Economics 174

Problem Set 1 -- Due Wednesday, April 16
These questions are due at the beginning of class, April 16.  Sample solutions will be available on the web shortly thereafter.

These are designed to be answered in a paragraph or two on the average.  Write as much as you need toward providing a clear and full response to the question, but no more.

If you want more practice with the material, additional problem set questions (from when I previously taught this class) are on the web.  Solutions will be available to these questions as well after April 16.

Good luck!

1. Does value maximization imply efficiency? Why or why not?

2. Why are contracts incomplete?  Explain why contractual incompleteness can create a situation where individuals make decisions which are not value-maximizing (with respect to the organization).  Describe an activity or institutional feature which organizations adopt in response to individuals' incentives to exploit such situations and gain privately at the expense of others within the organization.

3. The First Welfare Theorem maintains that every competitive equilibrium is efficient.  Under the assumptions of the FWT, pursuit of private goals by individual firms and consumers leads to socially efficient outcomes.  In the FWT, all coordination is mediated by market prices.

4. In our discussion of Coase's "The Nature of the Firm" in class, we considered the following situation:

Suppose you hire another individual to prepare your taxes.  This individual does not have perfect information about your finances, nor can you perfectly anticipate what information he/she needs and supply it beforehand.  Therefore, after you agree initially to the terms of trade with your tax consultant, there is the need for further coordination.

Ignore legal liability issues.

5. One of the trends in business during the past ten years or so is the increasing use of electronic data interchange, or EDI. In electronic data interchange, firms use computer networks or dial up connections to exchange information such as invoices, orders, delivery confirmation. These replace previous processes in which such information was exchanged using phone, fax, or even mail-based systems. One advantage is that they permit the timely exchange of data. Another is that they can be linked to firms' internal computer systems so that individuals do not have to rekey information when it comes in. A drawback is that they often require firms to purchase considerable amounts of new hardware or software, and they can require them to make costly changes to their existing business practices to take full advantage of the new capabilities.

Suppose we are considering whether a specific supplier and manufacturer will adopt this new technology.

Suppose that the manufacturer anticipates that the new system will generate production improvements that will greatly outweigh the cost savings, but that the supplier anticipates that the new system will not "pay for itself."