Pareto efficiency a distribution of resources is P.E.

if there is
no alternative allocation that keeps all individuals at least as
well off but makes at least one person better off. When market
trade benefits participants and provide gains, people are
involved in trade, and this creates surplus, but trade ceases
when theres no longer beneficial e.g. when PE, trade ceases
since no one can be better off from trade. Market mechanism
is aiming to achieve PE through prices. Externalities exist,
according to Coase theorem, regardless of the initial property
rights, as long as the contracting costs (search, info costs, and
bargaining and decision costs) are low and property rights
(Property rights: use rights & alienable rights.) are clearly
assigned, the ultimate resource allocation will be efficient.

Market/central planning
Market: price motivates use of knowledge and information
and economic decision. Incentives for individual to make
productive decisions. Decentralised decision making rights
assigned to people have the specific knowledge.
Central planning: difficult to aggregate specific knowledge and
costly to transfer. Cost of communications, less incentive.
Contracting costs: 1. M+N M*N (in the market) 2. Managers
harder to make timely/effective decisions as the firm expands.
Game theory: credible commitments, NE, SPE (solve
backwards)

Owner-manager conflict:
1. Effort: perks
2. Risk exposure
3. Horizons
4. Over investment
5. Free-riding/perks
Controlling incentive: Manager M gets U=f(C, P) C money
compensation P perks. Realised profit r is r = p P
Agency/principles interest, profit/wellbeing maximisation,
effort, monitoring (costs exist)
Implicit contracts: promises/understandings/not formalised by
legal documents

Q1 discount factor.
Gains/reputation/likelihood of detection higher
Cooperate get:
(P cH) + (P cH) +
= [P cH]/(1 - )
= H/(1 )
Cheat get:
P cL + 0 + 0 = L

Value maximisation: Incentive problems generate costs that
reduce value. It is in the interests of all parties to a contract to
develop efficient solutions to agency problems. More value is
created, which can be shared among all.
Organisational architecture (determine the success) general,
can help set expectations of employees
1. Assignment of decision rights
2. Rewarding individuals
3. Evaluate the performance
Principals challenge in designing both firms and economic
systems is to maximise the likelihood that decision makers
have both relevant information to make good decisions and
the incentives to use information productively.

Architecture of market:
1. Through market transactions decision rights for
resources rearranged so tend to be held by individuals
with specific information about productive resource use.
2. Market provides a mechanism for evaluating and
rewarding performance.
3. This occurs spontaneously with little/no thought or
direction.
Architecture of firm: major determinant of firm value
1. No automatic system for assigning decision rights to
individuals within formation or for motivating individuals
to use their info to promote firms objectives.
2. Organisational architecture created by executives through
implicit and explicit contracts that constitute the firm.
3. Decision rights granted to employees through formal and
informal job descriptions; rewards are specified in formal
and informal compensation contracts; evaluation through
formal and informal mechanisms.
Most resources allocated administratively within a firm.
Optimal incentives/resources control system depends on how
decision rights are allocated.
Architectural determinants:
1. Firm types
2. Business environment
3. Strategy(affects architecture but also other way)
Corporate culture corresponds closely to architecture and
explicit about mechanism. Softer corporate culture rituals and
role models complements not substitutes for formal incentive
structures.
When architecture fails: F manager/M for corporate control/P-
market competition.

Q2 Provision of quality when:
1. More trustworthy people
2. Mark-up higher (P - c)/P
Lec3 p7 utility for not paying tip
Centralisation & decentralisation
Benefits of decentralisation:
1. Effective use of local knowledge(local demand/price,
centralised will have to transfer the knowledge/decision
made with uninformed)
2. Speed of decision making
3. Conservation of management time
4. Training and motivation for local management(attracts
talented employees and provides training for them)
Costs of decentralisation:
1. Incentive problems(local managers dont have strong
incentives)
2. Coordination costs and failures
3. Less effective use of central information
Net benefit of decentralisation highest in rapidly changing
environments.
More stable environments: centralise decision making
More decentralisation with more markets entered.
Technology assist decentralisation (easier
monitoring)/centralisation (info transfer less costly)
Assign decisions to group, benefits:
1. Improved use of knowledge
2. Employee buy-in
Costs:
1. Collective action problems
2. Free rider problem
Decision making process: initiation (DM), ratification (DC),
implementation (DM), monitoring (DC). Granting both DM and
DC to an employee will encourage perverse behaviour.
Influence costs benefit: reduce resources on individuals who is
trying to influence decision.
Cost: trade-off which caused by not using info which could be
helpful.
Formal/ real authority: legal right/ effective control

Q3 P-formal authority:
UP = EB + (1 E)eB gP(E)
UA = Eb + (1 E)eb gA(e)
A-formal authority:
UPd = eB + (1 e)EB gP(E)
UAd = eb + (1 e)Eb gA(e)
Differentiate, equal 0, solution, greater/smaller
Multiple principles: B/n
Commitment/cheat/intervening

Benefits of specialised task (function)
1. Exploiting comparative advantage (eco of scale/match
jobs with skills...)
2. Lower cross-training expenses(avoid more broad tasks,
more training)
Costs:
1. Forgone complementarities across tasks
2. Coordination costs
3. Reduced flexibility (?)
Broad task assignment incentive contract needs to provide
motivation.(reason lec4 p6)
U-form: unitary form, places each primary functions in one
major subunit, specialised task for individual.(senior
management responsibilities)
M-form: multidivisional form, operating decisions
decentralised to the business unit level.(senior, large
enterprise?)