Session 9

Question 1

Firms will choose to acquire and trade resources in a way that …

Answer 1

reduces both their production and transaction costs.

Please note that transaction costs hide between the lines of the balance sheet​

Question 2

Transaction Costs

Answer 2

• Search and Information Costs
• Bargaining Costs
• Policing and Enforcement

Question 3

Transaction costs depend on:

Answer 3

• Frequency
• Specificity
• Uncertainty
• Bounded Rationality
• Opportunism

Question 4

Risk augmented transaction costs trade-off

Answer 4

choice between
- transacting with a limited number of partners
or
- participating in the open market

Question 5

Transaction Costs & Outsourcing in TCE

● Markets VS Hierarchies​ (in house production).

Answer 5

● Markets​: higher quality from specialized suppliers at a lower production price.
● Markets have high transaction costs!

● If transaction costs are too high, the firms trade off economies of the market for transaction cost savings and decide to move to hierarchies (produce in-house).*

Question 6

Coordination costs

Answer 6

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

Question 7

Which effects decrease coordination costs.

Answer 7

• Electronic Communication Effect
• Electronic Brokerage Effect
• Electronic Integration Effect

Question 8

Asset Specificity

Answer 8

the degree to which an input used by a firm could be easily used by another firm.

Question 9

Complexity of Product Description

Answer 9

amount of information needed to specify the attributes of an input so that the firm can make a decision to buy it.

Question 10

IT makes…

Answer 10

• Product Descriptions less complex
• Assets less Specific

This pushes firms towards markets!

Question 11

The Electronic Market Hypothesis: Market Evolution

Answer 11

1. Biased market
2. Unbiased market
3. Personalized market

Question 12

Transaction cost =

Answer 12

coordination cost + operational risk + opportunism risk

Question 13

IT reduces…

Answer 13

1. Coordination Cost.
2. Operational Risk.
3. Opportunism Risk.

All of these together reduce the Need for Ownership, hence push firms towards higher degrees of outsourcing.

Question 14

Despite IT will lead to a greater degree of outsourcing, firms will rely on…

Answer 14

fewer suppliers in close and long-term relationships.

Question 15

Despite IT will lead to a greater degree of outsourcing, firms will rely on fewer suppliers in close and long-term relationships. This is due to:

Answer 15

● Transactional economies of scale
● Incentives to suppliers
● Increased costs and reduced benefits of search

Question 16

Operational risk

Answer 16

describes the situation in which other parties in the transaction willfully misrepresent or withhold information or underperform responsibilities. Imagine a supplier delivering late or providing products of lower quality.

Question 17

Opportunism risk

Answer 17

Arises from lack of bargaining power.

For example, due to relationship-specific investments. Imagine a firm that only has one client. If the client decides to re-negotiate the contract and cut costs such form is exposed to potential loss.

Question 18

Asymmetric Information

Answer 18

● The more informed party willfully exploits their private information to gain (economic) advantage
● The less informed party is damaged by the information exploitation.

Question 19

Two types of Information Asymmetry problems:

Answer 19

1. Adverse Selection

2. Moral Hazard

Question 20

Adverse Selection

Answer 20

• The seller knows the quality of the product, while the
buyer only observes the quality after the purchase.

• The seller will price a low quality product (lemon) at the buyer’s WTP for a high quality one (peach).

Question 21

Moral Hazard

Answer 21

• The information asymmetry problem happens after the transaction has happened.
• In this case the less informed party (i.e. the car insurance) bares all the risk of the more informed party (i.e. driver).

Question 22

Signaling

Answer 22

an action by an informed party to reveal information.

e.g. master diploma

Question 23

Screening

Answer 23

an attempt by an underinformed party to filter information.

e.g. motivation letter

Question 24

A contract/mechanism is Incentive Compatible when it…

Answer 24

reflects the best interest of all the counterparts/participants.

Question 25

The Principal-Agent model is

Answer 25

the stylization of the decision making process under asymmetric information.

Question 26

Signalling and screening are not always sufficient. A way to combat information exploitation is:

Answer 26

• Understanding the agents’ incentives
  and
• Designing appropriate contracts and mechanisms that prevent them from exploiting their information advantage

Question 27

Contracts against adverse selection

Answer 27

● In the used cars example, the contract should bind dealers to “reveal” the true quality of the car.
● How is this done in reality? For example by implementing compulsory warranties on the performance of the car.

Question 28

Contracts against moral hazard

Answer 28

● The contract should bind risky agents to disclose how “risky” they intend to behave.
● How is this done in reality? For example by charging high extra fees in case of smoking-related issues in non-smoker health insurance plans.

Question 29

There are two simple ways to reduce information exploitation problems

Answer 29

1. Signalling

2. Screening