Organisation Economics Week 1 Quiz
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Questions and Answers

What is the main reason for establishing a firm according to Coase?

  • Reduced costs associated with market usage (correct)
  • The need for a centralized authority
  • Higher efficiency in production processes
  • Increased price competition in the market

What are the two main types of transaction costs identified in the content?

  • Management costs and Production costs
  • Co-ordination costs and Motivation/Incentive costs (correct)
  • Motivation costs and Transportation costs
  • Co-ordination costs and Information costs

How do firms differ from market transactions according to the content?

  • Firms involve more participant choices than in markets
  • Firms rely solely on external market conditions
  • Firms eliminate the market structure of exchange transactions (correct)
  • Firms allow for price changes that direct production

What significant gap does Coase aim to bridge in economic theory?

<p>The gap between resource allocation and price mechanisms (A)</p> Signup and view all the answers

Which statement best reflects Coase's perspective on worker movements within a firm?

<p>They are often mandated by managerial orders. (C)</p> Signup and view all the answers

What role does the entrepreneur-coordinator play within a firm?

<p>They replace the need for a price mechanism. (C)</p> Signup and view all the answers

How does Coase view the interaction between market efficiency and firm organization?

<p>Efficiency is context-dependent and can favor either organization or market. (C)</p> Signup and view all the answers

What is implied by the existence of transaction costs according to Coase?

<p>Firms may provide solutions to certain market inefficiencies. (B)</p> Signup and view all the answers

What characterizes an efficient economic outcome according to the Efficiency Principle?

<p>No party can be made better off without making another party worse off. (B)</p> Signup and view all the answers

According to the theory of the firm, what is the key condition for a firm to operate efficiently?

<p>Marginal Revenue must equal Marginal Cost. (D)</p> Signup and view all the answers

What is 'Organisational Architecture' in the context of firms?

<p>The structure of decision-making and resource allocation within a firm. (B)</p> Signup and view all the answers

What reason do economists typically give for the existence of firms?

<p>Firms can manage resources more effectively than the price mechanism. (C)</p> Signup and view all the answers

What aspect of firm organization does Coase highlight as an alternative to the price mechanism?

<p>The internal structure and decision-making processes of firms. (B)</p> Signup and view all the answers

Which statement aligns with Ronald Coase's view of the economic system?

<p>Society operates like an organism, rather than an organized structure. (D)</p> Signup and view all the answers

What scenario describes a 'back person' in the context of airline seating?

<p>A passenger who pays less than their desired fare to avoid inconvenience. (B)</p> Signup and view all the answers

What is a significant limitation of the market price mechanism as implied by Sir Arthur Salter?

<p>It oversimplifies the complexities of firm behavior. (B)</p> Signup and view all the answers

What are transaction costs primarily associated with?

<p>Costs incurred beyond the price paid to the supplier of a product (A)</p> Signup and view all the answers

Which of the following is NOT a type of motivation/incentive cost?

<p>Legal fees for contract enforcement (B)</p> Signup and view all the answers

What contributes to co-ordination costs in transactions?

<p>The process of determining prices and negotiating contracts (B)</p> Signup and view all the answers

Which issue is related to imperfect commitment in transactions?

<p>The failure to ensure that parties follow through on agreements (C)</p> Signup and view all the answers

What can cause mutually advantageous trade to fail?

<p>Fear of being victimized due to asymmetric information (B)</p> Signup and view all the answers

Which example best illustrates transaction costs?

<p>Costs incurred in locating and negotiating with a buyer (C)</p> Signup and view all the answers

Why might a supplier be hesitant to make a significant investment for a manufacturer?

<p>Concerns over future payment defaults by the manufacturer (D)</p> Signup and view all the answers

Which of the following best defines search costs in transaction theory?

<p>The costs associated with finding the right supplier or buyer (B)</p> Signup and view all the answers

What is the role of the price mechanism in market efficiency?

<p>It allocates resources based on consumer willingness to pay (C)</p> Signup and view all the answers

Why might firms exist despite the efficiency of markets?

<p>To avoid the costs associated with using the market mechanism (C)</p> Signup and view all the answers

How does increased demand for a product like bottled water affect its market equilibrium?

<p>Buyers will pay higher prices to secure the product (D)</p> Signup and view all the answers

What occurs to the supply of other goods when resources are redirected to produce bottled water?

<p>The price of inputs used elsewhere becomes more expensive (C)</p> Signup and view all the answers

What is one potential benefit of creating a market for airline seat recline negotiations?

<p>It allows mutual benefit through voluntary exchange (D)</p> Signup and view all the answers

What would be the effect of an increase in the supply of bottled water?

<p>A decrease in market prices due to oversupply (C)</p> Signup and view all the answers

In the context of Uber and traditional taxis, what aspect makes Uber potentially cheaper?

<p>Variable pricing based on market demand (D)</p> Signup and view all the answers

What is organizational architecture primarily concerned with?

<p>Enhancing the innovation process within firms (A)</p> Signup and view all the answers

What primarily distinguishes the effectiveness of different organizational forms in economic transactions?

<p>The nature and impact between organizational forms (B)</p> Signup and view all the answers

Which factor does NOT influence the type of market or organization that is considered best for a transaction?

<p>The color scheme of the branding (D)</p> Signup and view all the answers

What is a fundamental goal of any economic organization?

<p>To produce output that consumers want at the lowest cost (C)</p> Signup and view all the answers

Which statement about the Transaction Costs approach is accurate?

<p>It acknowledges that production and transaction costs are interdependent. (D)</p> Signup and view all the answers

What challenge does the 'Information Problem' pose in organizational design?

<p>Relevant information is incomplete or expensive to obtain. (C)</p> Signup and view all the answers

Which aspect is critical in maximizing the effectiveness of decision-makers in economic organizations?

<p>Ensuring all relevant information is accessible (C)</p> Signup and view all the answers

What can be said about the relationship between transaction costs and organizational design?

<p>Firms design organizational structures to minimize both production and transaction costs. (D)</p> Signup and view all the answers

Why is it a problem if individuals have incompatible objectives in an economic organization?

<p>It creates inefficiencies and reduces productivity. (C)</p> Signup and view all the answers

What is the main objective for the owners in an organizational context?

<p>Profit maximization (C)</p> Signup and view all the answers

How can bonuses be structured to improve staff morale?

<p>Connected to company performance (B)</p> Signup and view all the answers

What major consequence resulted from the high-powered incentives in the Dieselgate scandal?

<p>£24 billion in costs by 2019 (A)</p> Signup and view all the answers

What distinguishes John Lewis Partnership from traditional public companies?

<p>Employees have a stake in the business (B)</p> Signup and view all the answers

What is one reason why markets may not be the most efficient method for organizing economic activity?

<p>They lack automatic motivation mechanisms (C)</p> Signup and view all the answers

Which factor is NOT closely linked to organizational architecture?

<p>Corporate branding strategy (A)</p> Signup and view all the answers

What is a potential risk of imbalances in organizational architecture?

<p>Company failure (B)</p> Signup and view all the answers

How can changes in the business environment influence organizational architecture?

<p>By driving innovation in organizational practices (A)</p> Signup and view all the answers

Flashcards

Price Mechanism Efficiency

Market forces (prices) efficiently allocate resources to their most valuable uses.

Bottled Water Market

Example of how markets efficiently allocate resources based on demand and supply, especially in response to changes like a health scare.

Market Equilibrium

A state where supply matches demand, leading to an efficient allocation of resources in a market.

Cost of Using Market Mechanism

Potential drawbacks of relying solely on markets for resource allocation, including coordination challenges and information asymmetry.

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Organizational Architecture

Structure and processes of a firm that coordinate resources and tasks to achieve goals.

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Firm vs. Market

Comparing the use of markets (prices) vs. firms (internal coordination) in allocating resources.

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Uber/Taxi Example

Illustrative case used to identify efficiency and application of microeconomic principles.

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Hotel Upgrade Auctions

Illustrative case showing negotiation for desired outcomes in resource allocation and price in service industries.

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Efficient Outcome Airline Seats

An outcome where no one can be better off without making another worse off. Many prices can lead to an efficient allocation of resources, even in airline seat assignments.

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Efficiency Principle

If people can negotiate effectively and enforce agreements, economic outcomes tend to be efficient for those involved.

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Production Function

A set of instructions that shows how inputs are transformed into outputs.

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Marginal Revenue = Marginal Cost

The point where a firm operates efficiently in production.

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Coase's view of firms

Firms exist because the price mechanism alone doesn't perfectly coordinate all economic activity.

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Microeconomics & Theory of the Firm

How firms transform inputs into outputs following production functions, operating efficiently to maximize profit.

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Back Person Airline Seat

A passenger who pays less for a seat to avoid reclining.

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Transaction Cost

Any cost incurred by a buyer beyond the price paid to the supplier, including search, negotiation, and facilitation.

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Hidden Transaction Costs

Costs associated with market transactions that are not immediately obvious, often related to information gathering, negotiation, and contract enforcement.

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Coordination Costs

Costs associated with bringing buyers and sellers together, setting prices, and ensuring a smooth exchange process.

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Incomplete Contracts

Contracts that cannot specify all future contingencies, leading to uncertainty and potential for opportunistic behavior.

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Motivation/Incentive Costs

Costs arising from the need to motivate and incentivize parties to fulfill their obligations in a transaction, often due to information asymmetry and incomplete contracts.

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Imperfect Commitment

The inability of parties to bind themselves to future actions, leading to potential opportunism and reluctance to invest in long-term relationships.

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Sunk Cost

An irreversible investment made in a transaction that cannot be recovered, potentially leading to opportunistic behavior.

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Non-Market Organizations

Organizations that operate outside the traditional market system, such as internal departments within a company.

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Economic Organisation

A structured entity where people work together to achieve shared economic goals, involving both individual and collective aspirations.

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Specificity of Investments

The degree to which assets used in a transaction have limited use outside that transaction.

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Frequency and Duration

How often similar transactions occur and how long they last.

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Complexity and Uncertainty

How difficult it is to clearly define what is required in a transaction and how much uncertainty exists about future demands.

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Measurability of Performance

How easily the outcome of a transaction can be measured and attributed to specific actions.

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Connectedness of Transactions

How intertwined a transaction is with other transactions involving different parties.

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Fundamental Problem of Organisational Design

Maximizing productivity and efficiency by ensuring decision-makers have access to relevant information and are incentivized to use it productively.

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Price Mechanism

A system where supply and demand determine the prices of goods and services, allocating resources efficiently.

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Firm's Internal Coordination

A firm's internal processes, directed by management, allocate resources and coordinate tasks without relying on the market.

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Incomplete Information

A situation where buyers and sellers lack complete knowledge about the goods or services being exchanged.

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Make-or-Buy Decision

A firm's decision on whether to produce a good or service internally (make) or purchase it from an external supplier (buy).

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Profit Maximization

The primary goal of businesses, aiming to generate the highest possible profits for the owners.

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Organizational Architecture (OA)

The structure and processes within a firm that coordinate resources, tasks, and decision-making to achieve goals.

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Incentives in OA

Mechanisms that encourage or motivate individuals to act in a way that aligns with the firm's goals, often through rewards or penalties.

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Opportunistic Behaviour

When individuals act in ways that benefit themselves, even if it contradicts the firm's best interests.

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High Powered Incentives

Incentives that can lead to risky or unethical behavior when individuals focus too much on maximizing their own rewards.

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Aligning Incentives

Designing reward systems that encourage individuals to prioritize the firm's goals over self-interest.

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John Lewis Partnership

An example of a company where employees are partners, sharing ownership and benefiting from company performance through bonus payments.

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OA Determinants

Factors that influence the design and effectiveness of a company's organizational architecture, including strategy, industry, and environmental changes.

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Study Notes

Course Information

  • Course title: Organisation Economics
  • Course code: MEEE and ME
  • Topic 1.1: Firms vs Markets
  • Topic 1.2: Boundaries of Firms
  • Fall 2024
  • Week 1
  • Instructor: Pedro Luís Silva

Lecture 1 Outline

  • Review of Market Efficiency: The Price Mechanism
  • If Markets are Efficient, Why do Firms Exist?
  • Costs of Using the Market Mechanism
  • What is Organisational Architecture? How does it Link to Innovation?

Review of Market Efficiency: The Price Mechanism

  • Example: Manufacturing water bottles at 50p each.
  • Price mechanism rations demand, allocating it to the highest bidders.
  • Demand curve shift (e.g., health scare) leads to a new market equilibrium price.
  • This market equilibrium outcome is considered efficient.
  • Efficiency on the demand side: only consumers willing to pay the most get the product.
  • Efficiency on the supply side: resources are redirected to their highest value use (e.g., plastic from other uses).
  • Efficiency on resource allocation in other industries: price mechanism directs resources to highest value use (e.g., raw plastic—used in food wrappers—replaced with paper bags).

Applications of Microeconomics

  • Uber/Bolt: Is Uber cheaper than a taxi?
  • Hotel Upgrade Auctions
  • Airline Seats: Passenger fights, seat reclining, price mechanisms.
  • Economist's solution: create a market, allowing people to sell seat reclining rights.
  • Example: Overweight passenger charged for taking up additional seat space.

The Concept of Efficiency

  • Efficient outcome: no one can be better off without one party becoming worse off.
  • There can be multiple efficient outcomes.

Microeconomics and the Theory of the Firm

  • Firms transform inputs to outputs
  • Production functions: a recipe to make outputs from inputs.
  • Operate efficiently: where Marginal Revenue = Marginal Cost

Economics of Organisation

  • Purpose: to overcome the static "black box" view of a firm in microeconomics.
  • Why do firms exist? How are they organized?
  • Firms beyond one central manager, acting to maximize firm profit.
  • Firms allocate resources through managers, not prices.
  • Organizational Architecture:
    • Who makes decisions?
    • How are employees rewarded?
    • How is employee performance measured?

Why Do Firms Exist? Transaction Costs

  • Transactions occur within markets or firms/organizations.
  • Much research in economics focuses on transaction costs.
  • Two main types of transaction costs: co-ordination costs and motivation/incentive costs.

Co-ordination Costs

  • Determining prices/details (e.g., negotiating and writing contracts).
  • Making potential buyers and sellers known to each other.
  • Bringing buyers and sellers together.

Motivation/Incentive Costs

  • Uncertainty and incomplete/asymmetric information.
  • Protecting against opportunistic behavior from parties.
  • Inability of parties to commit to promises.

Transaction Costs: A Reflection

  • Transaction costs affect non-market organizations too.
  • The nature of transaction costs varies across different organizational forms.
  • How to decide the best organizational form for a specific transaction.

Aligning Incentives: John Lewis Partnership

  • Instead of being a public company, John Lewis is a partnership.
  • Employees have a stake in the business.
  • Partners receive annual bonuses as a percentage of their salary, connected to company performance.

Themes within Organisational Architecture (OA)

  • Markets not always the most efficient method for economic activities.
  • No automatic system for assigning decision rights/motivating individuals within firms.
  • Internal organization of firms mimics market forces.
  • Decision-rights, rewards, and performance evaluation are linked.
  • Imbalances can cause company failures.
  • Changes in the external environment can motivate OA change.

OA Determinants

  • Business environment (technology, markets, regulation)
  • Strategy (industry choice, price, quality, service)
  • Organisational Architecture (decision rights, reward systems, performance evaluation)
  • Incentives and actions
  • Firm value
  • Feedback effects between OA and strategy
  • Companies in similar industries follow similar OA.

Review of Topic 1

  • Review of market efficiency and prices.
  • The efficiency principle.
  • Why do firms exist?
  • What determines if transactions occur within or outside of a firm?
  • What are transaction costs and why do they matter?
  • Introduction to OA: 3 key ingredients.
  • The principle challenge in designing firms: maximize the likelihood that decision-makers have relevant information and are incentivized to use it productively.

Associated Reading

  • Required Journal Article: Coase (1937) The Nature of the Firm, Economica
  • Highly recommended: Milgrom & Roberts, Chapter 1 (background) and Chapter 2 (p. 28-35)
  • Required chapter: Brickley et al., Chapter 11, Organisational Architecture.
  • Article references (The Economist)

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Organization Economics Past Paper (Fall 2024) - PDF

Description

Test your understanding of the key concepts discussed in the first week of Organisation Economics, focusing on the efficiency of markets and the reasons why firms exist. This quiz covers essential ideas such as the price mechanism and organisational architecture. Perfect for students looking to deepen their grasp of the course material.

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