Session 7 Online Markets

Question 1

what are transaction costs: 3 types

Answer 1

1. search and information costs: finding the best goods from the best supplier at the lowest price
2. Bargaining costs: drawing the best contract at the best conditions with the best suppliers
3. policing and enforcement: make sure everything works out as contracted and penalize who doesn’t respect the agreements

Question 2

Transaction costs depend on

Answer 2

1. frequency: how often does the transaction happen
2. specificity: what transaction-specific investments are needed to achieve the least cost?
3. uncertainty: how unpredictable is the market: more uncertainty = more costs
4. bonded rationality: what access to information does the firm have
5. opportunism: what is the risk of opportunistic behavior?

Question 3

markets vs Hierarchies in transaction costs economics

Answer 3

markets: higher quality from specialized suppliers at a lower product price. High transaction costs (finding, contracting, enforcing)
Hierarchies: internal supply chain

Produce in-house when transaction costs are high
source through an open market when production costs are higher than transaction costs
mixed strategy can be useful to stay flexible when there is no big difference between production and transaction costs.

Question 4

Definition of electronic market hypothesis

Answer 4

“by reducing the costs of coordination, information technology will lead to an overall shift toward proportionately more use of markets rather than hierarchies to coordinate economic activity.”

Question 5

Coordination Costs

Answer 5

Include the transaction (or governance) costs of all the infor processing necessary to coordinate the work of people and machines that perform the primary processes.

Question 6

Three effects that decrease coordination costs

Answer 6

1. electronic communication effect: more information communicated faster
2. electronic brokerage effect: IT allows firms to access large amounts of information on their commercial counterparts
   - number and quality of alternatives
3. electronic integration effect: access unified data sources allow efficient exchange and use of information

Question 7

what is asset specificity

Answer 7

the degree to which an input used by a firm could be easily used by another firm; IT makes it less specific

Question 8

complexity of product description

Answer 8

amount of information needed to specify the attributes of an input so that the firm can make a decision to buy it; IT makes it less complex

Question 9

explain market evolution

Answer 9

biased markets -> unbiased market -> personalized market

Question 10

Explain operational and opportunism risk

Answer 10

operational risk: describe the situation in which other parties in the transaction willfully misrepresent or withhold information or underperform responsibility
opportunism risk: arises from lack of bargaining power

Question 11

what is information asymmetry

Answer 11

an economic agent has more information than their counterpart
the more informed part exploits their private information to gain economic advantage
the less informed party is damaged by the information exploitation

Question 12

two types of information asymmetry

Answer 12

1. adverse selection: the seller knows the quality of the product, while the buyer only observes the quality after the purchase
2. moral hazard: the information asymmetry problem happens after the transaction has happened. a situation in which one party engages in risk behavior because it knows the other party bears the economic consequences of their behavior

Question 13

How to reduce information risk?

Answer 13

1. signalling: an action by an informed party to reveal information
2. screening: an attempt by an under-informed party to filter information