1. Production, Information Costs, and Economic Organization
Armen a. alchian & Harold demsetz
American Economic Review, 1972
Weihao Li
(Originally created by Joshua Downs)

2. Main Points The motivation to organize firms
Team production: 1+1>2
Metering performance of team
Reducing shirking and metering costs
The essence of the classical firm
Joint input; several input owners; a monitoring central common party to a set of bilateral contracts; rights to renegotiate contract independently; residual claimant; right to sell central contractual residual status.
Different types of firms are organized due to different needs of metering
Owners of the firm will be investors of resalable capital equipment
The firm can be considered as a privately owned market
Continuous contractual renegotiation
No authority

3. The Metering Problem 2 Key demands on an economic organization
Metering input productivity
Metering Rewards
Problem: productivity doesn’t automatically create reward
System of rewarding stimulates productivity responses
Poor metering leads to loose correlation between rewards and productivity
Productivity thus rises and falls depending on ability to meter
Dan Murphy: Vancouver mulls new high-tech parking meters

4. Team Production Team Production Team Production vs Individual Inputs
Several types of resources are used
The product is not a sum of separable outputs of each cooperating resources
Not all resources belong to one person
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
Choose team production instead of individual inputs
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
Earns his residual trough the reduction in shirking that he brings.
Monitoring the monitor
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. The Classical Firm
The following bundle of rights defines the ownership of the classical firm
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 necessary 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 behave
Classical capitalist firms: joint input; several input owners; a monitoring central common party to a set of bilateral contracts; rights to renegotiate contract independently; residual claimant; right to sell central contractual residual status
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
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)

8. Types of Firms The Corporation Mutual and Non-Profits Partnerships
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

9. 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 or depreciation inflicted upon the input in its use
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
Absentee ownership is impossible in human capitial
Labor service cannot be performed in the absence of its owner

10. The firms as a private market
The firm is
a device for enhancing competition among sets of input resources
a device for more efficiently rewarding market
The firm and the ordinary market as competing types of markets
Competition between private proprietary markets and public or communal markets

11. Discussion
Does the claim that authority is not attributed to the conception of the firms or its efficiency contradict behavioral theory or the hierarchy in TCE?
Do you agree that metering team performance is an essential problem in achieving efficiency?
How should we understand the firm is a specialized private market?
Team spirit and loyalty