Exam 19: Vertical Integration and Outsourcing

DrugCo has two demand equations for its retail products (pain reliever and cancer): Pain relief: P = 100 - 10 Q Cancer drug: P = 200 - 15 Q The marginal cost of production is $30.Which product should go to the retail market and which should go to the wholesale market? What are the corresponding retail and wholesale prices? What would happen if the sales are switched from the retail to the wholesale and vice versa?

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Question 1

Correct Answer:

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Starting with the pain relief drug,P = 100 - 10 Q
So,MR = 100 - 20 Q
Setting MC = MR,we get 30 = 100 - 20 Q or
20 Q = 70
Or Q = 3.5 units and so,P = 100 - 10 (3.5)= $65
Now going to the cancer drug,P = 200 - 15 Q
So,MR = 200 - 30 Q
Setting MC = MR,we get 30 = 200 - 30 Q
Or 30 Q = 170 or Q = 5.67 units and so P = 200 - 15(5.67)= $115
So in the retail markets the drugs will be priced at $65 and $115respectively.
The wholesale drug will cost $115 to the wholesalers and the company will retail the cheaper drug to the consumers.Switching this order will allow other manufacturers to buy the cheaper drug which can be resold in the wholesale market for a much higher price but less than $65,and drive DrugCo out of business.

When a firm establishes a long-term contract with another firm,whereby the first firm grants the second independent business the rights to use the former's name,reputation and business format,it is referred to as a:

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Question 2

Correct Answer:

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Agri-Tech makes machinery for chicken slaughterhouses.Agri-Tech has developed a de-boning technique specifically for Tasty Chicken.It is likely that Agri-Tech will desire:

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Question 3

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Why are firm-specific assets so important in the decision to build internally,negotiate a long-term contract,or buy on the open market?

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Question 4

Tasty Chicken has been buying its animal feed in the open market.It notices that about 10 percent of its purchases are watered down,so that the feed seems to weigh more than it actually does.To improve quality of its purchases,Tasty Chicken might consider:

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Question 5

Markets are usually preferred by economists for efficient transactions.However,Ronald Coase noted that administrative solutions may be superior because market transactions are:

(Multiple Choice)

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Question 6

Which of these motivate a firm to use nonmarket transactions to acquire inputs and downstream services?

(Multiple Choice)

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Question 7

Agri-Tech supplies is a patented sweetener to various food processors.It has noticed that the value of the sweetener varies dramatically from one buyer to another,depending on the end-use demand.But its experiments with charging higher prices to some buyers have failed.The demand for the juices is highly price elastic while the demand for sweetened medicine is relatively less elastic.Can Agri-Tech find a way to successfully price discriminate?

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Question 8

LightCo sells fairly standard light bulbs to Bodyworks,while BodyWorks sells components that can only be used by AutoCorp.LightCo is only interested in price while BodyWorks hires a law firm to negotiate its contracts with AutoCorp because:

(Multiple Choice)

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Question 9

AutoCorp is a dealership that has a contract that prevents the main company from opening another dealership within a 30-mile radius.This is an example of:

(Multiple Choice)

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Question 10

An iron and steel manufacturing plant was facing a power crisis on a daily basis.The unit had to stall production for about two hours on an average per day.In order to minimize the loss,the owner decided to invest in a cogeneration unit that would produce enough power to facilitate production during the peak load hours.This action of the manufacturer exemplifies:

(Multiple Choice)

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Question 11

When a firm decides to move away from ownership of a vertically integrated production process and begins to purchase supplies or other services from other businesses,it is said to be:

(Multiple Choice)

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Question 12

When asset specificity is very low and there is no market uncertainty,it is best for a firm to:

(Multiple Choice)

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Question 13

Nonmarket transactions refer to:

(Multiple Choice)

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Question 14

Tasty Chicken Inc.is a large producer of chicken for grocery stores.It usually engages in a long-term contract with these stores to maintain demand for its product.However,Tasty Chicken is regularly plagued with rising and falling prices for its supplies: particularly chicken feed and new chicks.Should Tasty Chicken vertically integrate upstream,building or buying a hatching company and an animal feed company? What are the pluses and minuses of such a decision?

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Question 15

A major advantage of long-term contracts over short-term contracts is that they increase the incentives of the contracting parties to:

(Multiple Choice)

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Question 16

Which of these is an important determinant of contract duration as suggested by the economic models on franchise contracts?

(Multiple Choice)

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Question 17

Tasty Chicken Inc.has worked hard to develop its brand name.Its motto "Absolutely Tasty" has become a common term used for good food.But the company finds that grocery stores do not feature their products in high visibility areas.Further,restaurants never tell their patrons they are eating food manufactured by Tasty Chicken.What needs to be done?

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Question 18

Granting exclusive territories to distributors:

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Question 19

Independent distributors of soda can free ride on the brand name of the company manufacturing soda.Two solutions to this problem are:

(Multiple Choice)

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Question 20

Showing 1 - 20 of 43

When a firm establishes a long-term contract with another firm,whereby the first firm grants the second independent business the rights to use the former's name,reputation and business format,it is referred to as a:

Agri-Tech makes machinery for chicken slaughterhouses.Agri-Tech has developed a de-boning technique specifically for Tasty Chicken.It is likely that Agri-Tech will desire:

Why are firm-specific assets so important in the decision to build internally,negotiate a long-term contract,or buy on the open market?

Tasty Chicken has been buying its animal feed in the open market.It notices that about 10 percent of its purchases are watered down,so that the feed seems to weigh more than it actually does.To improve quality of its purchases,Tasty Chicken might consider:

Markets are usually preferred by economists for efficient transactions.However,Ronald Coase noted that administrative solutions may be superior because market transactions are:

Which of these motivate a firm to use nonmarket transactions to acquire inputs and downstream services?

LightCo sells fairly standard light bulbs to Bodyworks,while BodyWorks sells components that can only be used by AutoCorp.LightCo is only interested in price while BodyWorks hires a law firm to negotiate its contracts with AutoCorp because:

AutoCorp is a dealership that has a contract that prevents the main company from opening another dealership within a 30-mile radius.This is an example of:

When a firm decides to move away from ownership of a vertically integrated production process and begins to purchase supplies or other services from other businesses,it is said to be:

When asset specificity is very low and there is no market uncertainty,it is best for a firm to:

Nonmarket transactions refer to:

A major advantage of long-term contracts over short-term contracts is that they increase the incentives of the contracting parties to:

Which of these is an important determinant of contract duration as suggested by the economic models on franchise contracts?

Granting exclusive territories to distributors:

Independent distributors of soda can free ride on the brand name of the company manufacturing soda.Two solutions to this problem are:

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