Shared Flashcard Set

Details

Lecture 3
Vertical Boundaries of the Firm
19
Economics
Undergraduate 3
10/03/2016

Additional Economics Flashcards

 


 

Cards

Term
What is the difference between the Vertical Chain and Value Chain?
Definition

Vertical Chain

- Process that begins with purchasing raw material and ends with distribution of finished goods

 

Value Chain

- Identifying steps in vertical chain where more value is added 

Term
What are the 5 activities of Michael Porter's Value chain?
Definition

Purchasing/Inventory Handling

l

Production

l

Distribution

l

Sales/Marketing

l

Customer Service

 

Human resources, R&D and corporate infrastructure all support these activities

 

Term
What 3 things does Value Added depend on?
Definition

Consumer Value

 

Cost/Efficiency

 

Ability of firm to extract some of the difference between the two

Term
Define Vertical Boundaries of a Firm
Definition
Activities that the firm performs itself as opposed to purchasing from independent firms in the market
Term
What is the difference of upstream and downstream vertical chain of production?
Definition

Upstream = early steps in production (ex. inputs)

 

Downstream = finished goods (ex. sales)

Term
What does the Make vs. Buy decision set?
Definition

Establishes the vertical boundaries of the firm

 

Make = perform activity yourself

 

Buy = purchase from independent firm; arms length transactions (only choose between 1 company or another)

Term
What are reasons to Buy (Use the Market)?
Definition

Exploiting Scale and Learning Economies

 

Agency & Influence Effects 

 

 

Term
How does exploiting scale and learning economies give reason to buy?
Definition

Market specialist can sell to many buyers and take advantage of economies of scale and scope

 

Think of linamar production of car parts for ford. Can produce more units at lower cost

Term
How does Agency and Influence Effects give reason for buying?
Definition

Market firms enjoy benefits related to incentives over their integrated rivals

 

Independent firms must survive discipline of market competition; this encourages efficiency & innovation

 

Corporate success can hide inefficiencies and lack of innovatieness 

 

Independent firms may have more incentive to innovate within a division within a firm because departments can never be sure if they are making/losing money

Term

Define the following:

 

Agency Costs

Transfer Price

Influence Costs

Definition

Agency Costs

- Costs associated with slack effort and administrative costs to deter slack effort

- EX. Employees searching web during work

 

Transfer Price

- Internal price between divisions of company

- EX. IT support in large firm 

- Difficult to determine this

 

Influence Costs

- Costs associated with lobbying for resources which may lead to biased information and destructive competition within a firm 

- EX. John Deere sprayers - engineers want high tech sprayers, where marketing wants cheap sprayer

Term
What are the reasons to Make (Vertically Integrate)?
Definition

Co-ordination of Production Flows

 

Leakage of Private Information

 

Transaction Costs

 

Term
How does the Co-ordination of Production Flow give reason to Make?
Definition

Production flow in the vertical chain can be compromised when purchasing from independent market

 

Fit can be in terms of time, size, colour, sequence or R&D fit

 

fit can be attained through either doing tasks in house or through contract with independent firm

Term
How does Leakage of Private Information give reason to Make?
Definition

Firms don't want to risk losing private information (dealing with independent market may require divulging info.)

 

Private information gives firms advantage in market

 

Firm can constrain use of certain information through contracting with non-compete clause or patents 

Term
How do Transaction Costs give reason to Make?
Definition

Costs of transacting with other firms can be avoided by performing activity yourself 

 

Transaction costs = cost of organizing and transacting exchanges between arms-length partners in market



Monetary price -> administrative costs -> information search -> quotes for business -> enforce contract

Term

Define the following:

 

Arms-length transactions

Contract

Definition

Arms-length Transactions

- Autonomous or independent parties acting in their own self-interest exchange goods and services with another

 

Contract

- An agreement that defines the conditions of exchange

- If this agreement is broken, there are formal (ex. court) or informal (ex. reputation in town) institutions that will settle the problem 

Term
What are reasons for contracts?
Definition

Prevent trading partners from taking advantage of one another

 

Without them, exchange activities would be biased towards those in which performance occurs simultaneously with payment (pay cash immediately)

 

Cost of transacting business would increase significantly

Term
What is the difference between Complete and Incomplete Contracts?
Definition

Complete Contract

- Stipulates each party's responsbilities and rights for every contingency that could possibly occur

- Must be enforcable

- Must stipulate what acceptable performance is and measure it

 

Incomplete Contract

- Most contracts are incomplete

- Have amiguity or open-endedness about what each party involved is required to do

Term

What factors prevent complete contracting?

 

"BAD"

Definition

1. Bounded rationality

- We cannot come up with all the potential "what ifs"

 

2. Difficulty in Specifying & Measuring Performance

- Hard to quantify different things (ex. wear and tear on rental vehicle - what constitutes this?)

 

3. Asymmetric Information

- Occurs when one party knows more tan the other about the conditions of exchance and takes advantage of them 

- See agriculture industry moving towards more reliance on contracts and product vs. process standards 

 

 

Term
What is a Relationship-Specific Asset?
Definition

An investment made to support a specific transaction

 

Cannot be redeployed to another transaction without some loss of productivity or by incurring an additional cost

 

Can take the form of site specific, physical asset specificity, dedicated assets or human asset specificity

Supporting users have an ad free experience!