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.
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.
Might alternative means of coordination be efficient if the assumptions
of the FWT hold? Might they make everyone better off than under price-based
"No missing markets" and "all firms and consumers are price takers" are
necessary conditions for the FWT to hold. Why might price-based coordination
not lead to efficient outcomes if these conditions do not hold?
Might alternative means of coordination be efficient under when these assumptions
are relaxed? Might such means make everyone better off than under
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.
According to Coase, what characterizes firms?
In your judgement (and intellgent disagreement with your professor is encouraged),
would Coase consider transactions between you and your tax consultant transactions
within a firm? If the answer is "it depends," explain what it depends
on and why. Justify your position in a paragraph or two.
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."
What determines whether doing so is efficient relative to their current
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?