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Production, Information Costs, and Economic Organization

Production, Information Costs, and Economic Organization. Armen Alchian and Harold Demsetz (1972) American Economic Review Presented by Daniela Pedraza Novak. Two important problems.

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Production, Information Costs, and Economic Organization

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  1. Production, Information Costs, and Economic Organization Armen Alchian and Harold Demsetz (1972) American Economic Review Presented by Daniela Pedraza Novak

  2. Two important problems • To explain the conditions that determine whether the gains from specialization and cooperative production can be better obtained within an organization like the firm or across markets • To explain the structure of the firm • Firm as superior to the market (power to settle issues by fiat, authority or disciplinary action) • Long term contracts are not the essence of the firm • Firm team use of inputs + centralized contractual agent

  3. Main Argument • Capitalistic society  Resources are owned and allocated by nongovernmental institutions • Markets and firms - Owners increase productivity through cooperative specialization/production • Team Production - Difficult to measure individual contributions to team production Behavior cues? - With team production it is difficult, solely by observing total output, to define or determine eachindividual’s contribution. - The output is yielded by a team and it is not a sum of separable outputs of each of the members.

  4. The Metering Problem • Shirking  Represents a real issue to institutions • Economic theory • Failed to address the costs associated with metering (measuring) productivity and rewards • Assumptions Metering costs = 0 Productivity creates rewards • Author’s Opposing View • System of rewarding as a system that stimulates productivity. • - Rewards create productivity • An economic organization that meters well will have higher productivity. • (productivity will rise, shirking will fall depending on the ability to meter)

  5. How can team production be organized to reduce shirking and the costs of detecting performance? • The Monitor = will meter the marginal productivity of individual inputs to the team’s output - Residual claimant status  Earns his residual trough the reduction in shirking that he brings - Central party to all contracts with inputs - Observes input behavior - Has power to revise contract terms and incentives

  6. Necessary conditions for the existence of the classical firm (1) It is possible to increase productivity through team-oriented production A production technique for which it is costly to directly measure the marginal outputs of the cooperating inputs, and that makes it more difficult to restrict shirking through simple market exchange between cooperating inputs. (2) It is economical to estimate marginal productivity by observing or specifying input behavior • Firms exists due to costs of managing • Extension of Coase (1937) Classic Capitalist Firm “Ceteris paribus, the higher is the cost of transacting across markets the greater will be the comparative advantage of organizing resources within the firm.”

  7. Types of Firms

  8. Regardless of firm type choice a spirit of loyalty should be instilled among members.

  9. Inputs Owned by the Firm • Rented versusowned Renting may be more costly than owning • Employers will invest in inputs with higher resale values and longer expected use • Monitor gross product performance of inputs as well as the abuse and depreciation inflicted upon the input in its use. • The degree to which it is easier to detect cost by monitoring usage behavior over inspection post use increases likelihood of ownership

  10. Firms as specialized market institutions • The firm serves as a highly specialized surrogate market • A device for enhancing competition among sets of input resources. • A device for more efficiently rewarding these inputs. • Employer acquires superior information about input’s productive talents -Helps employer’s market hiring efficiency -Allows for opportunities for profitable team production to be ascertained more economically and more accurately.

  11. Conclusion • Monitoring or metering the productivities to match marginal productivities to costs of inputs and thereby to reduce shirking can be achieved more economically in a firm. • The firm takes on the characteristic of an efficient market in that information about the productive characteristics of a large set of specific inputs is now more cheaply available. The firm can be considered a privately owned market.

  12. Discussion • How should we interpret the idea of the firm as a specialized private market? • Should we then consider the firm and the ordinary market as competing types of markets?

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