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Unformatted text preview: Chapter 6: Answers to Questions and Problems 1. When an input has well-defined and measurable quality characteristics and requires specialized investments, the optimal procurement method is a contract. A contract reduces the likelihood of opportunistic behavior and underinvestment by creating a legal obligation between the firms. One disadvantage of a contract is that it increases a firms transaction costs. An example, Boeing contracting with an aluminum manufacturer. 2. When a firm requires a limited number of standardized inputs that are sold by many firms in the marketplace, the optimal method of procurement is spot exchange. One advantage of spot exchange is that they permit firms to specialize. A disadvantage is that the firm may potentially face the hold-up problem. An example, a painter purchasing paint from a local paint store. 3. a. Contract. b. Vertical Integration. c. Spot exchange (or possibly contract if a specific investment in many motors is required). d. Spot exchange. 4. Engine manufacturing involves specific investments and a complex contracting environment. By vertically integrating, the potential for opportunism is reduced. Mirrors are relatively uniform products that can be purchased by spot exchange or contract. 5. a. Human capital. b. Physical asset specificity; note that the assembly line was designed especially for a particular firms product. c. Site specificity. 6. The manager prefers the compensation scheme that pays a fixed salary plus a percentage of the profits. Essentially, the manager is faced with a choice between two consumption bundles: (1) a $125,000 fixed salary plus 10 hours of on-the-job leisure and (2) $125,000 in salary plus bonus plus 3 hours of on-the-job leisure. Since the original compensation package of a $125,000 and 10 hours of shirking is still available, the fact that she chose to work 7 hours reveals that she prefers the second pay scheme....
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