1. Production, Information Costs, and Economic Organization
Joshua Downs
9/13/2015
Production, Information Costs, and Economic Organization
Armen a. alchian & Harold demsetz
American Economic Review, 1972

2. Main Points
Difficult to resolve alternative forms of organization by transaction costs alone, seeks to identify and explain a particular contractual arrangement induced by the cost of information factors
Continuous contractual renegotiation
No authority
Employees with leisure and income considerations on utility curve have incentive to shirk, shirking problem coupled with potential for greater marginal productivity through joint use of inputs (team production) explains the firm with a monitoring central common party to a set of bilateral contracts
Presence of monitoring central agent reduces shirking by employees, assignment of residual income to monitor constrains shirking by the monitor
Relative costs/benefits of monitoring behavior or output also determines inputs owned by firm

3. The Metering Problem Productivity doesn’t automatically create reward
2 Key demands on an economic organization
Metering input productivity
Metering Rewards
Competitive markets meter the outputs directly, reveals the marginal product and apportions the rewards to resource owners in accord with that direct measurement of their outputs
Those who change outputs control change in market prices
System of rewarding stimulates productivity responses
Productivity thus rises and falls depending on ability to meter
Dan Murphy: Vancouver mulls new high-tech parking meters

4. Team Production Team Production vs Individual Inputs
Central common party to a set of bilateral contracts vs numerous multilateral contracts among all inputs
Joint use of inputs vs Sum of products of separately used inputs
Higher vs lower costs of monitoring due to nonseparability of marginal input productivities
Lower vs higher leisure costs = Higher vs Lower Shirking Problem
Individuals adjust rate of work to bring demand prices of leisure and output to equality with their true costs
When net increase in productivity available from team production over metering costs, team production will be used
Similar to Coase’s comparative analysis

5. Reducing Shirking: The Monitor
1 team member specializes as a monitor
Measuring output performance
Apportioning rewards
Disciplining Shirking
Observing the input behavior of inputs as means of detecting or estimating their marginal productivity
Giving assignments or instructions in what to do and how to do it
Task of monitoring monitor remains
Market mechanism constrains shirking, but limited
Assignment of net earnings of the team, residual product above prescribed amounts
Must be agreed to by owners of cooperating inputs

6. Emergence of the Firm Bundled rights of the residual claimant
Defines ownership of the classical firm, arises if it is comparatively better at resolving shirking non-centralized contractual arrangement
To be a residual claimant
To observe input behavior
To be the central party common to all contracts with inputs
To alter the membership of the team
To sell these rights
2 Conditions for the emergence of the firm
It is possible to increase productivity through team-oriented production
It is economical to estimate marginal productivity by observing or specifying input behavior
Leads to classical capitalist firms: joint input production, several input owners, & centralized common party to bilateral contracts
Other Theories of The Firm: Coase and Knight
Coase: Difficult to resolve alternative organizational forms with transaction costs alone
Knight: Risk aversion not sufficient of incentive to explain classical firm

7. Types of Firms Profit-sharing firms Socialist firms The Corporation
As percentage of monitor’s residual claims decreases, cost of team production increases from monitor shirking
Incentives to shirk are positively related to the optimal size of the team under an equal profit-sharing scheme
Best in smaller firms where cost of specialized management is large relative to increased productivity of team production
Monitoring becomes reciprocal, dedicated specialization in monitoring not required
Socialist firms
All employees are residual sharers
Increased costs from monitor shirking requires management technique innovation, (Employee committees recommending managers termination)
The Corporation
Financial capital inputs acquired through promise of future returns
Shirking of multiplicity of small relative to cumulative firm investors dealt with through limited liability
Control achieved by transferring decision authority to smaller group of input managers constrained by unrestricted salability of shareholders (Principal and Agents)
Agent shirking reduced through probability of shareholder action (Proxy battles)
Mutual and Non-Profits
No present day value of future improvements means shirking should be more prevalent
Partnerships
Reduced monitoring costs should be less relative to employee employer contract writing
Employee Unions
Serve as monitors of employers on behalf of employees for more ambiguous and contingent types of compensation than straight wages

8. Inputs Owned by the Firm
Residual claimants will be investors of resalable capital equipment
Monitoring not only gross product performance of inputs but the abuse inflicted upon the input in its use
Unbreakable hammer with measured marginal product = 0 use cost
Breakable equipment with vulnerability varying according to degree of carelessness in use
Use or monitoring by owner will have lower price than rental absent owner
The degree to which it is easier to detect cost by monitoring usage behavior over inspection post use increases likelihood of ownership
Human labor impossible to separate into absentee ownership category
Information collected and collated by firm through virtue of monitoring
Information sold by firm to employees through facilitation of team production

9. Discussion Would Thor prefer to rent or own his hammer?
What concepts presented here require more effort to reconcile logically?
Do ordinary markets suffer from defects of communal property rights in organizing and influencing use of valuable resources?
Does the discussion effectively counter behavioral theory of the firm’s concept of authority?
Team spirit and loyalty