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Prices and Markets > Week 11 > Flashcards

Week 11 Flashcards

1
Q

The firm

A

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

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2
Q

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

A

6/10

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3
Q

Problems with the traditional approach

A

why do firms exist at all?

How are they internally organised?

What determines their boundary ?

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4
Q

5 Assumptions of traditional economics

A

Perfect rationality and information

Profit maximisation

Identical costs and profits

One single and identical product

Zero transaction cost

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5
Q

Reality of Perfect rationality and information

A

Firms are evolving hierarchies of procedures to process information

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6
Q

Reality of Profit maximisation

A

Firms are coalition of stakeholders with different, conflicting objectives

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7
Q

Reality of Identical costs and profits

A

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

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8
Q

Reality of One single and identical product

A

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

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9
Q

Reality of Zero transaction cost

A

Firms are command and control mechanisms that internalise market transactions

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10
Q

The firms boundary

A

6/10

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11
Q

The firms boundary definition

A

Defines what the firm does

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12
Q

Vertical chain

A

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

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13
Q

Vertical Boundary

A

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)

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14
Q

Horizontal boundary

A

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

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15
Q

Transaction costs

A

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

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16
Q

Transactions involve

A

Identifying trading partners

Negotiating contracts

Monitoring compliance

Enforcing fulfilment

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17
Q

Transactions are costly due to

A

Bounded rationality

Opportunism/moral hazard

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18
Q

Firms are command-and-control mechanisms

A

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

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19
Q

Firm integration

A

6/10

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20
Q

Vertical integration

A

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).

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21
Q

Make or buy decision

A

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

22
Q

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

A

Economies of scale and scope

Number of firms

Asset specificity

Firm specific knowledge

Uncertainty

Scope for opportunism

Monitoring/governance costs

Complexity of production

23
Q

Make or buy decision

Starbucks example

A

6/10

24
Q

Horizontal integration

A

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.

25
Q

Economies of scale

Horizontal integration

A

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

6/10

26
Q

Real economies

Horizontal integration

A

changes in input quantities as a result of volume

Indivisibilities of fixed assets

Alternative production techniques

Specialisation

Inventories

27
Q

Pecuniary economies

Horizontal integration

A

changes in prices paid by the firm for inputs

Purchasing power

Advertising

R & D

28
Q

Diseconomies

Horizontal integration

A

Higher wages and unionisation

Incentivisation and monitoring

Red tape: communication and coordination difficulties

Specialised resources spread too thin

29
Q

Horizontal integration

Learning economies

A

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

30
Q

Learning economies vs. economies of scale

A

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

31
Q

Horizontal integration

Economies of scope

A

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.

32
Q

Sources of economies of scope

A

Indivisibilities: under-utilised fixed assets

Core competences: firm-specific assets

Networks: customers, suppliers, contacts with banks, government

Brand name: exploit customer loyalty

33
Q

The factors of production

A

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

34
Q

The 3 FOP categories

A

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

35
Q

The factors market - Introduction

A

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

36
Q

Labour market imperfections and wage differentials

A

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:

37
Q

Assumptions of the labour market:

A

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).

38
Q

11.3 Labour market imperfections and wage differentials

When broken diagram

A

6/10

39
Q

. Labour differentiation: compensating differentials

A

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.

40
Q

. Labour differentiation: compensating differentials

Examples

A

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.

41
Q

11.3.1. Labour differentiation: human capital

A

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.

42
Q

Education and human capital

A

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.

43
Q

Human capital and higher productivity

A

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).

44
Q

Labour differentiation

Natural ability

A

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.

45
Q

Labour differentiation

Effort

A

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.

46
Q

Labour differentiation

Chance

A

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.

47
Q

Labour differentiation: discrimination

A

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.

48
Q

Wage differentials and discrimination

A

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).

49
Q

Imperfect competition: the superstar phenomenon

A

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

50
Q

Superstars arise in markets that have two characteristics:

A

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.

51
Q

. Imperfect competition: efficiency wages

A

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.

Prices and Markets (18 decks)

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