Week 9

Question 1

Benefits of outsourcing

Answer 1

• Economies of scale
• Competition encourages efficiency
• Less bureaucracy and distortion of incentives

Question 2

Cost Structure definition

Answer 2

Cost structure refers to the types and relative proportions of fixed and variable costs that a business incurs. The concept can be defined in smaller units, such as by product, service, product line, customer, division, or geographic region. Cost structure is used as a tool to determine prices, if you are using a cost-based pricing strategy, as well as to highlight areas in which costs might potentially be reduced or at least subjected to better control.

Question 3

Benefits of integration

Answer 3

• Coordination: delivery and pricing
• Avoid risk of leakage of information
• Avoid contracting costs.

Question 4

Coordination definiton

Question 5

Hold up problem

Answer 5

a situation where two parties may be able to work most efficiently by cooperating but refrain from doing so because of concerns that they may give the other party increased bargaining power, and thereby reduce their own profits. When party A has made a prior commitment to a relationship with party B, the latter can ‘hold up’ the former for the value of that commitment. The hold-up problem leads to severe economic cost and might also lead to underinvestment.

Question 6

Hold up: consequences

Answer 6

• Firms will anticipate hold up problem and the initial contracting is likely to be time consuming and costly
• Possibility of hold up will tend to decrease the investments in relationship specific assets
• Firm might substitute general purpose asset for more specific one: alumina producer might build a refinery that can process different grades of buxite rather than an unique grade
• Creates incentives to integrate.

Question 7

Solutions to hold-up problem?

Answer 7

• Building reputation for not re-visiting the teams
• High concetration of suppliers&producers in the same area.
• Vertical integration
• Decrease technological specificity

Question 8

Vertical integration is more likely:

Answer 8

• The smaller the ability of suppliers to use scale eonomies (small setup costs)
• The more the assets are relationship specific
• The more the process and the demand are uncertain (makes contracting difficult)

Question 9

Double marginalization

Answer 9

Question 10

Solutions to double marginalization

Answer 10

• Integration: total profits would be highest for single integrated monopolits
• Two part tariff: Upstream charges
  
  • Per unit price equal to marginal cost
  • Franchise free equal to profits of integrated firm
• Force downstream price with “resale price maintenance” (RPM)

Question 11

Resale price maintenance definition

Answer 11

the practice whereby a manufacturer and its distributors agree that the distributors will sell the manufacturer’s product at certain prices (resale price maintenance), at or above a price floor (minimum resale price maintenance) or at or below a price ceiling (maximum resale price maintenance).