What is Organizational Economics?

Organizational economics is a branch of applied economics that studies the transactions occurring within individual firms, as opposed to the transactions that occur within the greater market.

Organizational economics is broken down into three major subfields: agency theory, transaction cost economics, and property rights theory. Courses in organizational economics are usually taught at the graduate or doctoral level.

Key Takeaways

  • Organizational economics is used to study transactions within individual firms and determine management approach to managing resources.
  • It is broken down into three major subjects: agency theory, transaction cost economics, and property rights theory.
  • The three theories together provide a method for causal analysis of critical motivations and decisions in an organization.

Understanding Organizational Economics

Organizational economics is useful in developing a firm's human resource management policies, determining how a firm should be organized, assessing business risk, implementing rewards systems and making, analyzing and improving management decisions.

For example, organizational economics could be used to assess why the 2010 BP oil spill in the Gulf of Mexico was able to occur and how a similar disaster could be prevented in the future.

How Organizational Economics Can Be Used to Examine Causal Factors

Applying organizational economics can reveal both the weaknesses of a current management approach and ways to effect change. Looking at the subfields that comprise this method offers a way to understand the motivations and decisions that lead to operational decisions within an organization.

For instance, drawing in the agency theory subfield, an assessment can be made about the directives that were in place prior to the 2010 BP oil spill, what drove those choices leading up to the incident, and why the agents involved felt compelled to operate under those conditions. Furthermore, there can be an examination of why the principals at BP may or may not have been aware of the issues and motivations at play with the agents on the oil rig.

Under the transactions cost economics subfield, an assessment could be made about any transactional costs that might have been made regarding the safe operation of the Deepwater Horizon oil rig and how those choices may have affected the disaster. There appear to have been cost-cutting decisions made by BP that contributed to the eroding stability of the rig. Furthermore, the safety measures put in place on the oil rig by the company may not have sufficed to give the potential risks.

Applying the property rights theory subfield, where individuals or organizations make choices based on available resources, raises questions regarding the decisions made about the resources at hand on the oil rig. From one perspective, the company wanted to see a particular amount of operational output within the confines of the time and assets it had committed to the operation of Deepwater Horizon. Achieving those targets, however, may have come at the cost of investing in the maintenance and safety measures that might have prevented the disaster.