S1 - procurement and incentives

Question 1

what are the ways to acquire inputs

Answer 1

spot exchange
contracts
vertical integration

Question 2

what is spot exchange

Answer 2

Informal relationship between a buyer and seller in which neither party is obligated to the other beyond the current exchange
Often used when inputs are standardised
Anonymous
Firms and input manufacturer can specialise in what it does best
Risk that it won’t be available when you need it

Question 3

what are contracts

Answer 3

Formal relationship between buyer and seller that obligates them to exchange at terms specified
Contracts can be incomplete
Purchasing firm can specialise in what it does best and has a greater ability to purchase nonstandard
Costly to write, time consuming and difficult to cover all contingencies that could occur in the future

Question 4

what is vertical integration

Answer 4

A firm produces the inputs required to make its final product
Doesn’t have to rely on other firms to provide desired inputs and goods can be as specialised as they like
Doesn’t get gains from specialisation and has to manage production of inputs and final products - bureaucratic costs

Question 5

what is the principal agent problem

Answer 5

obstacle of separation and control when owners deciding how to compensate managers to encourage maximum effort
Owners don’t know how much shirking the managers consume
Principals must align agents interests with theirs

Question 6

what are compensation mechanisms

Answer 6

fixed salary - independent of labour hours and effort - no strong incentive to monitor other employees - adversely impacts firms performance
Combine income and shirking as the manager derives utility from both - indifference curve - max utility is maximum shirking and all income
Incentive contract - bonus only or fixed + bonus - tie bonus to firms performance - can reach a higher indifference curve with less shirking - better for the firms profits

Question 7

what are external incentives

Answer 7

reputation - job mobility - choose to do a good job of running the firm if they wish to work elsewhere someday
Takeover or bankruptcy threat - firm may collapse or be bought out and replace management with new managers