You are on page 1of 13

The Organization of the

firm
Adib Aprilianur
Alifia Trisna Dheyanti
Ira Iryani
Mohamad Hidayat Rifai
Wahyu Syaripudin
Managers Role
Procure inputs in
the least cost Costs C(Q)
manner A
$100
Provide incentives B

for workers to put 80


forth effort
Failure to
accomplish this 0 $10
Output

results in a point
like A
Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Methods of Procuring
Inputs
Spot Exchange
When the buyer and seller of an input meet,
exchange, and then go their separate ways.
Contracts
A legal document that creates an extended
relationship between a buyer and a seller.
Vertical Integration
When a firm shuns other suppliers and
chooses to produce an input internally.

Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Transaction Costs
Costs of acquiring an input over
and above the amount paid to the
input supplier.
Includes:
Search costs
Negotiation costs
Other required investments or
expenditures

Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Specialized Investments
Investments made to allow two parties
to exchange but has little or no value
outside of the exchange relationship.
Site specificity
Physical-asset specificity
Dedicated assets
Human capital
A relationship-specific exchange that
occurs when the parties to a
transaction have made specialized
investments.
Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Implication of Specialized
Investments
Costly Bargaining
There is no other supplier capable of providing the desired
input at a moments notice and no market price for the
input.
Underinvestment
Specialized investments are required to facilitate
exchange, the level of the specialized investment often is
lower than the optimal level.
Opportunism and the Hold-Up Problem
Specialized investment must be made to acquire an input,
the buyer or seller may attempt to capitalize on the sunk
nature of the investment by engaging in opportunism.

Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Optimal Contract Length
$

MB

Contract
0 L* Length
(in
Michael R. Baye, years)
Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Specialized Investments
and Contract Length
$
MC

Due to greater MB1


need for
specialized
MB0
investments

Longer
Contract
Contract
0 L0 L1
Length
Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Contracting Environtment and
Contract Length

$ Due to more
complex
contracting MC2
environtment
MC0
Due to less
complex MC1
contracting
environtment MB

Contract
0 L L L1 Length
Michael R. Baye, Managerial Economics
2 and Business
0 Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
The Economic Trade-Off

No Spot Exchange

Substantial
specialized
investments Yes
Complex
relative to contracting
contracting costs? environment
relative to costs of
No integration?
Yes

Contract Vertical
Integration
Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
The Principal-Agent
Problem
Occurs when the principal cannot
observe the effort of the agent
Example: Shareholders (principal) cannot
observe the effort of the manager (agent)
Example: Manager (principal) cannot
observe the effort of workers (agents)
The Problem: Principal cannot
determine whether a bad outcome was
the result of the agents low effort or
due to bad luck
Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Solving the Problem
Between Owners and
Managers
Internal incentives
Incentive contracts: Stock options &
year-end bonuses
External incentives
Personal reputation
Potential for takeover

Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999
Solving the Problem Between
Managers and Workers
Profit sharing
Revenue sharing
Piece rates
Time clocks and spot checks

Michael R. Baye, Managerial Economics and Business Strategy, 3e. The McGraw-Hill Companies, Inc. , 1999