Economics 174

Problem Set 1 -- Due Wednesday, April 17

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

2. Movie theater chains and distributors are often under the same firm name (under the legal definition). For example, United Artists both distributes movies and owns a large theatre chain. Top executives have control rights with respect to both divisions. For example, the CEO at UA probably has the right to hire and fire staff within both divisions. However, when movies come out, federal law requires them to be offered to theatres on a non-discriminatory basis. Theatres within United Artists' chain must bid against local competitors for the right to show movies distributed by United Aritsts. According to the criteria proposed by Coase, are UA's distribution division and UA's theatre chain part of the same firm, or are they different firms?

3. In Alchain and Demsetz, a "metering problem" gives rise to a particular set of contractual arrangements which they claim shares aspects with the neoclassical firm. Do these contractual arrangements eliminate shirking altogether? Is production likely to be greater, the same, or less than in the case where individuals do not shirk at all? Given that this "metering problem" causes individuals to invent novel and potentially sophisticated means of mitigating its effects, why is team production ever chosen over individual production? (After all, in individual production, one can measure individuals' productivity and pay them accordingly -- so they bear the cost of their own shirking.)

4. Define bounded rationality. Why does bounded rationality lead to incomplete contracts?

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.

What determines whether doing so is efficient relative to their current fax-based system?

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." Does this mean that adoption is inefficient? Why or why not?

Assume that adoption is efficient relative to current systems. Under what set of assumptions is adoption guaranteed to take place, even if the investment does not "pay for itself" for one of the firms?

Automobile makers (Ford, GM, Chrysler, et al) have been struggling for the past five to ten years to get their outside suppliers to move to EDI-based systems. Using the ideas presented in class, why would you expect that they would have such a difficult time doing so, assuming that EDI is efficient relative to other systems?