We now start getting to grips with Transaction Cost Economics (TCE). If you doubt how practical the ideas of Information Economics are, you should not doubt the practicality of TCE. Malone, Yates and Benjamin (1989) were implicitly using TCE to explain how the world of business would change because of 'electronic markets' and what businesses have to do about it.
Williamson is viewed by many, particularly scholars of Strategy and Marketing, to be the father of Transaction Cost Economics (TCE), however Williamson's work was based upon the discoveries of Ronald Coase and others.
Being first with the idea or its elaboration pays off, even if it seems obscure is difficult to read, slow to gel. This early article by Oliver E. Williamson expanded upon Coase's work, then 20 years old, to further understand how transaction cost economics may account for different organisational forms. For this Williamson shared the Sveriges Riksbank Price in Economic Sciences in Memory of Alfred Nobel 2009. Elinor Ostrom for her 'analysis of economic governance, especially the commons', subject matter for another course. Williamson 'for his analysis of economic governance, especially the boundaries of the firm'.
The paper was worked into the first chapters of Williamson's influential 'Markets and Hierachies: Analysis and Antitrust Implications' (1975).
Monday, 21 July 2014
4. The Nature of the Firm (the grandfather of TCE)
Information technology has had, and continues to have, a disruptive and transformative impact on the organisation of firms, markets, and whole economies. But without a theory of what firms are and why they arise we cannot really understand why firms exist, after all, if market mechanisms are the bedrock of capitalist production why do firms exist at all? Is it technological determinism, the deus ex machina, or can we identify constructs and structures that matter?
Ronald Coase's 1937 paper addressed existential questions on nature of the firm. Coase -- died aged 102 in 2013 -- was then 27 years old and had the brilliance and Chutzpa to ask and answer a fundamental question -- why companies exist? In what ways are firms better ways of organising production and exchange than markets? The answer he concludes lies in what we now term Transaction Costs -- the costs of going to the market. He wrote about 'the cost of organising an extra transaction' (Coase, 1937:p396) versus 'the costs involved in leaving the transaction to be "organised" by the price mechanism.' (Coase, 1937:p404). He called them Marketing Costs, but this was 1937 and he didn't mean 'marketing' as we do. Namely, the costs of searching for information about products, prices, vendors. Yes, information again. Transaction costs include also the costs of bargaining, contracting, etc.
This paper has had immense impact in the field of Economics. However Coase waited more than 60 years for the ultimate recognition. You should watch his 2003 Coase Lecture. You would not expect a lecture by a very old professor of Economics to be funny, but it is.
Some questions to think about:
Q: Would Coase have argued that a postal service should or should not be 'bundled' with for-profit goods and services such as banking or insurance, and competing where the markets and industry can easily provide them instead?
A: Should also unbundle the infrastructure paid for by citizens before selling off bits that the state gives unfair advantage to (semi-state monopoly co's). You can be sure that industry doesn't really want to operate a universal postal service unless it gets handsome subsidies.
Ronald Coase's 1937 paper addressed existential questions on nature of the firm. Coase -- died aged 102 in 2013 -- was then 27 years old and had the brilliance and Chutzpa to ask and answer a fundamental question -- why companies exist? In what ways are firms better ways of organising production and exchange than markets? The answer he concludes lies in what we now term Transaction Costs -- the costs of going to the market. He wrote about 'the cost of organising an extra transaction' (Coase, 1937:p396) versus 'the costs involved in leaving the transaction to be "organised" by the price mechanism.' (Coase, 1937:p404). He called them Marketing Costs, but this was 1937 and he didn't mean 'marketing' as we do. Namely, the costs of searching for information about products, prices, vendors. Yes, information again. Transaction costs include also the costs of bargaining, contracting, etc.
This paper has had immense impact in the field of Economics. However Coase waited more than 60 years for the ultimate recognition. You should watch his 2003 Coase Lecture. You would not expect a lecture by a very old professor of Economics to be funny, but it is.
Some questions to think about:
Q: Would Coase have argued that a postal service should or should not be 'bundled' with for-profit goods and services such as banking or insurance, and competing where the markets and industry can easily provide them instead?
A: Should also unbundle the infrastructure paid for by citizens before selling off bits that the state gives unfair advantage to (semi-state monopoly co's). You can be sure that industry doesn't really want to operate a universal postal service unless it gets handsome subsidies.
Sunday, 20 July 2014
3. The Market for Lemons (information asymmetry)
This seminal paper by George Akerlof is elegant and easy to read. The style of the paper is very different from Fama's paper on the EMH.
Akerlof starts with a mundane question: why are used cars are so much cheaper than new cars? As this is a course about the Economics of Information (Technology), you can guess the answer -- something about information? There are good cars (cherries) and bad cars (lemons), and some of the participants in the market have more information than others .. please read the paper for the full answer.
The history of this paper is very interesting. It was rejected for its 'triviality' by both the American Economic Review and the review of Economic Studies. It was rejected for being incorrect by the reviewers from the Journal of Political Economy.
It turns out that this is one the most cited papers in Economics, it is one of the first works to study markets with asymmetric information and it is the one paper mentioned by the Noble Prize committee when they announced Akerlof's prize ... what a trivial paper!
A nice question for the exam may be about the Tax problems of Henry VIII. He replaced almost half of the silver in coins with base metals, to increase the government's income without raising taxes. Merchants knew that and saved the old pure silver shillings while circulating the bad ones. Namely bad money drove out good money and this has become to be known as Gresham's law. Is this story the same as Akerlof's story about cars and lemons? The answer is in the paper.
Akerlof starts with a mundane question: why are used cars are so much cheaper than new cars? As this is a course about the Economics of Information (Technology), you can guess the answer -- something about information? There are good cars (cherries) and bad cars (lemons), and some of the participants in the market have more information than others .. please read the paper for the full answer.
The history of this paper is very interesting. It was rejected for its 'triviality' by both the American Economic Review and the review of Economic Studies. It was rejected for being incorrect by the reviewers from the Journal of Political Economy.
It turns out that this is one the most cited papers in Economics, it is one of the first works to study markets with asymmetric information and it is the one paper mentioned by the Noble Prize committee when they announced Akerlof's prize ... what a trivial paper!
A nice question for the exam may be about the Tax problems of Henry VIII. He replaced almost half of the silver in coins with base metals, to increase the government's income without raising taxes. Merchants knew that and saved the old pure silver shillings while circulating the bad ones. Namely bad money drove out good money and this has become to be known as Gresham's law. Is this story the same as Akerlof's story about cars and lemons? The answer is in the paper.
Saturday, 19 July 2014
2. Efficient Market Hypothesis (EMH)
The Efficient Market Hypothesis is the second item in our very small selection of papers about Information in Economics. The idea is simple -- prices on traded assets reflect the information available in the markets. So, markets are information-ally efficient.
It probably should have been the first item in this course as this idea is possibly the most influential concept in contemporary Economics. Many would say the most damaging concept.
The original paper by Eugene Fama from 1965 is so long that we selected a later paper by Fama, his review from 1970. It is still a long and complex paper, we have highlighted selected several paragraphs for reading.
The style of the paper is very different from our next reading, Akerlof's elegant Market for Lemons.
Fama deals with empirical research of complex phenomenon with a lot of data, so elegance of writing is not possible. But the idea that markets are efficient is so attempting and influential that the effort in reading parts of the paper is worthwhile.
We have also considered the recent arguments against and for this hypothesis as reflected by The Economist.
It probably should have been the first item in this course as this idea is possibly the most influential concept in contemporary Economics. Many would say the most damaging concept.
The original paper by Eugene Fama from 1965 is so long that we selected a later paper by Fama, his review from 1970. It is still a long and complex paper, we have highlighted selected several paragraphs for reading.
The style of the paper is very different from our next reading, Akerlof's elegant Market for Lemons.
Fama deals with empirical research of complex phenomenon with a lot of data, so elegance of writing is not possible. But the idea that markets are efficient is so attempting and influential that the effort in reading parts of the paper is worthwhile.
We have also considered the recent arguments against and for this hypothesis as reflected by The Economist.
Friday, 18 July 2014
1. The Logic of Electronic Markets
This is our first paper and it sets up problems and assumptions that we address in the remainder of the course. It is a short readable article by three researchers from MIT boosting the idea that electronic markets will supplant firms' internal systems and displace buyer-seller relationships to electronic markets.
Claims stated include: reduced transaction and contracting costs, commoditisation, operational cost savings, lower prices, increased competitive advantage for 'winners', reduced vertical integration of firms, disintermediation of physical by electronic suppliers, benefits of standardisation (go-it-alone or industry agreements),
Implied in the argumentation is the application of Transaction Cost Economics (TCE). They apply the ideas of TCE to the potentialities of 'electronic buyer-seller connections'.
In other publications they analysed the transaction costs and the possibility of 'hold-up' (or lock-in) to predict in detail the emergence of 'electronic markets' ten years in advance. The logic of electronic markets predicts that smaller companies will arise. In three US sectors the authors checked, the prediction has not been supported. We've put also on the portal a recent article from the Economist that seems to support TCE ideas.
However in order to fully understand the reasoning of Malone, Yates and Benjamin, it is essential to know a little bit about foundational economics concepts, about markets, models of utility and buyer-seller relationships. The structure of the remaining readings addresses this as follows:
Claims stated include: reduced transaction and contracting costs, commoditisation, operational cost savings, lower prices, increased competitive advantage for 'winners', reduced vertical integration of firms, disintermediation of physical by electronic suppliers, benefits of standardisation (go-it-alone or industry agreements),
Implied in the argumentation is the application of Transaction Cost Economics (TCE). They apply the ideas of TCE to the potentialities of 'electronic buyer-seller connections'.
In other publications they analysed the transaction costs and the possibility of 'hold-up' (or lock-in) to predict in detail the emergence of 'electronic markets' ten years in advance. The logic of electronic markets predicts that smaller companies will arise. In three US sectors the authors checked, the prediction has not been supported. We've put also on the portal a recent article from the Economist that seems to support TCE ideas.
However in order to fully understand the reasoning of Malone, Yates and Benjamin, it is essential to know a little bit about foundational economics concepts, about markets, models of utility and buyer-seller relationships. The structure of the remaining readings addresses this as follows:
- The assumptions of how markets and the market-price-mechanism works (Eugene F. Fama).
- How markets may fail and how buyers and sellers deal with uncertainty (George A. Akerlof).
- To deeply understand the relationship between the organisation of markets and firms through the discovery and nature of transaction costs and property rights (Ronald H. Coase).
- ...culminating in the development of transaction cost economics to account for different organisational forms (Oliver E. Williamson).
- Finally we look at some characteristics of network industries and assumptions around supply, demand, utility, value and price (Michael L. Katz and Carl Shapiro).
Information Economics, Transaction Cost Economics, Externalities
Revised readings and structure
Economic theory about the role of information in markets has grown dramatically during the last decades. We will review some seminal economics articles presenting first principles treatments of economics theories of organisation, firms and markets.- MaloneEtAl, The Logic of Electronic Markets, 1989.
- Fama, Efficient Capital Markets, 1970.
- Akerlof, The Market for Lemons, 1970.
- Coase, The Nature of the Firm, 1939.
- Williamson, Markets and Hierarchies, 1973.
- KatzShapiro, Network Externalities Competition Compatibility, 1985.
Our first paper sets up problems and assumptions that we address in the remainder of the course. It is a short readable article by three researchers from MIT boosting the idea that electronic markets will supplant firms' internal systems and displace buyer-seller relationships to electronic markets.
Implied in the argumentation is the idea of markets, firms, networks and Transaction Cost Economics (TCE) and their potentialities for the economics of Information Technology and Digital Markets. It is essential therefore to know a little bit about foundational economics concepts, about markets, models of utility and buyer-seller relationships. The structure of the remaining readings addresses this as follows:
• The assumptions of how markets and the market-price-mechanism works (Eugene F. Fama).
• How markets may fail and how buyers and sellers deal with uncertainty (George A. Akerlof).
• To deeply understand the relationship between the organisation of markets and firms through the discovery and nature of transaction costs and property rights (Ronald H. Coase).
• ...culminating in the development of transaction cost economics to account for different organisational forms (Oliver E. Williamson).
• Finally we look at some characteristics of network industries and assumptions around supply, demand, utility, value and price (Michael L. Katz and Carl Shapiro).
Shapiro and Varian's book "Information Rules: A Strategic Guide to the Network Economy" (1999), is background reading. Chapters may be discussed if time allows.
Wednesday, 28 May 2014
Classroom, location (for 2014)
Classes will be held at UCD's main Belfield campus in room Q113, 1st floor, the Lochlann Quinn Building, UCD Belfield.
From 2 to 6pm.
From 2 to 6pm.
View The Quinn Building in a larger map
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