Business Economics I

1. Business Economics I Markets and Organizations I

2. Introduction What is a Society? What is an Organization? What is a Market? Markets & Organization The Social Problem – Liberalism & Socialism Exchange and Property The Economic Problem Specialization Transformation and Transaction Costs Specialization and Costs The Market Solution The Role of Prices Property Rights Pareto-efficiency Fairness in Exchange The Political Solution A New Balance ? The Organizational Solution Externalities The Coase Theorem Plan of the Topic

3. Introduction • What is the Economic Problem? • What to produce? • How to produce? • Who to produce for? • What is the Social Problem? • How can we combine individual freedom with social cohesion?

4. What is a society I? • A society is a collection of individuals who are in relations with each others. • Examples: • Users of internet; • The people who live in Catalonia • The people who live in Spain • The bees in a hive

5. What is a society II? • As a whole, a society is composed of both individualsand their relationships. In this sense, a society is more than its components • Therefore, if we just gather together a Catalan, a French, and a British, they will not represent a society.

6. What is an organization I? • An organization is a society where social relations among individuals are organized by social rules. • Examples: • UPF • Telefonica • The United Nations

7. What is an organization II? • Social rules that govern an organization can be explicit (laws, procedures, etc.) and/or implicit (culture, language). • Does the bee hive represent an organization? • Do the Internet users represent an organization? • Is our class an organization?

8. What is a market? • A market is a society where individuals exchange goods and resources at a price. • Examples: • The buyers and the sellers of computers • Auction site of Yahoo!, eBay • Financial markets

9. Remarks • Who participates in the exchange? • Exchanges can take place among individuals, between individuals and organizations, among organizations or within an organization. • What is the level of application of the rules? • The sales and purchase of computers in Spain is defined by certain rules as well as the trade of shares on Wall Street is governed by the strict rules of the SEC (Securities and Exchange Commission) • The sales of tobacco is strictly regulated nationally BUT not on the international market • Nowadays, one of the most important issues for the organization of the international markets is the lack of an international political authority

10. The Social Problem I • How can we combine individual freedom with social cohesion? • Liberalism: If individuals are let to be free to exchange, then social cohesion will result naturally. Liberalism focuses on freedom of exchange. • Socialism: Individuals have to be constrained so that social cohesion is preserved. Socialism focuses on rules that govern relationships.

11. The Social Problem II • Economics has been at the center of the ideological battle between liberalism and socialism. • In practice, both freedom and rules exist in society. • Do we accept to talk about both or do we reduce the understanding of society to one aspect or the other?

12. The Social Problem III Economics has been criticized for reducing the social problem to the one of freedom of exchange. Today, a main issue is the organization of international markets in the absence of international political authority.

13. Liberalism I • Many authors in Economics have tried to show that exchanges determine social cohesion, for the good or for the bad. • For instance, Adam Smith has argued that the free exchange of goods and resources leads to an efficient social allocation of resources by itself.

14. Liberalism II • Later, Ronald Coase has argued that such an efficiency does not depend on the initial allocation of property rights provided these rights can also be exchanged at low cost. • The argument is that freedom by itself leads to social cohesion and social development.

15. Socialism I • Karl Marx has argued that freedom of exchange can be a means to ensure social domination of one class of individuals (those who can acquire property rights, i.e. the capitalists) over other classes (the individuals who must sell their property rights). • Ultimately, alienation of rights was told to lead to the collapse of a system based on the free exchange of private property rights. Marx proposed that the allocation of resources must be dictated by the society as a whole. The property of rights to produce should be collective.

16. Socialism II The end of XX century has seen the collapse of the “communist system” as understood as the collective property of production means. But the beginning of the XXI century also shows signs that a system solely based on free exchange is fragile and may collapse.

17. The Economic Problem I • Economics has been primarily concerned by the question of exchange of goods and resources among individuals. • Two forms of exchange are distinguished: initiated by the individual or controlled by the society. • But exchange presupposes the notion of property. Therefore, we must consider simultaneously the notions of exchange and of property. • Two forms of property are distinguished: individual or collective.

18. The Economic Problem II • What to produce? • Allocation of resources • How to produce? • Efficiency in the use of resources • Who to produce for? • Distribution

19. Specialization • Specialization: a resource is specialized when it is usually more suitable for a specific product/service and offers comparative advantage in its production/provision • Example: • Primary school teacher and University professor • Upa Dance and Celine Dion • Axe and machine gun • When a resource gets more specialized, the total cost of production varies due to the increase of the transaction costs and the decrease of the transformation costs.

20. Transformation and Transaction Costs I • The cost of producing a product or a service consists of the sum of the transformation costs and the transaction costs

21. Transformation and Transaction Costs II • Transaction Costs – All the costs incurred directly or indirectly by the by the need to coordinate the specialized resources and to motivate their owners

22. Transformation and Transaction Costs III • Coordination costs: the costs caused by the need to coordinate the supply and the demand • The participants in the exchange need to know the answers of 3 questions about the resources that are offered and demanded: • When • Where, and • in What quantities

23. Transformation and Transaction Costs IV • Examples: • Advertisements • Announcements in the newspapers • Internet (eBay) • Miguel and Maria

24. Transformation and Transaction Costs V • Motivation costs: all the costs that are incurred in order to align the interests of the participants in the exchange • Examples: • Supervision and Monitoring • Audited financial statements • Ticket controllers in the public transport

25. Transformation and Transaction Costs VI • Why do motivation costs exist? • Most exchanges are complex and represent promises linked to certain circumstances that are more or less expected beforehand • Example: • Maria has to develop a webpage by the 1st of March, which presupposes that she will be healthy and capable to work, the computer will be functioning correctly, there will electricity, etc.

26. Transformation and Transaction Costs VII • Promises, however can be broken • Example: • Maria does not finish the webpage on time because of • a) being sick or • b) preferring to go to many UPF parties

27. Transformation and Transaction Costs VIII • Opportunism: behaviour that harms the other party and is undertaken in order to serve the interest of the party that breaks the promise. • Example: • Maria and Miguel have to finish a webpage by today and have already been paid. They, however, don’t finish it on time because they work on another project for which they get more money.