lOMoARcPSD|14840171
Global business history - IB
Lecture 1
Theory of the firm
Theory of the firm
3 main perspectives:
• Neo-classical (Marshall 1890)
• New institutional (Coase 1937)
• The entrepreneur (Schumpeter 1912)
Neo-classical theory
The representative firm
• A model firm not necessarily in existence which as an abstract construction is used to
illustrate the operations of a market as a whole
• Transforms input into outputs
• Maximizes profit, given prices and technology
Firm size under perfect competition
MR: marginal revenue
TC: total costs = fixed + variable
costs ATC: average total costs =
TC/Q
MC = ∆TC/ ∆Q
We assume price takers and perfect competition.
Therefore marginal revenue is constant sells any quantity
of a food for the same price (cannot sell for higher price)
Due to the law of diminishing marginal returns the marginal costs initially fall due to
improvements to specialization. However, after hitting the point of diminishing marginal
returns, they arise.
New institutional theory
Why do firms even exist?
Why not leave all the transactions to the market?
The firm is hierarchical
(coercion) Market is voluntary
(freedom)
The market is not frictionless
The firms reduce transaction costs:
• Discover prices
, lOMoARcPSD|14840171
• Negotiate and conclude contracts
• Taxes
• Principle-agent problem
So why is the market? The firm is costly as well
• Decreasing returns to management
The size of the firm is determined:
• Marginal costs of hierarchical transitions (inefficiencies)
• Vs. marginal costs of market transactions (frictions)
This is determined, among other factors, by technology
• Information technology
• Management technology/institutions
E.g. the telephone makes it easy to organize spatially (pushing the size of the firm upwards)
but also to discover prices (pushing the size of firm downwards)
The entrepreneur
• Where does technology come from?
• Beyond determinism: change come from within (the top of) the firm
• The entrepreneur as agent of technological change
Technology broadly defined:
• New customers’ goods
• New methods of production & transport
• New markets
• New form of organization
Entrepreneurship motivated by monopolistic profit.
Focus on disequilibrium and change: “creative destruction is the essential fact of capitalism”
Preindustrial organization
Proto-industry
• Work from home (cottage)
• Surplus workers in countryside
• Traditional/no innovation
• Inefficiency does not lead to elimination (no Schumpeteriam competition)
• Phased out due to the decline in prices and move of the people to the cities
Putting-out system / cottage industry
Merchant-entrepreneur uses a network of households
• Subcontracting work
• Workers use own machines
• Suited to pre-urban times because workers did not have to travel from home to work
• Flexibility
• ‘Piece-wage’
, lOMoARcPSD|14840171
• No surveillance
Craft guilds
• Quasi enterprises that organized labor and capital
• Managed human capital formation
• Quality control
• Controlling entry to the labor market
• Stability of income
• As monopolies they restricted supply
• Stifled innovation
• Division of labor based on age and status not skill
The industrial revolution
The onset of modern economic growth The demographic transition
Structural transformation
What is the industrial revolution?
Industrial revolutions are sharp transitions in technological paradigms
• Clusters of inventions (e.g., steam engine, cotton spinning)
• Associated with new General-Purpose Technology
Steam and the first industrial revolution (1780 – 1850)
Electricity and the second industrial revolution (1870 – 1913)
ICT and the Third industrial revolution (1970 - …)
Energy transition Cotton production
, lOMoARcPSD|14840171
The entrepreneurs as investors
• Newcomen invested 10 years in R&D and unsuccessfully tried to patent his engine
• Watt raised nearly £1,000 for R&D on the engine project, patented it in 1796
and build a successful business
• Hargreaves was a hand-loom weaver, who raised money (<£500), sold
spinning jennies, but made little money
• Arkwright was probably the richest entrepreneur of the industrial revolution,
who raised funds and also invented the cotton mill, becoming a factory owner
Coal and industrial location
• At first steam engine supplements water power
• Independence from water or workers
• Move outside of the cities to suitable locations near coal
• New urban centres (Manchester)
• Reliability
• Dependence on coal
The factory system
The factory system: timeline
• Early 1700s: few big factories employed 300/800 people (shipyards), almost
work done at home or next to it
• 1800: 900 cotton spinning factories, but only 300 employed 50+ people
• 1830s: average Manchester mill had 400 workers, ironworks employ up to
5000 people
• 1914: majority of Western European workers no longer worked at home (2/3
in France)
Benefits of the factory system
• Economies of scale and scope
• Monitoring costs
• Discipline
• Communication vs. transportation costs
Scale
Economies of scale
• Factories mostly specialize in one good
• Factories cluster in same places (backward and forward linkages)
• Mechanization & fixed costs
Global business history - IB
Lecture 1
Theory of the firm
Theory of the firm
3 main perspectives:
• Neo-classical (Marshall 1890)
• New institutional (Coase 1937)
• The entrepreneur (Schumpeter 1912)
Neo-classical theory
The representative firm
• A model firm not necessarily in existence which as an abstract construction is used to
illustrate the operations of a market as a whole
• Transforms input into outputs
• Maximizes profit, given prices and technology
Firm size under perfect competition
MR: marginal revenue
TC: total costs = fixed + variable
costs ATC: average total costs =
TC/Q
MC = ∆TC/ ∆Q
We assume price takers and perfect competition.
Therefore marginal revenue is constant sells any quantity
of a food for the same price (cannot sell for higher price)
Due to the law of diminishing marginal returns the marginal costs initially fall due to
improvements to specialization. However, after hitting the point of diminishing marginal
returns, they arise.
New institutional theory
Why do firms even exist?
Why not leave all the transactions to the market?
The firm is hierarchical
(coercion) Market is voluntary
(freedom)
The market is not frictionless
The firms reduce transaction costs:
• Discover prices
, lOMoARcPSD|14840171
• Negotiate and conclude contracts
• Taxes
• Principle-agent problem
So why is the market? The firm is costly as well
• Decreasing returns to management
The size of the firm is determined:
• Marginal costs of hierarchical transitions (inefficiencies)
• Vs. marginal costs of market transactions (frictions)
This is determined, among other factors, by technology
• Information technology
• Management technology/institutions
E.g. the telephone makes it easy to organize spatially (pushing the size of the firm upwards)
but also to discover prices (pushing the size of firm downwards)
The entrepreneur
• Where does technology come from?
• Beyond determinism: change come from within (the top of) the firm
• The entrepreneur as agent of technological change
Technology broadly defined:
• New customers’ goods
• New methods of production & transport
• New markets
• New form of organization
Entrepreneurship motivated by monopolistic profit.
Focus on disequilibrium and change: “creative destruction is the essential fact of capitalism”
Preindustrial organization
Proto-industry
• Work from home (cottage)
• Surplus workers in countryside
• Traditional/no innovation
• Inefficiency does not lead to elimination (no Schumpeteriam competition)
• Phased out due to the decline in prices and move of the people to the cities
Putting-out system / cottage industry
Merchant-entrepreneur uses a network of households
• Subcontracting work
• Workers use own machines
• Suited to pre-urban times because workers did not have to travel from home to work
• Flexibility
• ‘Piece-wage’
, lOMoARcPSD|14840171
• No surveillance
Craft guilds
• Quasi enterprises that organized labor and capital
• Managed human capital formation
• Quality control
• Controlling entry to the labor market
• Stability of income
• As monopolies they restricted supply
• Stifled innovation
• Division of labor based on age and status not skill
The industrial revolution
The onset of modern economic growth The demographic transition
Structural transformation
What is the industrial revolution?
Industrial revolutions are sharp transitions in technological paradigms
• Clusters of inventions (e.g., steam engine, cotton spinning)
• Associated with new General-Purpose Technology
Steam and the first industrial revolution (1780 – 1850)
Electricity and the second industrial revolution (1870 – 1913)
ICT and the Third industrial revolution (1970 - …)
Energy transition Cotton production
, lOMoARcPSD|14840171
The entrepreneurs as investors
• Newcomen invested 10 years in R&D and unsuccessfully tried to patent his engine
• Watt raised nearly £1,000 for R&D on the engine project, patented it in 1796
and build a successful business
• Hargreaves was a hand-loom weaver, who raised money (<£500), sold
spinning jennies, but made little money
• Arkwright was probably the richest entrepreneur of the industrial revolution,
who raised funds and also invented the cotton mill, becoming a factory owner
Coal and industrial location
• At first steam engine supplements water power
• Independence from water or workers
• Move outside of the cities to suitable locations near coal
• New urban centres (Manchester)
• Reliability
• Dependence on coal
The factory system
The factory system: timeline
• Early 1700s: few big factories employed 300/800 people (shipyards), almost
work done at home or next to it
• 1800: 900 cotton spinning factories, but only 300 employed 50+ people
• 1830s: average Manchester mill had 400 workers, ironworks employ up to
5000 people
• 1914: majority of Western European workers no longer worked at home (2/3
in France)
Benefits of the factory system
• Economies of scale and scope
• Monitoring costs
• Discipline
• Communication vs. transportation costs
Scale
Economies of scale
• Factories mostly specialize in one good
• Factories cluster in same places (backward and forward linkages)
• Mechanization & fixed costs
