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The Organization of the

firm
Adib Aprilianur
Alifia Trisna Dheyanti
Ira Iryani
Mohamad Hidayat Rifai
Wahyu Syaripudin

Baye. Managerial Economics and Business Strategy. Inc. 3e. . 1999 . ©The McGraw-Hill Companies. Manager’s 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.

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

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

Inc. 3e. – 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. Specialized Investments • Investments made to allow two parties to exchange but has little or no value outside of the exchange relationship. ©The McGraw-Hill Companies. . Managerial Economics and Business Strategy. Michael R. Baye. 1999 .

Managerial Economics and Business Strategy. 3e. Baye. Inc. 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. . Implication of Specialized Investments • Costly Bargaining There is no other supplier capable of providing the desired input at a moment’s notice and no market price for the input. ©The McGraw-Hill Companies. 1999 . • Underinvestment Specialized investments are required to facilitate exchange. Michael R. the buyer or seller may attempt to capitalize on the “sunk” nature of the investment by engaging in opportunism.

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

Specialized Investments and Contract Length $ MC Due to greater MB1 need for specialized MB0 investments Longer Contract Contract 0 L0 L1 Length Michael R. ©The McGraw-Hill Companies. 3e. 1999 . Managerial Economics and Business Strategy. Baye. . Inc.

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. Managerial Economics 2 and Business 0 Strategy. Baye. Inc. ©The McGraw-Hill Companies. 1999 . . 3e.

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. Managerial Economics and Business Strategy. 3e. . Baye. Inc. ©The McGraw-Hill Companies.

. 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 agent’s low effort or due to bad luck Michael R. 3e. Baye. ©The McGraw-Hill Companies. Inc. Managerial Economics and Business Strategy. 1999 .

3e. Inc. 1999 . Managerial Economics and Business Strategy. 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. ©The McGraw-Hill Companies. .

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