages, rent and profit/interest for labour, land and capital respectively. In many ways, factors markets resemble goods markets. 6/10

Question 36

Labour market imperfections and wage differentials

Answer 36

The perfectly competitive labour market generates a single market-clearing equilbrium wage (W) for all workers. In reality, wages differ between different types of workers and there is unemployment. The reason lies in certain imperfections of the labour market:

Question 37

Assumptions of the labour market:

Answer 37

The firms hiring workers sell their goods in a • perfectly competitive market. The labour market has lots of buyers (firms) and sellers (workers), and is therefore perfectly competitive. Workers are homogeneous (i.e. undifferentiated). Wages are flexible (no transactions cost).

Question 38

11.3 Labour market imperfections and wage differentials When broken diagram

Answer 38

6/10

Question 39

. Labour differentiation: compensating differentials

Answer 39

Compensating differential is the difference in wages that arises to offset the non-monetary characteristics of different jobs. In many cases compensating differentials explain why people with similar levels of education earn different wages.

Question 40

. Labour differentiation: compensating differentials Examples

Answer 40

Miners are paid more than other workers with similar levels of education. Their higher wage compensates them for the dirty and dangerous nature of mining. Workers who work the night shift at factories are paid more than similar workers who work the day shift. University lecturers are paid less than lawyers and doctors, who have similar amounts of education. Lower wages compensate them for the intellectual and personal satisfaction that their jobs offer.

Question 41

11.3.1. Labour differentiation: human capital

Answer 41

Human capital is the accumulation of investments in people, such as education and on the job training. The most important type of human capital is education.

Question 42

Education and human capital

Answer 42

Education represents an expenditure of resources at one point in time to raise productivity in the future. An investment in education is tied to a specific person, it is therefore called human capital.

Question 43

Human capital and higher productivity

Answer 43

Firms are willing to pay more for workers with more human capital because they have higher productivity. When people get a university degree, they signal their high ability to prospective employers. Because it is easier for high-ability people to get a degree than for low-ability people, more high-ability people get degrees. As a result, it is rational for firms to interpret a degree as a signal of ability. Most likely, education produces a combination of productivity-enhancing effects (human capital) and productivity-revealing effects (signaling).

Question 44

Labour differentiation Natural ability

Answer 44

Natural ability is important for workers in all occupations. Because of heredity and upbringing, people differ in physical and mental attributes that determine how productive they are.

Question 45

Labour differentiation Effort

Answer 45

Closely related to ability is effort. Some people work hard, others are lazy. We should not be surprised to find that those who work hard are more productive and earn higher wages.

Question 46

Labour differentiation Chance

Answer 46

Chance also plays a role in determining wages. A person who trained to manufacture cars just before the car industry shut down will end up earning a low wage compared with others with similar years of training.

Question 47

Labour differentiation: discrimination

Answer 47

Discrimination is the offering of different opportunities to similar individuals who differ only by race, ethnic group, sex, age or other personal characteristics. Discrimination reflects some people’s prejudice against certain groups in society.

Question 48

Wage differentials and discrimination

Answer 48

Some observed wage differentials may be attributable to discrimination, but there is no consensus about how much. Even in a labour market free of discrimination, different people may have different wages due to compensating differentials, human capital, ability, etc. However, differences in human capital among groups of workers may reflect earlier discrimination (e.g. inferior access to education and health during childhood).

Question 49

Imperfect competition: the superstar phenomenon

Answer 49

Although most actors earn very little and often have to take jobs as waiters to support themselves, the best actors earn millions of dollars for each film they make. What explains the difference

Question 50

Superstars arise in markets that have two characteristics:

Answer 50

Every customer in the market wants to enjoy the good supplied by the best producer; and The good is produced with a technology that makes it possible for the best producer to supply every customer at low cost.

Question 51

. Imperfect competition: efficiency wages

Answer 51

Efficiency wages are above equilibrium wages paid by firms in order to increase worker productivity. Because efficiency wages are above the wages that would result when supply equals demand, they can potentially explain unemployment as well as earnings. They are offered to improve health, productivity, decrease turnover, encourage effort and attract higher quality workers.