Chapter 1. Markets and organizations
Framework:
Environment and
institutions
Division of labour
Specialization
Coordination
Organizatio
Market Information
n
1.1 The economic problem
● Economic problem: what is the optimal allocation of scarce resources over the
alternative uses that can be made of them → resources are used with
efficiency
● Economic approaches to organizations are used when the problem has an economic
aspect: whenever part of the problem deals with (optimal) allocation of scarce resources
● The economic contribution to our understanding of an organizational problem, increases
when the economic problem forms a greater part of the organizational problem we are
trying to understand
1.2 The division of labour
● Division of labour: Splitting of composite tasks into their component parts and having
these performed separately to make more in the same or even less time
● Progressive division of labour → productivity increases → increasing ‘wealth of
nations’
1.3 Specialization
● Specialized production: More efficient as there is more production with less goods / time
○ All attention goes to 1 specific tasks, and you can gain more experience
● Cost of specialization: choices have to be made, you can’t specialize in 2 things
○ Costs: restricted choices, gains: higher levels of performance can be reached
,1.4 Coordination
● For specialization, exchange has to take place (goods / money / information)
● Goods involving exchange have to be scarce
● Whenever exchange takes place, we speak of a transaction
● How is the coordination achieved within an economic system? Or; how do parties willing
to exchange in a transaction find each other? (1.5)
1.5 Markets and organizations
● The price system is the coordinating device that takes care of allocation
○ The price is a sufficient statistic: the price contains all the information you need to
base your transaction on; you don’t need to know anything else (no personal contact)
● Market mechanism → equilibrium: an optimal allocation of a good has been
achieved
● There is a cost associated with using the price system:
○ A cost (time) involved finding out the relevant prices
○ A contract is usually drawn to provide the basis for a market transaction
○ There may be conditions under which it is hardly possible (/extremely costly) to reach
a contractual agreement that may serve as a basis for market exchange
● In those cases, organization may provide an alternative: The price system is replaced by
authority: choices are made based on the cheapest transaction costs.
○ Organizations: firms, governments, trade unions, church, etc.
● An ideal market is characterized by the fact that prices act as ‘sufficient statistics’ for
individual decision-making
● Ideal organizations can be characterized as all those forms of coordination of
transactions that do not use prices to communicate information between the transacting
parties
1.6 Information
● Information is crucial in the framework
● There are many situations in which the price cannot absorb all the information necessary
to enable the execution of transactions.
○ The price has to be supplemented / the price mechanism is fully incapable
○ Organizations arise as solutions to information problems:
Market ↔️ organization is based on the particular information requirements of the situation.
1.7 The environment and institutions
● The environment: The context in which the trade-offs market ↔️ organizational
coordination are made (in nature, social, political, cultural, institutional dimensions)
, ● Evolutionary approaches to organizations are pressured/selected by their environment
(abortion)
● Organizations and markets do not operate in a vacuum, but live in an environment that:
○ Provides the conditions for particular organizations to be created
○ Shapes all organizations by exerting economic, social, political, other pressures
○ Is also the ultimate selection mechanism for determining which organizations can
survive and be successful (while other organizations are ‘selected out’ and perish)
● Governments have a fundamental influence on which markets are allowed to exist and
how they function (in centrally planned economies and in market economies)
● Institutions: the rules of the game in a society; the humanly devised constraints that
shape human interaction
○ Formal: written laws, constitutions, regulations and the like
○ Informal: Norms of behaviour, conventions, internally imposed rules of conduct
● The government is a particularly important actor in the environment of markets and
organizations (E.G. governments stepped in and compensated for such ‘market failures’)
1.8 Historical perspective
2 reasons why it took so long to raise the question: Why do we observe so many organizations
if markets are so efficient ( Coase, 1937)
● Until recently, most (but not all) economists focused their attention on how the markets
achieves coordination between organizations (and individuals)
○ First the theory of markets itself was elaborately investigated
○ New theoretical approaches: ec. Transactions → executed within
organizations
● Most (but not all) organization theorists studied coordination within organizations
○ First attempts to formulate ‘one best way to organize’ → dependent on
situation
● Now: family of economic approaches to organizations:
○ Economic theories of organization
Chapter 2. Markets; SET
2.1 Introduction
● Standard microeconomic theory (SET) explains the functioning of markets which
○ Have demand +supply & matches them at a certain price (price → market interaction)
● SET: Market is the ideal mechanism for economic exchange (= perfect competition model)
, 2.2 Market interaction: analysis of demand and supply
● Law of demand (Price ↑ = demand ↓) vs law of supply (Price ↑ = supply ↑)
● Market equilibrium: intersection of the supply curve and the demand curve
2.3 Decision-making by consumers
● Transitive: Preference ranking of certain goods
● Transitive → indifference curves: preferences of a
set further from the origin
● Utility: The satisfaction consumers derive from
having goods
○ Consumers gets the same level of utility
from 2 points on the indifference curve
● Budget line: the quantity of 2 goods someone can
buy with their budget
● SET assumes: Measuring utility is not possible (only
ranking) + goal = maximizing level of utility (intersection
budget line + indifference curve)
2.4 Decision-making by producers
● 2 main questions in SET: How does a producer decide how much she is going to
produce // how they will produce the quantity → answering needs description of
a firm
● A firm: an entity that maximizes profit
○ depends on quantity produced (Q), amount of capital (K), amount of labor (L)
○ Direct relationship between these: Production function: Q=Q (K , L)
● SET assumes in a competitive market Q,K,L are easily calculated to give max profit
2.5 Market coordination
● Producer maximizes profit → supply curve, consumer maximizes utility →
demand curve
● Changes of demand/supply = shifts of demands/supply curve
2.6 The paradox of profits
● A firm can’t make profit in the long run (profit in excess of normal profit)
○ Low profit: free exit
○ Excessive profit → entry → supply ↑ → price ↓ → profit would vanish
● Management within firms wit SET:
○ Firms cannot change (are either adapted to environment / disappear)
○ No room for differentiation = isomorphism (same products, costs, structure)
○ No room for competitive advantage
Framework:
Environment and
institutions
Division of labour
Specialization
Coordination
Organizatio
Market Information
n
1.1 The economic problem
● Economic problem: what is the optimal allocation of scarce resources over the
alternative uses that can be made of them → resources are used with
efficiency
● Economic approaches to organizations are used when the problem has an economic
aspect: whenever part of the problem deals with (optimal) allocation of scarce resources
● The economic contribution to our understanding of an organizational problem, increases
when the economic problem forms a greater part of the organizational problem we are
trying to understand
1.2 The division of labour
● Division of labour: Splitting of composite tasks into their component parts and having
these performed separately to make more in the same or even less time
● Progressive division of labour → productivity increases → increasing ‘wealth of
nations’
1.3 Specialization
● Specialized production: More efficient as there is more production with less goods / time
○ All attention goes to 1 specific tasks, and you can gain more experience
● Cost of specialization: choices have to be made, you can’t specialize in 2 things
○ Costs: restricted choices, gains: higher levels of performance can be reached
,1.4 Coordination
● For specialization, exchange has to take place (goods / money / information)
● Goods involving exchange have to be scarce
● Whenever exchange takes place, we speak of a transaction
● How is the coordination achieved within an economic system? Or; how do parties willing
to exchange in a transaction find each other? (1.5)
1.5 Markets and organizations
● The price system is the coordinating device that takes care of allocation
○ The price is a sufficient statistic: the price contains all the information you need to
base your transaction on; you don’t need to know anything else (no personal contact)
● Market mechanism → equilibrium: an optimal allocation of a good has been
achieved
● There is a cost associated with using the price system:
○ A cost (time) involved finding out the relevant prices
○ A contract is usually drawn to provide the basis for a market transaction
○ There may be conditions under which it is hardly possible (/extremely costly) to reach
a contractual agreement that may serve as a basis for market exchange
● In those cases, organization may provide an alternative: The price system is replaced by
authority: choices are made based on the cheapest transaction costs.
○ Organizations: firms, governments, trade unions, church, etc.
● An ideal market is characterized by the fact that prices act as ‘sufficient statistics’ for
individual decision-making
● Ideal organizations can be characterized as all those forms of coordination of
transactions that do not use prices to communicate information between the transacting
parties
1.6 Information
● Information is crucial in the framework
● There are many situations in which the price cannot absorb all the information necessary
to enable the execution of transactions.
○ The price has to be supplemented / the price mechanism is fully incapable
○ Organizations arise as solutions to information problems:
Market ↔️ organization is based on the particular information requirements of the situation.
1.7 The environment and institutions
● The environment: The context in which the trade-offs market ↔️ organizational
coordination are made (in nature, social, political, cultural, institutional dimensions)
, ● Evolutionary approaches to organizations are pressured/selected by their environment
(abortion)
● Organizations and markets do not operate in a vacuum, but live in an environment that:
○ Provides the conditions for particular organizations to be created
○ Shapes all organizations by exerting economic, social, political, other pressures
○ Is also the ultimate selection mechanism for determining which organizations can
survive and be successful (while other organizations are ‘selected out’ and perish)
● Governments have a fundamental influence on which markets are allowed to exist and
how they function (in centrally planned economies and in market economies)
● Institutions: the rules of the game in a society; the humanly devised constraints that
shape human interaction
○ Formal: written laws, constitutions, regulations and the like
○ Informal: Norms of behaviour, conventions, internally imposed rules of conduct
● The government is a particularly important actor in the environment of markets and
organizations (E.G. governments stepped in and compensated for such ‘market failures’)
1.8 Historical perspective
2 reasons why it took so long to raise the question: Why do we observe so many organizations
if markets are so efficient ( Coase, 1937)
● Until recently, most (but not all) economists focused their attention on how the markets
achieves coordination between organizations (and individuals)
○ First the theory of markets itself was elaborately investigated
○ New theoretical approaches: ec. Transactions → executed within
organizations
● Most (but not all) organization theorists studied coordination within organizations
○ First attempts to formulate ‘one best way to organize’ → dependent on
situation
● Now: family of economic approaches to organizations:
○ Economic theories of organization
Chapter 2. Markets; SET
2.1 Introduction
● Standard microeconomic theory (SET) explains the functioning of markets which
○ Have demand +supply & matches them at a certain price (price → market interaction)
● SET: Market is the ideal mechanism for economic exchange (= perfect competition model)
, 2.2 Market interaction: analysis of demand and supply
● Law of demand (Price ↑ = demand ↓) vs law of supply (Price ↑ = supply ↑)
● Market equilibrium: intersection of the supply curve and the demand curve
2.3 Decision-making by consumers
● Transitive: Preference ranking of certain goods
● Transitive → indifference curves: preferences of a
set further from the origin
● Utility: The satisfaction consumers derive from
having goods
○ Consumers gets the same level of utility
from 2 points on the indifference curve
● Budget line: the quantity of 2 goods someone can
buy with their budget
● SET assumes: Measuring utility is not possible (only
ranking) + goal = maximizing level of utility (intersection
budget line + indifference curve)
2.4 Decision-making by producers
● 2 main questions in SET: How does a producer decide how much she is going to
produce // how they will produce the quantity → answering needs description of
a firm
● A firm: an entity that maximizes profit
○ depends on quantity produced (Q), amount of capital (K), amount of labor (L)
○ Direct relationship between these: Production function: Q=Q (K , L)
● SET assumes in a competitive market Q,K,L are easily calculated to give max profit
2.5 Market coordination
● Producer maximizes profit → supply curve, consumer maximizes utility →
demand curve
● Changes of demand/supply = shifts of demands/supply curve
2.6 The paradox of profits
● A firm can’t make profit in the long run (profit in excess of normal profit)
○ Low profit: free exit
○ Excessive profit → entry → supply ↑ → price ↓ → profit would vanish
● Management within firms wit SET:
○ Firms cannot change (are either adapted to environment / disappear)
○ No room for differentiation = isomorphism (same products, costs, structure)
○ No room for competitive advantage
