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Managerial Economics Chap 6 Solutions Essay

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Managerial Economics & Business Strategy Chapter 6
The Organization of the Firm

Michael R. Baye, Managerial Economics and Business Strategy, 5e. ©The McGraw-Hill Companies, Inc., 2006

Overview
I. Methods of Procuring Inputs
Spot Exchange Contracts Vertical Integration

II. Transaction Costs
Specialized Investments

III. Optimal Procurement Input IV. Principal-Agent Problem
Owners-Managers Managers-Workers
Michael R. Baye, Managerial Economics and Business Strategy, 5e. ©The McGraw-Hill Companies, Inc., 2006

Manager’s Role
• Procure inputs in the least cost manner, like point B. • Provide incentives for workers to put forth effort. • Failure to accomplish this results in a point like A. • Achieving points like B managers must
Use all inputs efficiently. Acquire inputs by the least costly method. Costs $100 80
A B

C(Q)

0

10

Q

Michael R. Baye, Managerial Economics and Business Strategy, 5e. ©The McGraw-Hill Companies, Inc., 2006

Methods of Procuring Inputs
• Spot Exchange
When the buyer and seller of an input meet, exchange, and then go their separate ways.

• Contracts
A legal document that creates an extended relationship between a buyer and a seller.

• Vertical Integration
When a firm shuns other suppliers and chooses to produce an input internally.
Michael R. Baye, Managerial Economics and Business Strategy, 5e. ©The McGraw-Hill Companies, Inc., 2006

Key Features
• Spot Exchange
Specialization, avoids contracting costs, avoids costs of vertical integration. Possible “hold-up problem.”

• Contracting
Specialization, reduces opportunism, avoids skimping on specialized investments. Costly in complex environments.

• Vertical Integration
Reduces opportunism, avoids contracting costs. Lost specialization and may increase organizational costs.
Michael R. Baye, Managerial Economics and Business Strategy, 5e. ©The McGraw-Hill Companies, Inc., 2006

Transaction Costs
• Costs of acquiring an input over and above the amount paid to the input supplier. •...

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