PHL295 Final Exam Prep

Morality is a set of constraints that any rational person must acknowledge. It's a system that operates independently of personal feelings or affections.

It's not reliant on sympathetic transmission of feelings but rather assumes a framework where rational constraints enable the more effective realization of individual interests.

Equilibrium refers to a state where supply and demand in the market are balanced.

Optimum refers to the most efficient and beneficial outcome given the existing conditions.

Morality becomes necessary when there's a discrepancy between the market's balance and the most beneficial outcome for individuals, indicating a departure from the most rational or efficient scenario.

Gauthier emphasizes that the perfectly competitive market's ideal state achieves both equilibrium and optimum simultaneously.

When the market operates optimally and in equilibrium, it's rational and efficient, removing the need for moral assessments because the outcome is justified by its rationality.

When the market is perfectly competitive, it operates rationally and optimally. This makes moral assessments inapplicable because the market's outcomes, driven by individual self-interest and interactions, don't necessitate moral judgment.

Managerial capitalism refers to a system where management, entrusted with controlling a firm, prioritizes the interests of stockholders.

Initially, it emphasized pursuing stockholder interests without significant hindrances. However, changes in laws and societal expectations have increasingly compelled corporations to consider interests beyond just stockholders.

A stakeholder, as defined by Freeman, is any group or individual affected by or affecting corporate actions.

He recognizes that stakeholders, like stockholders, have certain legitimate claims on the firm and require specific actions or considerations. Conflicting claims among stakeholders, as among stockholders, demand resolution methods.

1)Owners/Stockholders: Have a financial stake in the firm.

2)Employees: Have jobs, livelihoods, and specific skills tied to the firm.

3)Suppliers: Vital for quality and pricing, reciprocal relationships.

4)Customers: Exchange resources for products, crucial for revenue.

5)Local Community: Grants rights for building facilities, expects contributions, and responsible behavior from the firm.

Freeman proposes that the normative core comprises various principles that guide how corporations should be governed. This core is not singular but diverse that reflect different political constructions and societal ideals.

These cores are tied to notions of autonomy, solidarity, and fairness, which form the foundation of how value creation and contracting among stakeholders should occur.

The determination of this core involves integrating business and moral terms to establish principles that ensure equality among stakeholders and mutual interests' recognition.

Cooperation is the act of individuals working together towards shared goals or in a collective endeavor.

The common interest arises from the mutual benefit derived when individuals collaborate to achieve shared objectives.

The conflict of interest arises when it presents situations where individuals might have conflicting interests regarding how the benefits or burdens of cooperation should be distributed among them.

A "theory of justice" refers to a framework or set of principles that determine the fair and equitable organization of society. It's a structure that addresses how fundamental rights, liberties, opportunities, and social goods should be distributed among individuals in a fair manner.

Rawls emphasizes that a theory of justice should provide a framework for determining the proper allocation of societal resources and the rules governing social cooperation.

Rawls explains the "original position" as a hypothetical scenario where individuals, placed behind a "veil of ignorance," make decisions about societal principles without knowledge of their personal circumstances.

By withholding such information, Rawls aims to create a fair and impartial decision-making environment where principles are chosen without being influenced by individual advantages or disadvantages.

Classical utilitarianism is a moral theory that shows how society should be arranged to maximize overall happiness or welfare, summing up the net balance of satisfaction among all individuals.

Utilitarianism's focus on maximizing overall satisfaction neglects the potential for unjust outcomes where certain individuals or groups might consistently bear the costs or receive lesser benefits for the sake of the majority's happiness. Rawls argues that this failure to account for fair distribution undermines utilitarianism's adequacy as a theory of justice.

Smith's thinking, according to Polanyi, treats the economy as detached from social relations, governed by inherent laws of supply and demand.

Polanyi contends that the market isn't an independent entity but rather a part of a larger societal framework.

He argues that the economy is not self-regulating but deeply embedded in social, cultural, and institutional structures. The key objection is against the notion that the market operates independently of social influences.

Polanyi's use of "submerged" implies that economic activity is not an isolated entity governed solely by market forces. Instead, economic processes are deeply entwined within the fabric of social relations.

The term underscores how economic activities and transactions are intricately interwoven with social norms, customs, and institutional structures.

Essentially, the economy doesn't exist in isolation but is integrated and influenced by the broader social context in which it operates.

Reciprocity: The principle of reciprocity involves mutual give-and-take within social relationships. It refers to the exchange of goods, services, or favors with an expectation of some form of return. This principle ensures cooperation and sustains social bonds through reciprocal actions.

Redistribution: Redistribution involves the reallocation of resources, often through a centralized authority or institution. This principle facilitates the distribution of goods or wealth within a community, ensuring a more equitable sharing among its members.

Householding: This principle, later added by Polanyi, refers to economic autarchy or self-sufficiency within closed groups or households. It involves self-reliance and the organization of production and consumption within a localized setting.

Initially, markets existed in isolated forms, functioning within specific regions or for long-distance trade. However, the transformation into a market economy involved a deliberate shift orchestrated by external factors.

State intervention broke down barriers between local and intermunicipal trade, creating a national market. The state's actions aimed to unify markets, expand trade beyond localized settings, and establish a larger, more integrated market system.

This transition involved a shift from markets regulated by social authority to a more expansive, regulated market economy shaped by state intervention.

Non-adversarial schemes with incentives: They provide direct benefits based on performance without direct competition among participants.

Advantage: Minimize pressure and rivalry, allowing for more relaxed collaboration.

Disadvantage: Less motivation for improvement as benefits are not contingent upon outperforming others.

Adversarial schemes: These schemes involve direct competition, incentivizing participants to outperform others to gain exclusive benefits.

Advantage: Motivates people to reveal their full capacities due to competition.

Disadvantage: May lead to rule manipulation, collusion, and moral crowding-out.

Strict cooperative schemes: Here, participants cooperate without individual rewards.

Advantage: Encourages collaboration and collective efforts.

Disadvantage: Lack of personal incentives might reduce motivation.

Performance-downplaying refers to situations where individuals in non-adversarial schemes with incentives may not strive to enhance their performance beyond a certain level despite the potential for improvement. This lack of optimization occurs when the incentives for better performance don't outweigh an individual's desire for additional benefits. It can also stem from factors like rivalry aversion, weakness of will, or changes in preferences.

Rule manipulation, on the other hand, emerges when individuals in adversarial schemes alter or bend the rules to gain an advantage. This can involve cheating, altering task structures, or exploiting loopholes in the system to achieve success without genuinely improving performance. Both performance-downplaying and rule-manipulation hinder the intended outcomes of the schemes by impeding genuine improvement and fairness.

Advantage: Stimulating performance optimization through competition. In these environments, individuals are incentivized to reveal their full capacities due to the competitive nature of the scheme.

Disadvantage: Rule manipulation. As the pressure to excel intensifies, individuals might resort to cheating or manipulating the rules to gain an edge, which undermines the fairness and integrity of the system.

Automatic optimization of performance is a phenomenon where individuals naturally strive to improve their performance due to the competitive nature of an adversarial scheme.

In such setups, participants are motivated to outperform their rivals to secure exclusive benefits or rewards. This constant pressure to excel fosters a dynamic where individuals continuously push themselves to achieve their maximum capacities, ensuring that the scheme operates at its most efficient level.

The competitive environment in adversarial schemes inherently drives this automatic optimization by compelling individuals to seek ways to outdo their competitors in a bid to secure the offered benefits.

The Centralized planning system incentivized meeting production targets without sufficient regard for efficient resource utilization. As a result, there was a tendency to overproduce certain goods to meet quotas, leading to wastage of materials.

Additionally, inadequate coordination between production units and central planners resulted in inefficiencies, where surplus materials were often left unused or misallocated.

The significance of the quote lies in highlighting the fundamental challenge of the Soviet economic system. It emphasizes that good intentions alone are insufficient in improving the economy. Instead, the focus should be on identifying the most effective course of action and ensuring the necessary resources and means are available to implement it.

In a democratic setting, various stakeholders with diverse interests and perspectives are involved, making consensus challenging to achieve.

Additionally, economic decisions often require technical expertise and comprehensive understanding, which might not be uniformly present among the general population.

Balancing the diverse needs and opinions while making efficient economic choices can be intricate and challenging within a democratic framework.

Nove describes it as the impractical scale of centralized micro-economic planning. The system faced challenges in coordinating the actions of subordinate units with the broader economic goals.

The hierarchical nature of planning led to inefficiencies, as decisions were primarily based on fulfilling targets set by central authorities rather than responding to market demands or local needs.

The real dilemma revolves around reconciling the ideals of socialism with the practical challenges of economic governance. It involves balancing the desire for a more egalitarian society with the complexities of resource allocation, production efficiency, and the role of market mechanisms.

The dilemma lies in finding a working model of a socialist economy that can effectively address economic challenges without compromising socialist principles.

Hayek points out that the problem isn't merely about allocating resources based on given data, preferences, and complete knowledge, but about utilizing knowledge that isn't centralized or complete.

It's not about a single mind solving an optimized resource allocation problem but about utilizing the fragmented, contradictory, and incomplete knowledge dispersed among individuals to make the best use of available resources for various ends.

Decentralization allows for the utilization of diverse, specific knowledge possessed by individuals about their circumstances, resources, and needs. It ensures that decisions are made by those familiar with the immediate circumstances, contributing to the efficient allocation of resources.

The price system solves the problem of effectively communicating and coordinating dispersed knowledge among individuals. It transmits information about changes in supply and demand, guiding people to adapt their decisions and behaviors without needing to know the detailed reasons behind these changes.

In essence, it allows individuals to adjust their actions based on changes in relative scarcities reflected in prices, even without explicit knowledge of the causes behind those scarcities.

They signal changes in relative scarcities and act as a way for individuals to gauge the significance of resources in the context of their decisions.

Prices condense vast amounts of dispersed knowledge into a simple form that guides individuals' actions and resource allocation, contributing to a coordinated economic system without requiring comprehensive knowledge from any single entity.

A side effect or consequence of an industrial or commercial activity that affects other parties without this being reflected in the cost of the goods or services involved, such as pollination of surrounding crops by bees kept for honey.

Arrow points out that when firms' activities cause harm to others (external costs, like pollution affecting individuals), the market equilibrium does not account for these costs. This disrupts the invisible hand's efficiency in allocating resources because prices don't accurately reflect the true social costs or benefits of goods or services.

Arrow suggests that in cases where firms' actions cause substantial harm (external costs) to society, it becomes reasonable to expect firms to limit profit-maximization to prevent such harm. This is especially relevant in situations where the negative externalities are significant, like environmental pollution.

By pursuing profits, firms are driven to be efficient, innovate, and produce goods or services that consumers demand, ultimately leading to economic growth and improved living standards.

1) External Costs: Firms often ignore the external costs they impose on society (like pollution). This is a breakdown because the pursuit of profits doesn't account for the negative impact on others.

2) Information Asymmetry: In situations where one party (like the firm) possesses significantly more information than the other (consumers), the assumption that profit-maximization serves society's best interest breaks down. This is because consumers might be misinformed or unaware of potential harms caused by the firm's actions.

a) Regulation: Implementing regulations that enforce standards (like minimum safety standards) can ensure firms meet certain social obligations.

b) Legal Remedies: Legal actions against firms for violating social responsibilities can act as a deterrent.

c) Ethical Codes: Developing and adhering to ethical codes within industries can guide firms to behave responsibly, particularly in situations of asymmetric information.

d) Public Discussion & Education: Engaging in public discussions, educating through business schools, and indoctrination can instill ethical responsibilities among executives and future business leaders.

He illustrates that in the broader economic system, coordination typically occurs through the unconscious cooperation of various entities within the market, guided by the price mechanism.

However, within a corporation, conscious direction and control replace the market's unconscious cooperation. The firm stands as an entity capable of deliberate decision-making and direction of resources, distinct from the more spontaneous and decentralized coordination seen in the broader market.

Markets operate through the price mechanism, where supply is adjusted to demand and production to consumption automatically, based on price signals.

Planning involves deliberate organization and direction of resources. Markets rely on decentralized decision-making through price fluctuations, while planning involves centralized direction, often seen within firms.

This means that within a firm, transactions and resource allocation are directed by an entrepreneur or manager rather than through market transactions based on price signals. Instead of market coordination, the firm employs conscious direction, making decisions internally.

Coase highlights various costs involved in using the price mechanism to coordinate production, such as the costs of discovering relevant prices, negotiating and concluding contracts, uncertainties in long-term contracts, and difficulties in forecasting.

These costs can be reduced or eliminated within a firm by organizing transactions internally. The existence of the firm is justified by the savings in these transaction costs compared to using market exchanges.

Enhanced managerial skills enable more efficient organization and coordination of transactions within the firm. As firms become better at managing and coordinating resources internally, they expand to incorporate more transactions and functions, increasing their overall size and scope.

In the firm, the separation of ownership and control denotes a scenario where ownership rights (held by shareholders) diverge from managerial control. This separation is crucial because it can lead to a divergence of interests between owners and managers. Managers might pursue their own objectives, which might not align with the interests of shareholders.

Hansmann emphasizes its importance by highlighting how this separation often leads to agency costs—expenses incurred due to conflicts of interest between owners (principals) and managers (agents). This separation necessitates mechanisms for monitoring and aligning managerial actions with shareholder interests.

Residual earnings represent the remaining profits after all expenses, including interest, taxes, and operating costs, have been deducted. In the context of ownership, these earnings are significant as they directly pertain to the benefits or returns that accrue to the owners after all other claims on the firm's income have been met.

Hansmann describes a standard business cooperation as a "lender's cooperative" to emphasize that while supplying capital to a firm is one aspect of ownership, it is not the exclusive or defining feature.

This statement underscores that ownership in a firm is not solely tethered to supplying capital; it encompasses various transactional relationships.

It emphasizes that ownership, though often associated with supplying capital, encompasses a broader array of rights and relationships beyond mere capital provision.

A non-profit organization is oriented toward a specific social or charitable mission, and any surplus generated is not distributed among members or owners but is reinvested into furthering the organization's mission.

A cooperative focuses on serving the needs of its members, and any surplus, known as patronage refunds, is distributed among the members based on their transactions or contributions with the cooperative.

Hansmann conceptualizes the firm as a nexus of contracts, signifying that the relationships within a firm are structured through various contractual arrangements among different parties—owners, managers, employees, suppliers, and customers.

This perspective highlights that the firm's operations and governance are shaped by a network of contractual obligations and relationships among these stakeholders.

The costs of contracting encompass expenses associated with negotiating, enforcing, and executing contracts among different parties involved in the firm.

Ownership, as a contrast to contracting, offers benefits by reducing these costs. Hansmann outlines that ownership provides a bundled set of rights that negate the need for constant contracting among parties, thereby lowering transaction costs.

The primary costs of ownership involve expenses related to monitoring, overseeing, and ensuring that managers act in the best interest of owners. These costs arise due to the separation of ownership and control, leading to agency problems where managers might pursue their interests over the owners'.

Ownership of the firm is typically determined by the allocation of ownership rights and the capital contribution made by individuals.

In investor-owned firms, ownership is often tied to the acquisition of shares representing ownership stakes.

In cooperatives, ownership is connected to patronage or participation in the cooperative's activities.

It is uncommon due to the complexities and challenges arising from divergent interests among different patron groups. Aligning diverse interests and preferences while maintaining effective governance becomes exceedingly intricate, leading to increased costs and difficulties in decision-making within such structures.

Transaction costs are the costs incurred during the process of conducting an economic exchange or transaction. They’re essentially the expenses beyond the actual price of the goods or services being exchanged and encompass the costs of organizing and conducting the transaction itself.

The theory notes that economic agents, despite bounded rationality, are always tempted to opportunistic behaviors.

This significantly impacts transaction costs as it necessitates the creation of safeguards and structures within organizations to mitigate potential risks arising from opportunistic actions.

The presence of opportunism complicates contracting and leads to incomplete contracts, influencing the governance structures adopted by firms to minimize transaction costs.

Site-specific investments: These involve physical location-related investments, such as facilities designed for particular purposes at specific locations.

They give rise to fears of opportunism as they are highly specialized and not easily transferable. If one party acts opportunistically, it becomes challenging for the other party to find an alternative use or buyer for these site-specific assets.

Physical asset specificity: This pertains to investments in specialized equipment, machinery, or tools tailored to perform specific tasks or produce particular components.

Opportunism in such cases could lead to the exploitation of specialized assets, causing losses to the investing party due to limited alternative uses.

Human asset specificity: Investments in human capital, such as skills, knowledge, or experience, which are specific to a particular job or firm, represent another form of asset specificity.

Fears of opportunism arise because specialized human assets might be misused or undervalued if the relationship between the employee and the firm is severed.

The make-or-buy decision is the strategic choice made by a firm regarding whether to internally produce goods/services (make) or externally procure them from the market (buy). This decision significantly determines the extent to which the firm vertically integrates its operations.

When the transaction costs associated with external market exchanges (buying) exceed the costs of internal production (making), the firm tends to integrate its operations vertically, expanding its boundary to include those operations.

Conversely, if the costs of internal production outweigh the transaction costs of buying from the market, the firm might refrain from integration, opting to rely on external suppliers or markets.

The analogy suggests that managing human assets, especially those with specificity (like specialized skills or knowledge), involves structuring relationships and employment conditions within an organization to align incentives, mitigate risks of opportunism, and optimize the efficiency of these internal transactions involving human capital.

1. Hierarchy - structure of authority reporting to superiors

2. Complex division of labor - each role has a sphere of authorized action based on excellence in the application of technical expertise and/or knowledge 

3. Professional managers or administrators 

4. Products or “outputs” are joint or collective - produced in the cooperation of a number of individuals and subgroups 

5. Rely on rules and politics - written form 

6. Principal/agent relationships

In bureaucratic organizations, the principal/agent relationship refers to situations where an individual or group (the principal) delegates authority to another party (the agent) to act on their behalf.

The principal typically assigns tasks to the agent that the principal either cannot perform themselves or finds too costly or inconvenient to perform.

Agency risks involve the potential for the agent's actions or interests to diverge from those of the principal, leading to conflicts, lack of accountability, or failure to fulfill obligations.

The central ethical obligation within bureaucratic organizations revolves around ensuring accountability. Buchanan emphasizes the need for clear documentation of efforts at implementation and accountability for decisions made, especially at higher levels of authority.

First-order agency risks involve direct conflicts where the agent's actions deviate from the principal's interests. For instance, a manager making decisions solely to benefit themselves rather than the organization.

Second-order agency risks are about failures in creating conditions for accountability, such as insufficient documentation or lack of oversight leading to unclear responsibilities. An example might be a policy being introduced without a designated person responsible for its implementation.

• Limited Explanatory Power: Buchanan contends that role-derived obligations have limited explanatory power as they don't capture the general ethical principles needed to address the unique risks in bureaucratic organizations.

• Commonality with Other Organizations: While role-derived obligations exist in various settings, they fail to explain the distinctive features of bureaucratic ethics.

• Failure to Explain General Principles: Role-derived obligations fall short in explaining the overarching ethical principles crucial for reducing agency-risks within bureaucracies.

He believes that producing adequate documentation of activities is crucial within bureaucratic organizations because it serves as evidence of efforts made towards implementing policies. Lack of documentation can imply a failure of higher-level authorities to fulfill their obligations and can create a veil shielding individuals from scrutiny and attributions of blame.