Appunti del corso Business e Industrial economics

Module B

Economic resources are scarce, and the market solves these issues with the mechanism of prices, finding the equilibrium price and quantity of a good through interaction between buyer and seller.

Market mechanisms

• What to produce - One dollar one vote.
• How to produce - Efficiency and competition.
• How to distribute wealth

Firms are a hybrid solution between centralized and decentralized economies.

Pareto efficiency

Allocation of resources is efficient if it is not possible to improve the utility of an agent without reducing the utility of another.

Pareto efficiency problems

• Cannot solve inequity issues.
• Limited predictive power - Which Pareto efficient allocation emerges?

The Efficiency principle states that if economic agents can trade effectively, they will reach a Pareto efficient allocation of resources.

Welfare theorems

• First welfare theorem: By trading in perfectly competitive markets, economic agents can attain a Pareto efficient allocation of resources.
• Second welfare theorem: For any Pareto efficient allocation of resources, there are prices and an initial allocation that make that Pareto efficient allocation attainable by trading in perfectly competitive markets.

Market imperfections and failures

• Externalities: Cost (negative) or benefit (positive) imposed upon someone by others' actions.
  • Consumption - Example: smoke money.
  • Production - Merger is a possible solution.
• Coase's insight: Result from inadequate specification of property rights.
• Coase's theorem: If agents' preferences are quasi-linear in money, there is the same allocation of resources no matter who has the property rights.
• Information asymmetries
  • Adverse selection (example: market for lemons, skills for workers) - Remedy: signaling to separate high and low-quality agents.
  • Moral hazard - Remedy: incentive contracts.
• Public goods (not excludable and non-rival in consumption) - Policy maker intervention is probable due to the free riding problem, more likely if many agents are involved.
• Non-competitive markets - Example: natural monopoly.

The policy maker tries to remedy market failures by aiming to maximize social welfare.

Module C

Theories of the firm

This corpus of economics and managerial theories opens the firm black box of the microeconomics model.

• Explain why firms exist.
• Recognize that firms have multiple objectives beyond profit, and sometimes managers do not aim to maximize profits.

Objectives of the firms related to profits

• Surviving - Function of size and age, entry in an industry (entry and exit rates).
• Growing (sales and employees).
• Promoting social responsibility.

It acknowledges the prominence and heterogeneity of individuals in firms and firms' heterogeneity within and across industries.

Transaction costs theory

Firms exist because market transactions entail transaction costs, which are eliminated or reduced by internalizing the transaction in the firms. The assumption is that economic agents are boundedly rational, and bounded rationality causes transaction costs because it is impossible to draft complete contracts. The higher the uncertainty, the higher the transaction costs due to the possibility of opportunistic behavior exploiting contract incompleteness.

• Ex-ante
• Ex-post

Relational specific investments cause asset specificity, which causes the hold-up problem: the party investing depends on the other that can breach the contract.

• Physical capital
• Human capital
• Site specificity

We choose the market if the level of contract incompleteness and the threats of opportunism are low; we choose hierarchy otherwise. (Note: In the firm, you have the possibility of inefficient decisions and information asymmetries).

Agency theory

Agency relations occur when the principal delegates a task or decision to the agent.

• Owner-controlled firms: Owners are also managers.
• Managerial firms: Owners hire professional managers to run the firm. Managers are not interested only in maximizing profits; they also aim to maximize other variables related to sales.
  • One-period sales - Baumol model 1.
  • Cumulative sales - Baumol model 2.
  • Balanced growth rate of sales - Marris model.

Problems in principal-agent relations

• Conflicting goals.
• Information asymmetries - The agent is more informed and the principal cannot control.
• Diverse risk attitudes - The principal is risk-neutral; the agent is risk-averse.

Remedies to CEOs' moral hazards include aligning interests, increasing information, and transferring part of the risk.

Choosing the appropriate capital structure

Equity/debt:

• Equity: Financial capital held by owners who do not manage the firm. If increased, the CEO has less interest in acting in the interest of the firm.
• Debt: Financial capital provided by external investors. If increased, the CEO risks less.
  • Low agency costs of equity - Low risk of