BUS 374 – Session 2Organization theorySession 2: Why do organizations exist?

Agenda

0Reallocation of teams0Trial Memo presentation #10Trial Memo discussion #10Trial Memo presentation #20Trial Memo discussion #20Why do (capitalist) organizations exist?

Marxian view of a capitalist organization

0What if capitalist means of production was absent?0 Each laborer produces on his/her own

What is the problem with it?

0Cost of setting up workshops for each laborer is higher than the average cost of setting it up for a lot of laborers

0Cost of consumables will be higher for each laborer0 Willingness to cooperate will be limited or even absent, but

complex tasks need cooperation0When employed in a firm the average productivity

increases as less productive workers and more productive workers will average out.

Who is a capitalist (read entrepreneur)?

0 Someone who has expertise in a production process0 Someone who could hire labor to produce in larger

quantities

Why does capitalist organizations (i.e., firms) exist?

0To use the capitalist’s expertise to produce large quantities of a good

0So that laborers cooperate in this production process0 Even if it be merely working side-by-side using the same

supplies0Capitalists have the surplus capital to employ more

than one laborer on a production process

So what is the objective of the firm

0 “The directing motive, the end and aim of capitalist production, is to extract the greatest possible amount of surplus value” – Marx

0Didn’t Milton Freedman said something like this?

0Does this ring a bell?

0 “There is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits”

So what is Marx’s issue with capitalism?

0That the capitalist pays only each laborer the amount that he/she would have earned had he/she been an independent worker…

0 i.e., the workers do not get a cut of the surplus0And that the capitalist gets more than his fare share of

the surplus…0And, the laborers enter into a contract with the

capitalist but not with one another… causing all this.0BUT THAT IS A DEBATE FOR A DIFFERENT DAY

Coasian view of the firm

0What would be the alternative to the firm?0 The price mechanism (aka the market)

What is the problem with the price mechanism?

0A neoclassical view holds that the economy is not an organization that needs to be managed but an organism that manages itself through price mechanism

0But price discovery can be costly (i.e., search costs)0Uncertainty can add to it.0Requires a lot of costly contracts to ensure certainty

0 Even more exorbitant when it is not a spot market transaction but a serial transaction.

Why do firms exist?

0 Entrepreneur substitutes the price mechanism through fiat 0 i.e., The primary difference between the market and the

firm is price mechanism vs. entrepreneurial coordination respectively

0 Reduced contracting costs0 Greater certainty0 Anther peripheral reasons could be

0 transfer pricing advantages (i.e., lesser taxes for sales between units)

0 Volume discounts from suppliers to firms than to market participants (Marx also considers marketing advantages – i.e., monopoly rents)

What can be the limits of the firm?

0 Organizing costs can increase with each additional transaction that comes under a firm’s management

0 This is why transactions are carried out by various firms and not by one big firm (as in a communist economy)

0 So while Marx considers firm size as a function of capital outlay, Coase considers the cost of organizing.

0 While Marx consider the role of managers in a capitalist setting, her doesn’t consider agency costs that come out of it. Coase does not bring this to the discussion at all.

That’s is for today

0For our next session we will try to answer:0 “WHY ARE THERE SO MANY DIFFERENT TYPES OF

ORGANIZATIONS?”