Organizations, Contracts, and Transactions
Week 1 · August 31, 2026
Open the verified, annotatable HTML slides or download the revised PowerPoint deck.
On the HTML deck, tap Annotate in the lower-right corner to draw with a mouse, touch, or Apple Pencil. The browser saves annotations on that device.
Opening Hook
Imagine the first morning in a new job. You have signed a contract. It names your role, your pay, your start date, and perhaps a few duties. But it does not say exactly how carefully you should answer an email, when to interrupt a colleague, how much initiative counts as helpful rather than intrusive, or what to do when a customer, manager, and teammate all want different things at the same time.
Most of the work begins where the written contract stops. The organization fills the gap with routines, authority, norms, monitoring, trust, and repeated interaction. A manager can ask you to shift tasks. A teammate can expect help. A firm can create a way of doing things that is difficult to spell out in a legal document.
That gap is not a small detail. It is one of the reasons firms exist. If every task could be described, priced, verified, and enforced perfectly, much more of economic life could be handled by simple market exchange. Workplaces are built for a world where that is not true.
Here is the question this session is about: why is so much work organized inside firms and relationships rather than through complete, one-off contracts?
Open by asking students to name one useful thing an employee does that is unlikely to be written precisely into a contract. Put the examples into two columns: things that are easy to verify and things that rely on judgment.
A Simple Exhibit
This course begins with a distinction between what can be written down and what must be governed some other way.
| Workplace issue | Easy to write in a contract? | Why it matters |
|---|---|---|
| Hourly wage or salary | Often | Pay is observable and legally enforceable. |
| Start date and job title | Often | These are relatively clear terms. |
| Effort, care, initiative, and cooperation | Rarely completely | These are partly observed, context-dependent, and hard to verify in court. |
| Trust, voice, loyalty, and fairness | Rarely directly | These shape behavior but usually work through norms and relationships. |
The last two rows are where the economics of the workplace becomes interesting. The problem is not that contracts are useless. It is that contracts are incomplete.
Use the table to slow students down before introducing terminology. The key move is to distinguish “hard to observe” from “hard to verify to a third party.”
Organizations Solve Transaction Problems
A transaction is an exchange between people or organizations. Some transactions are simple: buying coffee, paying for a bus ride, or ordering a book. Others are complicated because they involve uncertainty, repeated decisions, private information, or investments that only make sense within a relationship.
Organizations help coordinate these complicated transactions. A firm can assign authority, create routines, monitor performance, build shared knowledge, and settle disputes without renegotiating every action from scratch. That does not mean organizations are always efficient or fair. It means they are one way of governing economic activity when markets alone are too thin a description.
A firm is not just a production technology; it is a governance structure for transactions that are difficult to handle through spot markets alone.
Think of a workplace you know well. Which parts of the job could be bought and sold as separate market transactions, and which parts seem to require an organization?
Common confusion: students may hear “markets versus firms” as “markets versus capitalism.” Keep the contrast narrower: different ways of coordinating transactions within the same economy.
Contracts Are Incomplete
A complete contract would specify what each party must do in every relevant state of the world, and it would be enforceable by an outside party at low cost. Employment contracts are almost never complete in this sense. The employer cannot list every future task. The worker cannot list every future obstacle. Neither side can perfectly verify every moment of effort, care, or cooperation.
Incomplete contracts create space for power. If the contract does not specify everything, someone has discretion. Managers may direct work. Workers may choose how much effort, attention, and voice to supply. The allocation of that discretion helps determine pay, motivation, dignity, conflict, and the distribution of surplus inside the firm.
Incomplete contracts make authority, norms, trust, and bargaining power central to the employment relationship.
Why is an employment contract usually incomplete?
- Because employment contracts are not legally binding.
- Because many important actions and future contingencies cannot be fully specified, observed, and verified.
- Because workers and employers prefer not to write anything down.
- Because wages are the only part of work that matters economically.
If a manager asks an employee to do something “not in the job description,” when is that a reasonable use of authority, and when is it an abuse of power?
This is the bridge to the course title. “People” enters because preferences, beliefs, and norms matter. “Power” enters because discretion has to sit somewhere. “Pay” enters because contracts and bargaining shape who gets what.
The Employment Relationship
The employment relationship is unusual because one party sells time and effort under conditions that cannot be fully pinned down in advance. The employer buys more than a completed object. The worker accepts more than a single task. Both sides enter a relationship in which cooperation, conflict, information, and authority will matter.
This is why the course keeps returning to rents. A rent is a benefit above the next-best alternative. If a worker has a good job relative to their fallback option, they may have an employment rent. If a firm can replace workers easily or restrict mobility, it may have power over pay and conditions. If both sides gain from staying together, the question becomes how that surplus is governed and divided.
The workplace is an economic relationship in which incomplete contracts and unequal fallback options shape both behavior and distribution.
Which example best illustrates why authority matters inside a firm?
- A customer pays the posted price for a sandwich.
- A supervisor reallocates workers across tasks after a machine breaks.
- A contract states the hourly wage.
- A firm compares two vendors before placing an order.
Should we think of employment as a voluntary exchange, a power relationship, or both? What would we miss if we used only one of those descriptions?
Review Cards
Work through these cards now, then Orbit will schedule them for review.
Connections
Builds on: Introductory microeconomics concepts such as marginal benefit, marginal cost, efficiency, and incentives.
Sets up: The next sessions on information, contracts, norms, and power, where we ask what happens when effort, quality, and intentions are hard to observe or verify.
Arc note: This session supplies the organizing language for the course. If students leave with only one idea, make it this: work is governed by contracts, but the most interesting economic action often happens in the gaps those contracts leave open.
Reading Guide
Required
Milgrom, Paul, and John Roberts. Economics, Organization and Management, Chapters 1-2. Canvas/library.
What to look for: Track how the authors move from simple exchange to the problem of organizing complicated economic activity.
Key argument: Organizations matter because economic coordination often requires more than prices and one-off contracts.
Prepare to discuss: One example of a transaction that seems simple in theory but difficult to govern in practice.
Optional
Shih. Reading on Toyota business practices and culture. Canvas/library.
Read for an example of how routines, norms, and organizational culture can shape what workers do beyond the written job description.
BBC. “Bubble Trouble in Japan.”
Watch for the institutional and organizational context around Japan’s late twentieth-century business environment.