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MARKET FAILURE AND UNCERTAINTYIn this essay I would like to argue that market failure is the reason for hierarchy I willargue that market failure leads to uncertainty and that uncertainty leads to incompletecontracts To explore the notion of incomplete contracts I have used the ideas of Milgromand Roberts They describe how incomplete contracts can lead to a relational contract oran implicit contract I will argue that relational contracts can lead to the formation ofan organisation Once an organisation is established it differs from other equallyorganisations by its social capital This social capital I will argue leads again touncertainty and again to incomplete contracts To prove this I will use repeated game theoryand the folk theorem I believe that the uncertainty within an organisation leads toimplicit contracts that capture the reputation of cooperation of the members of theorganisation In conclusion I will argue that this reputation of cooperation is corporateculture In the first part of Managerial Dilemma Miller argues that hierarchy at least in theoryexists by the grace of market failure Market failure is described by Miller 1992 as market equilibria that fail to allocate resources efficiently p17 Miller statesthat market failure is caused by market power information asymmetries and teamexternalities However if I take a closer look at these reasons for market failure I willargue that they can be the reason to form an organisation but not nesecarily have to be Market power by a small number of parties increases the amount of uncertainty about howthese parties are planning to use this power in ongoing or future transactions when faced byunforeseen contingencies Information asymmetry -when one party is deprived of vitalinformation available to the other side- also raises the amount of uncertainty about how theother party is likely to react to unforeseen contingencies The third reason for marketfailure externalities can also be seen as driver for uncertainty since transactions in themarketplace can have an impact on third parties So far I have argued that market
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