Posted at 10.02.2018
a) Please, give two types of transactions you know from experience that are governed by different governance structures, either market, hybrid, or hierarchy. Please, identify just what the transaction is the fact that you study in each case. (6 pts. )
Transaction 1: On-line Purchases (eBay), in this transaction, there is a client and a merchant utilizing a virtual market interface as a substitute to an actual market with physical goods. Since the transaction has a perceived inherent risk of defaults, Paypal was introduced as a kind of electronic payment from buyer to merchant where it charges a transaction charge once a transaction was made successful. Moreover, it also provides opportunity of reimbursement once the items purchased were no delivered from merchant to buyer. In cases like this, you assume a transaction cost equivalent to the amount charged by Paypal which streamed-lined the marketplace process while reducing the uncertainty of the transaction and its asset specificity is very low taking into consideration the investment made by the client are not transaction specific or even not existent providing market governance structure under a spot contract.
Figure 1: Transaction 1 Figure 2: Transaction 2
Transaction 2: Consider the situation of an iPhone App Developer and its client Apple. To make an iPhone App, the developer must use the Software Development Kit as a standardization requirement and buy Publishing Licenses in order to legally publish iPhone Apps exclusively under Apples website. This move allows a bilateral agreement over two companies wherein Apple technically integrates the developer into a vertical arrangement by using a contract granting partial ownership right to the iPhone App with a corresponding revenue sharing agreement. Frequency of transaction as designated by the contract agreement as specified in the license usually having the very least contract period of twelve months. While uncertainty is distributed by time which is technically risky given the fact that developer tend to be independent in nature and usually constitute other projects which could override the delivery of the iPhone Apps. As for the asset specificity, it is perceived to be low as the investments on transaction specific assets aren't substantial as the SDK are available for free. Thus, it is safe to say that the given is under a hybrid governance structure allowing contracts and vertical integration.
b) Please, review the three main hypotheses of Williamson regarding what factors determine transaction costs and the decision of governance structure and discuss if these hypotheses seem to be to be valid for the examples you chose. Explain why a particular hypothesis may not hold true or why you are unable to assess it. Make an effort to draw comparisons between the two transactions and just how they are governed. Methodologically, how can you go about studying the several types of transaction costs involved? What problems do emerge in the context of such a report? (14 pts. )
Williamson (1985) dimensions or variables used to characterize or determining almost any transaction cost and the decision of governance structure wherein transaction can be (1) frequent or rare; (2) have high or low uncertainty; (3) or involve specific or non-specific assets.
Frequency is straight-forward that it is usually omitted in the discussion. However, the result of frequency on transaction costs is very strong.
Uncertainty notes the probability dynamics that eventualities might occur during the transaction. Time, for example, is considered wherein uncertainty is relatively low when one doesnt have to predict the near future which usually the case for spot markets. Conversely, transaction that involve a committed action over time involve some inherent uncertainty built in to them as the completion of a long term contract may be jeopardize one in the instance when bounded rationality and opportunism is subjected.
Asset specificity involves assets that are only valuable (or are a lot more valuable) in the context of a particular transaction, transaction costs will tend to be reduced by vertical integration. Also, when transactions involve highly specific assets, transaction costs will tend to be low in a hierarchy than in market.
Consider the truth of the two previous transaction, where in it manage to provide the necessary variables needed to determine the type of transaction cost and the decision of governance structure. The classification and explanation of the dimensional variables has been extensively explained the prior answer because the governance structure is needed to define. However, it came to a conclusion that both has a different governance structure wherein Transaction 1 is distributed by the market seen as a the location contract while Transaction 2 is distributed by a hybrid governance structure given by a combination of contract and vertical integration. Spot contract are characterized by onetime contract between two entities doing a transaction without substantial uncertainty and non-existing need for transaction specific assets. Conversely, hybrid which really is a combination of the contract and vertical integration which is characterized by a continuous transaction engagement of both parties within the arranged time frame with a substantial uncertainty in the entire delivery of the contract with an existing dependence on transaction specific assets since it is usually the situation that the companies align their production into the acceptable standards as specified by the contracting company or entity.
Methodologically, there should start the agents, their relationships, specification of any transaction, determination of the sort of transaction cost, and choice governance of the structure. Once everything is defined, we can analyze the estimation of the actual cost function of such transaction to further provide quantification of such.
Based on Williamsons theory there are many problems would have to be mentioned; (1) separation of production and transaction costs doesnt always hold while the measurement of transaction cost is very difficult even if it was already defined, (2) bounded rationality is not sufficient as it pertains to the conflict of interest as agents interest may well not be correctly aligned, and (3) reputation and trust are not considered since transaction are treated as if they occur with no reference of the previous transactions that the parties engaged.
Task 2: Economic Theory of Democracy
c) What are the essential assumptions of the Economic Theory of Democracy and the key insights produced from this theory which, for example, can be demonstrated through spatial models? Which phenomena are addressed by the terms centripetal and centrifugal forces? Please use graphs. (20pts)
Anthony Downs (1957) in his Economic Theory of Democracy provided us with 3 major theoretical claims:
First, the median voter model wherein prospects must locate themselves at the median of your normally distributed voters to be able to maximize their chances of being elected. Failure to position could risk being outflanked by another prospect who requires a position between the first prospect and the median voter. Such model assumes Arrows problem by supposing that policy issues aggregately reduced to an individual left-right dimension.
Second, it was claimed that the voters actually have little incentive to vote as they can not expects to own any impact on the outcome of the said election. Since, they have a very little impact that any cost of voting negates any direct benefit from such action. This is later generalized by Mancur Olson (1965) in his logic of collective action.
Third, which is sub-divided into two claims, (1) is that individual citizens has no incentive even to learn enough to have the ability to vote intelligently and (2) that gaining such knowledge entails some costs.
Furthermore, as the primary insight which acts as a precursor for a spatial model, Downs uses the assumption under the classical democracy theory wherein people seek their self-interest in politics. In cases like this, voters are only concerned about the policies that the federal government will implement wherein these policy choices involve trade-offs which is often represented as an individual dimension. Each voter has spatial preferences over an issue, characterized by an insurance plan that the individual most prefers, deviations that lead to less good outcomes for such voter. Conversely, politicians seek to win public office while parties (treated as teams of politicians) seek to win control of the government. The electoral politics provides a menu of policy promises that applicants and parties offer to implement if elected while voters choose the candidate closest to their ideal policy. Predicated on such, competition for office will lead prospects and parties to represent public policies that mostly appeal to the median voter.
Under the median voter theorem observed in Figure 1, there exist two politician given by A and B wherein there is a normally distributed voting population where each voter is represented by a spot in a single dimension. Then politician A and B would, under all circumstances, make an effort to position its policy platform in reflective to the preference of the median voter. In cases like this, A would move aggressively in order to increase its votes from a0 to a1 which is then followed incrementally by B moving from b0 to b1, respectively. This creates a Nash Equilibrium effect providing a common convergence on the ideal point of the median voter making a centripetal tendency forming the rationale for real-world election under plurality. In cases like this, voters being indifferent between politicians since both now have equal probability in acquiring votes; a deviation to commit a new policy position would lead to decrease in the likelihood of receiving such vote.
Figure 3: Median Voter Theorem Figure 4: Formation of Extremist Politician/Parties
Following the median voter theorem, Figure 2 exhibits the countervailing centrifugal effects. In cases like this, C emerges having a job of political activist in the sense it pushes a far-leftist policy as compared to A & B which already met in the previously optimal median point. In this sense, a multiple politician/party system election tends to reinforce the divergence from overall voter median mainly due to the restricted enrollment in the primary electorate as disproportionate participation by hard-core supporters of the politician/party and the tendency to choose candidates reflecting the views of these voters. This provides for the existence of geographically based dissimilarities in party support and political attitudes, and the occurrence of policy-motivated goals of elected politicians. Furthermore, such divergence of C from the median allows to catch votes equivalent to c which is greater than a and b providing a definite advantage.
d) What's particular about the party preferences of farmers and what has shaped their party preferences? What conclusion can be drawn about the coordination capacity of elections for the agricultural sector? Please describe the next statement: For an agricultural politician who behaves in a rational way, favoring farmers by means of redistribution policies may cause too high opportunity costs in terms of votes. (20pts)
Picking from the previous discussion, self-interested citizens, make electoral choices and take actions, such as voting or reading about politics, to increase the expected advantages of confirmed action net the cost of those activities. A utility maximizing citizen will choose an even of political activity, in a way that the marginal expected benefit of the experience equals the marginal cost. Thus, farmers are specifically worried about the agricultural policies that the politician/party wanted to implement whilst they behave completely neutral on other political problems. Since theyre only interested on the evaluation supply of agricultural policies which is formed by the responses of the agricultural politician to policy demands. Furthermore, Farmers often get into four categorical voting behavior types namely; median voters, floating voters, regular voters, and extreme voters.
Median voters follow the pure allocation model often voting ones who provide the preservation of agricultural structures resting on the guarantee of private property in production factors. Floating Voters follow the perfect distribution strategy under the pure democracy wherein maximum favors for a minimum majority and maximum burdens for a maximum minority. Floating voters tend to be captured through additional gains through policy measures that redistribute income. Regular voters are the ones who rely on party competition requiring long-term maintenance of respective party identification which is decided by the foundation of the overall party program but not for particular agricultural policies. Extreme voters tend to be created when the agrarian minority are radicalized through legitimate crises in agricultural policy wherein they believe that the original state actors didnt prioritize their interest resulting into crises which threatens their economical existence (see: CDU/CSU as almost all) or through the ideological instrumentation by groups and organizations which can be near agriculture but result from urban society (see: NSDAP/Nazi Party from 1928 to 1933). In every of these behaviors, the farmer exemplified the classical democracy theorem that allows them to increase their benefits predicated on their individual interest.
In the situation of coordination capacity of election, that resolves the paradox of non-participation through 3 possibilities that requires a certain degree of coordination.
First, was the introduction of duty to vote (Riker and Ordeshook, 1968) wherein the incorporated a regular term that captures a citizens sense of duty to vote. Individuals with sufficiently high duty to vote will vote, and the ones with a low sense of duty will not vote.
Second, was through the consumption motivation of expressive voting wherein people who care more about the outcome in the sense of having a larger utility differential in their assessments of the applicants could be more more likely to vote (Schuessler 2000).
Third, was to embed individuals within social groups wherein Harsanyis notion of rule utilitarianism was further developed by Coate and Conlin (2002) the idea of group rule utilitarianism. A rule utilitarian solution holds that all would be better off if everyone voted than if nobody voted, therefore the group has an incentive to create a mechanism which induces all to vote.
Furthermore, it assumes that the utility derived from electoral participation and electoral choice is strictly consumption which is waged over a spatial dimension, with a valence component or even to assume that there exist mechanisms for coordinating groups of individuals to political action and such as churches, unions, political parties, and other social organizations.
For an agricultural politician who behaves in a rational way, favoring farmers through redistribution policies will cause too much opportunity cost in terms of votes specifically means that optimal redistribution strategy seen as a maximum favors for the very least majority results to maximum burden on a maximum minority wherein one party strategy will constantly countermined by the promises of a different one resulting in unstable political conditions. This is actually the usually the situation wherein redistribution schemes induce political fragmentation as there arise political disagreement between voters in different region. Such increases the likelihood of wasteful rent seeking. Further, a minimum majority is characterized by 51% of the voting public while maximum minority is approximately 49% of the voting public wherein 2% of the voting public can be separated through special favors resulting in rent seeking.
Task 3: Organization and Influence of Interest Groups
e) Please describe and clarify the Economic Theory of Collective Action produced by Mancur Olson. Which groups and determinants does he distinguish as regards the emergence and feasibility of collective action? Please use graphs. (20pts)
Olson(1965) and his financial theory of collective action discuss the provision of public goods (and other collective consumption) through the collaboration of two or more individuals, and the impact of externalities on group behavior. This explores the marketplace failures where rationality of individual consumer and firms' profit-seeking do not lead to efficient provision of the public goods, wherein another degree of provision would provide a higher utility better value.
Moreover, it also develops a theory of political science and economics of concentrated benefits versus diffuse costs. Wherein he noted a couple of things; (1) if everyone in an organization has interests in common, they will act collectively to attain them, and (2) in a democracy, the greatest concern is that almost all will tyrannize and exploit the minority. It also argues that folks in any group attempting collective action will have incentives to "free ride" on the efforts of others if the group is attempting to provide public goods. Individuals will not free ride in groups which provide benefits only to active participants.
In this case, public goods are goods which are non-excludable and non-rival. Without selective incentives to motivate participation, collective action is unlikely that occurs even though large groups of individuals with common interests exist.
Also, a huge group has been noted that it'll face relatively high costs when wanting to organize for collective action while small groups will face relatively low costs. While, individuals in large groups will gain less per capita of successful collective action; individuals in small groups will gain more per capita through successful collective action. Thus, in the lack of collective incentives, the incentive for group action diminishes as group size increases, so that large groups are less in a position to act in their common interest than small ones.
Furthermore, a collective action by large groups is difficult to achieve even though the interests are normal, but it may appear that the minority bounded together by concentrated selective incentives can dominate almost all.
On the other hand, Olson made mention about the groups, namely; large, small, privileged, intermediate, and latent.
Large group is where each individual gets proportionally smaller benefit from a collective good which, the average person contributes little to the organization. A member in this group would rarely act to secure a collective benefit unless the average person return is sufficient to cover the average person cost of action. Since this group is broad, they provide sanctions and incentives to ensure the loyalty of members who might otherwise identify strongly with small groups. Although it provides collective goods to their membership, they need to also offer non-collective goods to attract new members.
Small Group is often more viable because the costs of organization are less, and each member receives a more substantial part of the collective good. But this will not operate properly because the distribution goods and burdens between members will be unequal. The collective good is provided by the voluntary, rational, and unilateral action of 1 or two members who realize that their reward for providing the nice is easily more than the costs they bear. And since any member can consume the good once it's been provided, some members see no incentive to provide the good where they wrap up exploiting the few members who bear the expenses.
Privileged group some of the members have an incentive to supply the collective best for all. No formal organization is needed because a number of psychological, social, and monetary incentives can motivate members.
Intermediate group there are so many members a free-rider is not noticed and therefore no subgroup has an incentive to act independently. Thus, institutions are essential to help identify psychological, social, financial an psychological incentives for members to act.
Latent group there are so many members that neither the action nor inaction of any particular member would help supply the collective good. The one sets of incentives, if indeed they ever appear, are economic in form and are rarely enough to motivate collective action.
Furthermore, the determinants for the provision of public goods are basically two things; (1) group size and (2) intensity of preference. In the case of large group, once the intensities of preferences are equal then voluntary provision of public good very unlikely but after the intensities of preferences are unequal then the provision on the collective good is not sure. Conversely, the situation of small group, after the intensities of preferences are equal then voluntary provision of public good is not sure but once the intensities of preferences are unequal then the provision on the collective good is very likely.
f) Which mechanisms for collective action to come into being play a role in the Economic Theory of Olson? What mechanisms are used for organizing collective action regarding the German Farmers Union and regarding a drainage association at the coast of the North Sea, and why do they differ? (20 pts)
There are three mechanisms for the provision of collective good, namely; (positive) selected incentives, negative selected incentives or coercion, and irrationality.
Positive selective incentives allow paying members receive benefits or private goods wherein exclusion principle can be applied. Thus, non-paying members are excluded from such.
Negative selected incentives or coercion which frequently used by the federal government as it gets the legitimacy to use a formal and physical power on the society wherein it delegates tasks to associations with compulsory membership and it is implied that there is no free exit.
Irrationality is due when the expressive interests are emphasized in public policy which ignores the important practical considerations regardless of the underlying economic costs to be able to provide collective action. Caplan (2007) claimed that the voter choices and government are biased in favor because of its irrational beliefs. This is then effectively subsidized by democracy wherein anyone who derives utility from potentially irrational policies (such as protectionism) can receive private benefits while imposing the costs of such beliefs on the general public.
Under the case of the German Farmers Union, it effectively uses the mechanism of negative selected incentives or coercion since it can legitimately use the power of the state of hawaii granting so it has maintained a political monopoly through the prevention of the fragmentation of the agricultural association in Germany. Furthermore, GFU gets the leadership and management of the Central Committee of German Agriculture even though there is perceived ideological discrepancies with the inclusion of the post-socialist farmer unions from Eastern Germany.
Conversely, the drainage association at the coast of the North Sea effectively uses positive selective incentives since it doesnt have the best capacity to coerce the federal government in doing what they wished. Moreover, this case allowed excludability as only the stakeholders who are directly damaged by the creation, operation, and maintenance of the drainage system could get the benefits associated with having such of their property.