Economics of Information and stylized firm

Economics of Information:


1) Problem of agency, also called principal-agent problem. The principal should motivate her agent to act in her interests. With common or else public information the problem is trivial. Exchange or else compensation is contingent on performance: if you don’t deliver the goods, a court enforces the severe penalties enumerated in our contract (Forcing Contract).

2) In private or asymmetric information the agency troubles are more interesting. Something is unseen to at least one side.

Hidden Actions- I do not know whether my employees are working hard or else shirking. (imperfect information → Moral Hazard)

Hidden Information (or types): I don’t know whether your car is a lemon or you are high or low productive workers (incomplete information → Adverse Selection)

3) Theory of a Firm:

A set of cost curves? A production technology. Entrepreneur or plant as well as equipment? Or Stockholders otherwise top-management?

Now who possesses the firm? Stock-holders? Why not bond-holders? And what determines what activities are undertaken within the firm and what are purchased as products or services from outside suppliers?

The recent theory of the firm is that the firm is a collection of contracts. The firm is a legal fiction concocted to minimize the cost of transacting. We each write a contract with the firm, rather than each of us with each other.

A stylized firm: raw materials + equipments + labor = usable products (with value).

  • distribution to consumers.
  • management as well as finance.

In the absence of agency problems, it would make no difference whether all these activities were centralized within one firm (which would make its own raw materials, and distribute the final products to consumers) or decentralized into many firms (even into individual workers).

No market transactions or the entire market transactions? Or else something in between? The classical firm buys its raw materials from suppliers; owns much of its equipment; hires its workers; sells its product to another firm for distribution to consumers; and the process is funded by both debt and equity? Why? In particular, why link ownership (i.e. residual authority) with equity holding (that is residual income)? The residual authority must have something at stake to float debt. Or else walk away with the proceeds. So decision makers are agents; here the entrepreneur is the agent of the debt holders. Similarly, management is the agent of the stockholders, and workers are agents of management.

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