Lecnotes01 - ECON 696: Managerial Economics and Strategy...

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ECON 696: Managerial Economics and Strategy Lecture Notes 1: The Evolution of the Modern Firm This chapter in the text discussed the formation of a number of institutions between 1840 and the present day, which have resulted in the business world as we now recognize it. This discussion serves several purposes. First, it demonstrates several conditions necessary for markets to function with relative efficiency. This has its roots in the theory of perfect competition, which analyzes markets under the somewhat unrealistic assumptions of : Many small firms and consumers Perfect information Free entry and exit Identical products Under these assumptions (which, admittedly, are infrequently satisfied) markets are very efficient in the sense that the marginal cost of production is equal to consumers' marginal value. The lack of a good transport infrastructure meant that it was difficult for sellers from one region to enter the market for their good in another region. Further, the extreme difficulty of moving goods from one place to another could only perpetuate local monopolies and their accompanying inefficiencies. The lack of good flows of information meant that goods could not move from regions of the country where they were relatively plentiful (as indicated by low prices) to regions where they were relatively plentiful (as indicated by high prices). This not only restricted profitable opportunities for entrepreneurs, it also kept markets from fulfilling their important task of redistributing goods from where they are most common to where they are most critical. Second, analysis of situations in which different elements critical to the smooth functioning of markets are absent demonstrates quite effectively how markets function when these elements are missing. The lack of current information about prices in different places and the great amounts of time required to transport goods meant that middlemen took great risks in buying goods and moving them to other areas. The high level of risk meant that price differences had to be huge to provide sufficient incentives for interregional commerce. The lack of good financial systems (due in part to the lack of good information about people who were trying to borrow) limited entrepreneurs' and firms' ability to borrow the
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capital necessary to expand existing businesses or start new ones, even if those businesses stood a good chance of being profitable.
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Lecnotes01 - ECON 696: Managerial Economics and Strategy...

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