Chapter 6: Answers to Questions and Problems
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 firm’s transaction costs. An example, Boeing contracting with an aluminum
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.
Spot exchange (or possibly contract if a specific investment in many motors is
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
Physical asset specificity; note that the assembly line was designed especially for
a particular firm’s product.
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
Managerial Economics and Business Strategy, 7e
Spot checks and hidden video cameras are effective and relatively inexpensive to
implement initially. The disadvantage is that spot checks and hidden video cameras
may affect the morale of the workers. Moreover, implementing hidden cameras
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