Market structure and Industry Analysis

Question 1

What are Transaction costs?

Answer 1

The time and expenses, spent on negotiating, writing and enforcing the contract

Question 2

What is a relation-specific asset?

Answer 2

It supports a certain transaction and cannot be used for another transaction without losses or additional costs

Question 3

What forms of asset specificity exist?

Answer 3

• Site: assets may be located near each other to reduce transportation costs and increase efficiency
• Physical: Assets may be created with the assumption that they will be used with concrete inputs
• Dedicated: created for a particular buyer and useless for anyone else
• Human asset specificity: people who work for a firm learn skills which are only valuable within the firm

Question 4

What is a rent?

Answer 4

Rent is the profit you expect to get when you build the plant assuming that all goes as planned
Rent=Q(P*-C) - I

Question 5

What is a quasi-rent?

Answer 5

The difference between the profit you’ll get from selling to the intended buyer and the profit you’ll get from your next best option
Quasi rent = [Qx(P*-C) - I] - [Qx(Pm-C) - I]
- If Pm>C you sell to at leats recover VC

Question 6

What is a relationship-specific investment?

Answer 6

• If I>Pm, you cannot recover your investment
• I-Q(Pm-C) is RSI (the amount of investment that you cannot recover if your company doesn’t do business with the initial buyer)

Question 7

Hold-up problem

Answer 7

• If the asset was not relationship-specific, quasi rent will be 0 and P*=Pm
• In the presence of a relationship-specific asset, quasi-rent>0
• Hold-up problem: the firm can renegotiate the terms of the deal and holds up its trading partner

Question 8

What are the consequences of hold-up?

Answer 8

• more frequent bargaining
• investments designed to improve bargaining
• reduced investments

Question 9

What is technical efficiency?

Answer 9

It is the cost efficiency in the physical production of the good
- firm is minimising the costs of attaining the input
- usually market is superior

Question 10

What is agency efficiency?

Answer 10

The extent to which the change of goods can be organised to minimise transaction costs
- integration is superior

Question 11

Technical efficiency: graph

Answer 11

• As assets become more specific, the competitive advantage of the market firm is weaker and the scale and scope advantages decline.
• ΔT is always positive because market firms can take advantage of economies of scale and thus offer lower costs than firms who make it in-house

Question 12

Agency efficiency: graph

Answer 12

ΔA measure the differences in exchange costs when the item is MADE or BOUGHT
- Positive at low levels of asset specificity because holdup is not a problem and the market is more competitive
- Negative at high levels of asset specificity because it requires more detailed contracts, narrows market and increases likelihood of holdup

Question 13

ΔC

Answer 13

• production and exchange costs under vertical integration - production and exchange costs under outsourcing
• if C is positive - BUY
• if C is negative - Make

Question 14

Implications

Answer 14

• large market -> BUY
• larger share of market -> more benefits from vertical integration
• multiple product lines -> more benefits from VI in the production of shared components
• asset specific investments -> VERTICAL INTEGRATION

Question 15

Efficiency tradeoff and SCALE

Answer 15

• Vertically integrated firm enjoys better economies of scale
• the differential of technological efficiency decreases with every level of asset specificity
• the differential of agency efficiency becomes more sensitive to asset specificity
• ## the combined differential sharply declines for low asset specificity