Chapter 3

Question 1

What is the make-or-buy decision

Answer 1

A firm’s decision to perform an activity itself or to purchase it from independent firm

Question 2

What does make mean

Answer 2

Make means that the firm performs the activity itself

Question 3

What does buy mean

Answer 3

Buy means it relies on an independent firm to perform the activity, perhaps under contract

Question 4

What are make or buy the extremes of

Answer 4

Vertical integration

Question 5

Explain the Make-or-buy continuum

Answer 5

Arm’s length market transactions - Less integrated
Long-term contracts
Strategic alliances and joint ventures
Parent/subsidiary relationships
Perform activity internally - More integrated

Question 6

Benefits of using the market

Answer 6

Markets firms can achieve economies of scale that in-house departments producing only for their own needs cannot
Market firms are subject to the discipline of the market and must be efficient and innovative to survive

Question 7

Costs of using the market

Answer 7

Coordination of production flows through the vertical chain may be compromised when an activity is purchased from an independent market
Private information may be leaked
There may be costs of transacting

Question 8

Reasons to buy

Answer 8

Market firms enjoy two distinct types of efficiencies:
1. They exploit economies of scale and the learning curve
2. They eliminate bureacracy

Question 9

What are agency costs

Answer 9

Agency costs are the costs associated with shirking and the administrative controls deter it.

Question 10

What is shirking

Answer 10

Managers and workers who knowingly do not act in the best interests of their firm are shirking.

Question 11

What are influence costs

Answer 11

losses caused by individuals in the firm attempting to influence company decisions for their own private benefit, and the costs the firm incurs trying to prevent this

Question 12

What is Organizational design

Answer 12

Organizational design defines the lines of reporting and authority in the firm

Question 13

What happens to the organizational design of firms when they integrate

Answer 13

They usually unify

Question 14

What do contracts define

Answer 14

The conditions of exchange

Question 15

Why are contracts are valuable?

Answer 15

because they list the set of tasks that each contracting party expects the other to perform

Question 16

What does the effectiveness of a contract depends on?

Answer 16

The completeness of the contract
The available body of contract law

Question 17

What does a complete contract do

Answer 17

it eliminates the opportunities for shirking

Question 18

What are all real-world contracts:

Answer 18

They are incomplete

Question 19

What are the three factors that prevent complete contracting

Answer 19

1. Bounded rationality
2. Difficulties specifying or measuring performance
3. Asymmetric information

Question 20

What is bounded rationality

Answer 20

Bounded rationality refers to limits on the capacity of individuals to process information, deal with complexity, and pursue rational aims.

Question 21

What is Difficulties specifying or measuring performance

Answer 21

When the performance under a contract is complex or subtle, not even the most accomplished wordsmiths may be able to spell out each party’s rights and responsibilities.

Question 22

What is Asymmetric Information

Answer 22

Even if the parties can foresee all contingencies and specify and measure relevant performance dimensions, a contract may still be still incomplete because the parties do not have equal access to all contract-relevant information. If one party knows something that the other does not, then information is asymmetric.

Question 23

How do you coordinate production flows through the vertical chain

Answer 23

Timing fit
Sequence fit
Technical specification fit
Color fit

Question 24

What are design attributes

Answer 24

Attributes that need to relate to eachother in a precise fashion; otherwise they lose a significant portion of their economic value

Question 25

Three reasons to make

Answer 25

Coordination of production flows
leakage of private information
Transaction costs

Question 26

Are patents foolproof

Answer 26

no, because of bounded rationality

Question 27

What are three concepts from transaction costs economics:

Answer 27

Relationship specific assets
quasi-rents
Hold-up problem

Question 28

Forms of asset specificity

there are 4

Answer 28

Site specificity
Physical asset specificity
Dedicated assets
Human asset specificity

Question 29

What is site specificity

Answer 29

Site specificity refers to assets that are located side by side to economize on transportation or inventory costs.

Question 30

What is physical asset specificity

Answer 30

Physical asset specificity refers to assets whose physical or engineering properties are specifically tailored to a particular transaction. For example glass molds for custom tailored containers shapes

Question 31

What is dedicated assets

Answer 31

A dedicated asset is an investment in plant and equipment made to satisfy a particular buyer.

Question 32

What is human asset specificity

Answer 32

Human asset specificity refers to cases in which a worker, or group of workers, has acquired skill, know-how, and information that are more valuable inside a particular relationship than outside it.

Question 33

What is the fundamental transformation

Answer 33

Once the parties invest in relationship-specific assets, the relationship changes from a “large numbers” bargaining situation to a “small numbers” bargaining situation. This because before they invest in the assets they have alternative trading partners.

Question 34

What is rent

Answer 34

Your rent is simply the profit you expect to get when you build the plant, assuming all goes as planned.

Question 35

What is quasi-rent

Answer 35

Your quasi-rent is the extra profit that you get if the deal goes ahead as planned, versus the profit you would get if you had to turn to your next-best alternative.

Question 36

What is the holdup problem

Answer 36

A firm holds up its trading partner by attempting to renegotiate the terms of a deal.

Question 37

How does the hold up problem raise the cost of transacting arm’s length.

Answer 37

1. more difficult contract negotiations and more frequent renegotiations
2. investments to improve ex post bargaining positions
3. distrust
4. reduced ex ante investment in relationship-specific investments