Question

Economics Question 1.

a. Will positive network effects lead to positive or negative feedback effects, and given these feedback effects, will this lead to a larger or smaller size of the firm?

b. The article “The Nature of the Firm” by Ronald Coase introduced the idea of transaction costs. Discuss how transaction costs also affect the size of the firm?

Answer 1

Answer 1: The positive network effects lead to positive feedback effects. If they give positive outlook in the market, of course this will lead to larger size of the firm. Because optimistic view in the long run produces faith in the market.

Answer 2: The modern business firm is the basis of our economy. By far most goods and services are produced within business firms and a huge majority of workers are employed by them. In 2004 the U.S. Census Bureau counted nearly 5.9 million firms employing about 115 million people, with receipts of something over $23 trillion, and payroll of about $4.3 trillion. Of these nearly six million firms, only about 11 per cent had more than twenty employees, less than two per cent had 100 or more employees and .3 per cent employed 500 people or more. These are the numbers people refer to when they discuss the importance of small and medium sized firms. But the behemoths, while a small percentage of the population, produce a disproportionate amount of the U.S. output. The 891 largest firms (by sales) accounted for 23 per cent of U.S. employment, almost 30 percent of payroll, and a whopping 42 percent of sales or receipts.1 On average over the past 20 years or so, about eight to nine percent of firms fail each year and are offset by the birth of new firms equal to about ten percent of the total firm population. Over time, almost all firms fail or disappear. Many are absorbed into other firms. U.S. merger and acquisition activity in 2010 was valued at about $820 billion, about half that of worldwide M&A. The average acquisition premium, a measure of the acquiring company’s optimism, for U.S. deals was a little over 40 per cent, about ten points higher than the worldwide average.