Managerial Economics

In Class Exercise Eleven - Contracting and Specific Assets

1.  What are three general ways that a firm can obtain inputs?

2.  Define "asset specificity."

3.  Provide an example of each of the following:

a. site specificity:

b.  physical asset specificity:

c.  human capital specificity:

d.  capacity specificity:

4.  Why are transactions costs different when there are specific assets or investments?

5.  You might have answered "opportunism" to question 4 above -- so how does asset specificity lead to potential "opportunism" (what is opportunism)?  Give an example.

6.  Suppose you decide to make a contract for inputs -- theoretically at least, what is the "optimal" length of your contract -- what does it depend upon?  Answer both in words and graphically.

7.  Generally, when will integration be the best move for obtaining an input?  Example?

8.  Suppose you manufacture inboard motor-boats, and you agree to purchase 100,000 motors from Johnson Motor Company for $1,000 per motor, in two years time.  Feeling that you are protected from opportunism, you customize your boat design to accommodate the Johnson motors.  In the mean time, Johnson finds itself on the verge of bankruptcy, and says that it will go broke if the company doesn’t receive $1,500 per motor.

            a) Is there a "hold-up" in this situation - why?  Explain.

            b) What should you do?

            c) Could this situation have been avoided?

            d) Why do you think Johnson Motor Company went outside of its self-enforcing range in this situation?