Lecture 28 april 13 exam 3

Lecture 28 april 13 exam 3 - Announcements HW due tonight...

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Announcements HW due tonight (chs. 11-13) Ch 14 due Thurs (some will skip – e-mails out tomorrow). Ch 16 due next Monday (some will skip) 1 of 35
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Chapter 14: Transaction Costs, Imperfect Information and Market Behavior 2 of 35
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Firm’s Rationale; Scope of Operation Why do firms exist? Firms minimize transaction costs by making things on a large scale Firms minimize production costs - not easy though Basically having a firm make stuff for you is more efficient than you trying to do it yourself. 3
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Firm’s Scope of Operation Firm’s boundaries – insourcing (making your inputs yourself) vs. outsourcing (buying inputs from elsewhere) Vertical integration – “insourcing” Expansion into earlier/later stages of production A vertically integrated firm controls several stages of the production process. This lowers transaction costs and gives the firm more power, BUT, 1.It is hard for a manager to keep track of all the stages ( bounded rationality ) 2.A vertically integrated firm might not achieve minimum efficient scale (cheaper for someone else to make the input) 4
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Minimum efficient scale and vertical integration 5 1,000,000 Computers per year 0 5,000,000 1,000,000 Chips per year 0 Cost per unit (a) Computer manufacturer (b) Chip manufacturer The computer manufacturer is producing at the minimum efficient scale of 1,000,000 computers per year. That output requires 1,000,000 computer chips. If the computer manufacturer produced its own chips, the cost would be much higher than if it buys them from a chip maker, operating on a much larger scale. Economies of scale in chip production are fat from exhausted when 1,000,000 chips a year are produced. LRAC LRAC
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Firm’s Scope of Operation For these reasons, it might make sense for a firm to “outsource” the production of its inputs (and intermediate products). Outsourcing is more attractive if there is a “well-functioning” market for the needed input. This means: A. The quality of the input product is easily verifiable. B. There are many producers of the input product (so your supplier does not have power over you and you know the product is available – lots of competition) 6
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Advantages of Outsourcing: Economies of scale and specialization lead to lower costs and lower prices. So it is cheaper to buy than to make. A firm that specializes in making the input has comparative advantage in the production of that: each firm does what it is best at. Disadvantages of Outsourcing: Loss of control over inputs Could erode customer confidence in the product if they don’t know where the inputs came from. 7
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Lecture 28 april 13 exam 3 - Announcements HW due tonight...

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