Chapter 4

Question 1

What does the property right theory of the firm explain

Answer 1

It explains how integration affects performance in the vertical chain

Question 2

What is the main proposition regarding ownership of the Property right theory

Answer 2

Integration determines the ownership and control of assets, and it is through ownership and control that firms exploit contractual incompleteness

Question 3

Alternative forms of organising transactions

Answer 3

Nonintegration
Forward Integration
Backward Integration

Question 4

What is nonintegration form of transaction

Answer 4

The two firms are independent; each set of managers has control over its own assets

Question 5

What is forward integration form of transaction

Answer 5

Firm 1 owns the assets of Firm 2

Question 6

What is backward integration form of transaction

Answer 6

Firm 2 owns the assets of Firm 1

Question 7

What is a important observation into PRT

In the sense of legal

Answer 7

The resolution of the make-or-buy decision determines the legal right to control assets and disburse revenues obtained form use of the assets. The owner of an asset may grant another part the right to use it or receive revenues from it, but the owner retains all rights of control that are not explicitly stipulated in the contract.

Question 8

When is vertical integration desirable

Answer 8

When one firm’s investment in relationship-specific assets has a significantly greater impact on the value created in the vertical chain than does the other firm’s investment

Question 9

What is technical efficiency

Answer 9

Technical efficiency indicates whether the firm is using the least-cost production process.

Question 10

What is agency efficiency

Answer 10

Agency efficiency refers to the extent to which the exchange of goods and services in the vertical chain has been organised to minimize the coordination, agency, and transaction costs. If the exchange does not minimize these costs, then the firm has not achieved full agency efficiency.

Question 11

What does the trade off between agency efficiency and technical efficiency illustrate

Answer 11

The figure illustrates a situation in which the quantity of the good being exchanged is fixed at a particular level.

Question 12

What does the vertical axis of the trade off measure

Answer 12

The vertical axis measures cost differences between internal organisation and market transactions.

Question 13

What does a positive value on the vertical axis of the trade off mean

Answer 13

A postive value indicates that costs from the internal organization exceed costs from the market transactions

Question 14

What does a the horizontal axis of the trade off measure

Answer 14

The horizontal axis measures asset specificity. Higher values of k imply greater asset specificity.

Question 15

What does curve ▲T depict

Answer 15

The ▲T curve depict the differences in technical efficiency. It measures the differences in production costs when the item is produced in a vertically integrated firm and when it is exchanged through an arm’s length market transaction.

Question 16

What does curve ▲ A depict

Answer 16

The ▲ A curve reflects differences in agency efficiency. It measures differences in exchange costs when the item is produced internally and when it is purchased from an outside supplier in an arm’s-length transaction.

Question 17

What does curve ▲ C depict

Answer 17

The ▲ C curve depict the vertical summantion of the ▲ A and ▲T curves.

Question 18

What does scale and scope economics have to with the trade off?

Answer 18

We know that a firm gains less from vertical integration when outside market specialist are better able to take advantage of economies of scale and scope.

Question 19

What does product market share and scope have to with the trade off?

Answer 19

The more the firm produces, the more its demand for input grows. This increases the likelihood that in-house input production can take as much advantage of economies of scale and scope as an outside market specialist.

Question 20

What does asset specificity have to do with the trade off?

Answer 20

A firm gains more from vertical integration when production of inputs involves investments in relationship-specific assets.

Question 21

What are alternatives to vertical integration?

Answer 21

1. Tapered integration
2. Franchising
3. Strategic alliances and joint ventures
4. Close-knit semiformal relationships among buyers and suppliers

Question 22

Explain tapered integration

Answer 22

Tapered integration represents a mixture of vertical integration and market exchange.

Question 23

What are the benefits of tapered integration

Answer 23

First, it expands the firm’s input and/or output channels without requiring substantial capital outlays
Second, the firm can use information about the cost and profitability of its internal channels
Third, the firm can motivate its internal channels by threatening to expand outsourcing, and at the same time motivate its external channels by threatening to produce more in-house.
Finally, the firm can protect itself against holdup by independent input sellers.

Question 24

Explain franchising

Answer 24

If the business thrives, the owner may wish to expand to new markets. rather than borrow money and open new stores themselves, the franchiser gives partial ownership rights to franchisees.

Question 25

Explain strategic alliances

Answer 25

Firms have increasingly turned to strategic alliances as a way to organize complex business transactions collectively without sacrificing autonomy. Which can be horizontal (same industry) or vertical (related in the vertical chain) or neither.

Question 26

Explain joint ventures

Answer 26

A joint venture is particular type of strategic alliance in which two or more firms create, and jointly own, a new independent organisation.