Which of the following is a major disadvantage of organizing economic activity within firms?

• A. Increased exposure to market price fluctuations
• B. Reduced incentives for individual workers to innovate
• C. Lower ability to benefit from economies of scale
• D. Greater difficulty in coordinating production processes

Answer: (B)

Verified step by step guidance

1. Understand the context: Firms organize economic activity internally to reduce transaction costs and improve coordination compared to market exchanges.
2. Identify the typical advantages of firms, such as better coordination of production processes and the ability to benefit from economies of scale.
3. Recognize that exposure to market price fluctuations is generally reduced within firms because internal transactions are less sensitive to external market prices.
4. Focus on the concept of incentives within firms: since workers are often paid fixed wages rather than directly linked to output or innovation, their motivation to innovate may be lower.
5. Conclude that a major disadvantage of organizing economic activity within firms is the reduced incentives for individual workers to innovate, due to weaker direct rewards for innovation compared to market-based arrangements.