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Douma and Schreuder, Economic Approaches to Organisations PowerPoints on the Web, 5th edition, © Pearson Education Limited 2013

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Part 1

Foundations

Chapter 1

Markets and organizations


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LEARNING OUTCOMES:

At the end of this lesson, you will be able to:

Demonstrate an understanding of the basic conceptual framework in explaining the fundamental economic approach to organizations.Illustrate and describe the conceptual framework.Elaborate using real life example how division of labor leads to specialization. Describe the need of coordination.Explain the two types of coordination of exchange transactions: market and organizations.Relate the environmental context and an institutional framework in markets and organizations.


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1. Understanding the economic problem


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The economic problem

A situation where needs would not be met as a result of scarcity of resources – resources refers to all factors that may contribute towards the satisfaction of human needs.

The problem of how to make the best use of the available resources. Resources that are optimally allocated are said to be used with efficiency.

Economic approaches to organization are based on two perspectives below:1.Economic approaches to organizations focus specifically on the economic problem of optimal allocation of scarce resources.2.The economic contribution to our understanding of an organizational problem increases when the economic problem forms a greater part of the organizational problem that we are trying to understand.


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2. Focus on the basic conceptual framework

https://www.youtube.com/watch?v=8ruiUOQERnwWatch the video. Take note of what inspired you most.


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Figure 1.1 The basic concepts


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The pin factory:Tremendous increase in productivity of the work of pin-makers could be achieved by splitting this work up into distinct tasks and having each worker perform one specific task rather than making entire pins.

1.Division of labor:

It refers to the splitting of composite tasks into their component parts and having these performed separately.

Division of labor led to productivity increases that constituted the main source of the increasing ‘wealth of nations’.

Why would an increasing division of labor lead to productivity increases and thus to a growth in the ‘wealth of nations’?


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Figure 1.2 Division of labour leads to specialization


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2. Specialization:

According to Smith:

This great increase in the quantity of work, which, in consequence of the division of labor, the same number of people are capable of performing, is owing to three different circumstances;i.First, to increase of dexterity in every particular workman;ii.Secondly, to the saving of the time which is commonly lost in passing from one species of work to another;iii.Lastly, to the invention of a great number of machines which facilitate and abridge labour and enable one man to do the work of many.


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Figure 1.3 Specialization entails coordination


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3. Coordination:Division of labor and specialization are pervasive phenomena in society. As a result, hardly any people are economically self-reliant, in the sense that they produce all the goods and services they wish to consume. In order to obtain those goods and services, they have to acquire them from other specialized people.

In economic terminology we say that exchange has to take place. Goods and services are exchanged whenever the right to use them is transferred.

Exchange of goods is usually beneficial to both parties to the exchange. Whenever exchange takes place, we speak of an economic transaction.

Owing to the division of labor and to specialization, innumerable transactions have to occur in society. A vast network of exchange is necessary to allocate goods and services. How is the coordination achieved within an economic system?


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Figure 1.4 There are two types of ideal coordination: market and organization


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4. Markets and organizations

Specialization leads to a need for coordination. Essentially, we shall submit, there are two types of coordination. Transactions may take place either across markets or within organizations.

Ideal market is characterized by the fact that prices act as sufficient statistics for individual decision making.

Ideal organizations can be characterized as all those forms of coordination of transactions that do not use prices to communicate information between transacting parties.

Read ‘Why do firms exist?’ The Economist, 16 December 2010 athttp://www.economist.com/node/17730360

http://www.economist.com/node/17730360


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Figure 1.5 The market/organization mix depends on the particular informationrequirements of the situation


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5. Information

The actual mix of coordination mechanisms that we will observe in any situation will depend mainly on the information requirements that are inherent in that situation. Information is a crucial concept in the framework, explaining how coordination will take place.


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Figure 1.6 Environment as context for the market/organization mix


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6. The environment and institutions

The context in which trade offs between market and organizational coordination are made.

The broad concept of the environment includes many dimensions. They are not only economic in nature, but may also be social, political, cultural or institutional.

Organizations not only adapt to their environment, but are also shaped by pressures from the environment and may also be selected by their environment.


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The environment and institutions

Organizations do not operate in a vacuum, but live in an environment that:provides the conditions for particular organizations to be createdShapes all organizations by exerting economic, social, political and other pressures is also the ultimate selection mechanism for determining which organizations can survive and be successful (while other organizations are selected out and perish).


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Figure 1.7 Environmental pressure and selection codetermines market/organization mix


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Summary

The basic conceptual framework takes the division of labor in society as its starting point. The division of labor leads to specialisation, which allows efficiency gains to be made. With increasing specialization, however, there is a corresponding need for coordination. Coordination is necessary in order to arrange the vast network of exchange between specialized economic actors.

Two ideal types of coordination of exchange transactions: markets and organizations. Markets use the price system as the coordinating device, while organizations use non-price systems such as authority. In practice, both ideal types of coordination are usually mixed. The actual mix found in any situation will depend mainly on the information requirements of that situation.

Finally, we have argued that markets and organizations are embedded in an environmental context and an institutional framework. Therefore, environmental and institutional factors will codetermine the trade-off between market and organizational coordination.