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Endogenous Firm and Information Rent Under Demand Uncertainty

Author

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  • Li, Yanfei
  • Yao, Shuntian
  • Chia, Wai-Mun

Abstract

Increasing evidence shows that ICT investment improves firm performance. Among the many explanations on why ICT contributed to labor productivity surge since 1990, this is the most promising one. It is thus necessary to take the firm as an information processing organization, putting it in stochastic environment. As perfect information is no longer the assumption, that firms exogenously exist in the economy would no longer be assumed here. With these in mind, the paper provides a model that involves the division of labor and specialization, the production and consumption under demand uncertainty, and the value of information. It shows that under certain business conditions, a firm with certain type of information processing ability comes into being endogenously. A surplus, which could reasonably be argued as information rent, is generated with firm production. The size of this information rent depends on a few key parameters, including the level of uncertainty, the degree of market competition, and the cost of information processing. To test the model, case studies on the financial industry and the wholesale and retail industry are conducted, which corroborate the theoretical predictions of the model.

Suggested Citation

  • Li, Yanfei & Yao, Shuntian & Chia, Wai-Mun, 2009. "Endogenous Firm and Information Rent Under Demand Uncertainty," MPRA Paper 13506, University Library of Munich, Germany, revised 16 Feb 2009.
  • Handle: RePEc:pra:mprapa:13506
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    References listed on IDEAS

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    1. Carlton, Dennis W, 1979. "Vertical Integration in Competitive Markets under Uncertainty," Journal of Industrial Economics, Wiley Blackwell, vol. 27(3), pages 189-209, March.
    2. DeCanio, Stephen J. & Watkins, William E., 1998. "Information processing and organizational structure," Journal of Economic Behavior & Organization, Elsevier, vol. 36(3), pages 275-294, August.
    3. Thomas Marschak, 2004. "Information Technology and the Organization of Firms," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 13(3), pages 473-515, September.
    4. Carlton, Dennis W, 1978. "Market Behavior with Demand Uncertainty and Price Inflexibility," American Economic Review, American Economic Association, vol. 68(4), pages 571-587, September.
    5. Macho-Stadler, Ines & Perez-Castrillo, J. David, 2001. "An Introduction to the Economics of Information: Incentives and Contracts," OUP Catalogue, Oxford University Press, edition 2, number 9780199243273.
    6. Xiaokai Yang & Yew-Kwang Ng, 2006. "Theory Of The Firm And Structure Of Residual Rights," World Scientific Book Chapters,in: Inframarginal Contributions To Development Economics, chapter 10, pages 231-258 World Scientific Publishing Co. Pte. Ltd..
    7. Erik Brynjolfsson & Lorin M. Hitt, 2000. "Beyond Computation: Information Technology, Organizational Transformation and Business Performance," Journal of Economic Perspectives, American Economic Association, vol. 14(4), pages 23-48, Fall.
    8. Arrow, Kenneth J, 1985. "Informational Structure of the Firm," American Economic Review, American Economic Association, vol. 75(2), pages 303-307, May.
    9. Kenneth J. Arrow, 1975. "Vertical Integration and Communication," Bell Journal of Economics, The RAND Corporation, vol. 6(1), pages 173-183, Spring.
    10. K. J. Arrow, 1964. "The Role of Securities in the Optimal Allocation of Risk-bearing," Review of Economic Studies, Oxford University Press, vol. 31(2), pages 91-96.
    11. Joseph E. Stiglitz, 2002. "Information and the Change in the Paradigm in Economics," American Economic Review, American Economic Association, vol. 92(3), pages 460-501, June.
    12. Nicola Matteucci & Mary O'Mahony & Catherine Robinson & Thomas Zwick, 2005. "Productivity, Workplace Performance And Ict: Industry And Firm-Level Evidence For Europe And The Us," Scottish Journal of Political Economy, Scottish Economic Society, vol. 52(3), pages 359-386, July.
    13. Barrios, Salvador & Burgelman, Jean-Claude, 2007. "Information and Communication Technologies, Market Rigidities and Growth: Implications for EU Policies," MPRA Paper 5838, University Library of Munich, Germany.
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    More about this item

    Keywords

    demand uncertainty; information processing; firm; information rent;

    JEL classification:

    • D2 - Microeconomics - - Production and Organizations
    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • L1 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance

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